Beware The Hidden Franchise

Beware The Hidden Franchise

Have you entered into a partnership with others who are investing their time and money in your business, e.g. someone who sells your products or services in return for a fee or investment?  If so, you may be operating a hidden or “accidental franchise,” which means you are guilty of operating a franchise without following the FTC’s franchise disclosure rules. Violating these rules could cause you to lose your business and you could be subject to criminal felony charges.

Have you Inadvertently Entered into an Accidental Franchise?

If your business is publicly affiliated with another business, you may have entered into a de facto franchise license. So, when this marketing affiliation or joint venture was formed, the framework for a franchise was built, whether you realized it or not.

The FTC’s “Disclosure Requirements and Prohibitions Concerning Franchising” says that a business relationship is considered a franchise when it contains all of the following three elements:

  • The franchisee is granted the rights to conduct business using the franchisor’s trademark, or sell, offer, or distribute goods or services that bear or are associated with the franchisor’s trademark;
  • The franchisee must pay or agree to pay the franchisor (or an affiliate) a designated fee within the first six months of operation;
  • The franchisor can control or assist the franchisee in the operation of the business.  (The level of control can be as minimal as providing a training manual or operations guide.)

The fact that the two parties involved in the relationship do not consider it to be a franchise is immaterial to the determination of whether or not the relationship is a franchise in the legal sense.

Franchise Laws

Franchises are governed by the FTC and many states have laws that regulate franchises as well.  The FTC’s franchise rules require that the franchisor supply the purchasing franchisee with a Franchise Disclosure Document (FDD) no less than ten (10) days prior to signing the Franchise Agreement. Once that federally-regulated ten (10) day period has passed, the Franchise Agreement, which is a legal, binding contract, is handled by each state and their unique franchise-related laws.

Texas does not require a franchisor to register its FDD however prior to selling a franchise in the state, however franchisors must file for exemption under the Texas Business Opportunity Law.

What Entering into an Accidental Franchise Can Mean to Your Company

If it’s determined that you’ve franchised your company inadvertently, you will be subject to FTC enforcement proceedings which may include fines, cancellation of agreements with and restitution payed to aggrieved franchisees.  The FTC also may choose to seek permanent injunctions against your business for violations of The Franchise Rule.

If you’re thinking about expanding your business with a licensing agreement or wonder whether a commercial transaction you’ve made is an accidental franchise, your first order of business should be contacting an experienced business law attorney. The attorneys at Bennett Weston LaJone & Turner, P.C. can help you navigate the landscape regarding franchise agreements.

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