What images come to mind when you hear the word “franchise”?  Probably a fast food place.  But many businesses are franchises.  When someone creates a successful business, one way to profit from it is to sell the right to use the formula for success by franchising the business.  The person that sells this right is called a franchisor.

The purchase of a franchise can be quite risky.  That is why there are federal and state laws designed to protect franchisees.

A problem can arise when a business creates a relationship that looks like a franchise without complying with the franchise laws.  Whether a relationship is called a franchise or not, if it meets the definition of a franchise, the various rules governing franchises must be followed.

In California, a franchise will be considered to exist when the following four elements are present in a business agreement:

1. The agreement grants the right to a franchisee to engage in the business of offering, selling, or distributing goods or services;
2. The agreement prescribes a marketing plan or system that must be used by the franchisee;
3. The agreement grants the right to the franchisee to use a trademark, logo, or other commercial symbol as a substantial part of the franchisee’s business; and
4. The agreement requires the franchisee to pay a fee for the right to engage in the business.

So, if, for example, a business owner enters into an agreement with a distributor to sell a trademarked product using a particular marketing method and the distributor is required to purchase a particular display case, this agreement could be deemed a franchise.

In California, the following types of payments have been deemed a franchise fee:

• Initial set up fee
• Advertising fee
• Training fee
• Charges for sales kits, brochures, programs, forms, decals, shirts, displays, and announcements
• Consulting fees.

Any kind of business relationship that involves the licensing of a trademark could potentially be found to be a franchise.  It is important to structure agreements to prevent the creation of a franchise or, if that is impossible, to comply with applicable franchise law.

For more details on what constitutes a franchise in California, see the California Department of Corporations Commissioner’s Release on the topic.

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