Many people confuse a trademark license and a franchise. Even attorneys who are not experienced in the niche area of franchise law may find it confusing to differentiate between a trademark license and a franchise. Hopefully this article will help to clarify the difference.
To be a pure trademark license and not be a franchise is very difficult. The license agreement must be carefully drafted to ensure that the control over the licensee’s business is limited. Licensor may exercise control over the use of the trademark, but not over the licensee’s business. The Lanham Act, which governs trademark law, requires that a trademark owner carefully control the use of the trademark and police other’s use of it or possibly forfeit rights to the mark. Crafting a license agreement that exercises sufficient control over the trademark but does not step into the franchise realm is very difficult. Regardless of what the agreement is labeled, if the drafter lacks knowledge of franchise law, it may be a franchise if extreme caution is not exercised. For example, a licensor may want to charge royalties on the sales that the licensee makes using the licensed mark and then see financial records of the licensee. Is the requirement to provide monthly financial reports to the licensor sufficient control over the licensee’s business to qualify it as a franchise? What if the licensor demands samples and pre-approval of the literature on which the trademark appears – is that sufficient control to make it a franchise? What if the licensor requires that the colors used in the business match the colors in the trademark or logo? Unfortunately, there are no black and white answers to these questions. Franchise law is littered with cases trying to define the level of control that makes a license arrangement a franchise.
As mentioned above, a franchise consists of three criteria under the federal law – a trademark that is licensed to a third party, a fee of greater than $500 paid by the licensee to the licensor in the first six months for almost any product or service and control that the licensor exercises over the licensee’s business. The problem is that there is no clear-cut definition of the level of control that the licensor can exercise over a licensee and not be a franchise. If the relationship is one of a franchise, then the licensor/franchisor must comply with federal law (and state franchise laws if applicable) and provide a Franchise Disclosure Document (FDD) to a prospective licensee/franchisee. The FDD is a very complex document and takes a great deal of time to prepare. Certain states require that this document be registered with the state before a licensor/franchisor can sell in their state. Some of those states require that the licensor/franchisor provide audited financial statements in the FDD even if they have just started selling franchises. Franchising is a costly method of expanding a business, but one that usually reaps the rewards in the future. However, a licensor’s failure to abide by franchise law and sell franchises without the proper documentation can result in huge federal and state fines and penalties. CONCLUSION Anyone looking to license his or her trademark or logo must be careful not to exercise too much control or the relationship will be considered a franchise. The difference between a pure trademark license and a franchise is a very grey area and one that a franchise attorney best understands.