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Legal Issues
Feb 19, 2019

When is a Trademark License a Franchise Agreement?

Sponsored Content provided by Russell Nugent - Attorney, The Humphries Law Firm

Companies with successful brands can expand the reach of those brands by allowing other companies to produce goods and services under the trademark owner’s brand.

Other companies may want to secure the services of manufacturers and distributors that will apply the trademark owner’s trademark to products, then sell and distribute them. 

Still other companies may simply need a manufacturer to produce goods for sale by the trademark owner.

All these activities describe licensing arrangements. Trademark licensing is the way a trademark owner gives another permission to make and use their trademark.  

However, anytime a trademark is licensed, the owner needs to be careful not to trigger disclosure requirements issued by the Federal Trade Commission (FTC) meant to regulate the offering of franchises. These disclosure requirements are quite extensive and there are fines for failing to provide them to the prospective licensee. 

So, how does a trademark owner license their trademark without triggering these regulations?    

The FTC defines a franchise as a commercial arrangement that involves the following three requirements: (1) a promise to provide a trademark or other commercial symbol; (2) a promise to provide significant control or assistance in the operation of a business; and (3) a required minimum payment of $500 in the first six months of operations. 

Since a trademark license necessarily involves giving someone permission to use a trademark and will almost always involve a payment of more than $500, the difference between triggering and not triggering the FTC rules comes down to how much control or assistance the trademark owner offers to provide the licensee.

Trademark law requires the owner of a trademark to police and control the use of their mark, as well as the quality of the goods and services offered under the trademark. Should an owner fail to monitor and exert control over who uses their mark and/or the quality of the goods or services provided under the mark, then courts may conclude the owner has abandoned their rights in the trademark and the trademark registration becomes subject to cancellation. 

As a result, every trademark license needs to have provisions that allow the trademark owner to supervise some aspects of the use of their trademark. However, the more control that a trademark owner exerts over the licensee, the more likely the trademark owner is to trigger the FTC’s franchisor disclosure obligations. 

So, how much control can a trademark owner exert and still avoid creating a franchise? First, a franchise agreement involves the trademark owner exercising a significant degree of control or providing significant assistance over the franchisee’s method of operation. 

Significant control or assistance is more likely to be the case when the franchisee is relatively inexperienced in the type of business at issue, when they take a large financial risk and/or when the control or assistance offered is unique to that business rather than being generally known and practiced in the industry. In addition, the control or assistance must involve the franchisee’s overall method of operation, not just a small part of the franchisee’s business.

The FTC considers the following requirements to be examples of “significant control or assistance”:

  • Approval or selection of the site at which an unestablished business will be located
  • Approval of the design or appearance of the location
  • Specific hours of operation
  • Production techniques
  • Accounting practices or systems
  • Personal policies
  • Restrictions on which customers can be served
  • Training programs
  • Management, marketing or personnel advice
  • Providing system-wide networks or websites
  • Inventory controls
  • Providing a detailed operating manual
  • Required displays of goods
  • Required services or repairs (except warranty work)
  • On-the-job assistance with sales or repairs
  • Promotional campaign participation
  • Specified areas of operation
The FTC regulations contain a handful of exemptions.  For example, if the franchisee has two or more years of experience in a competitive business and anticipates that the revenue from selling the trademark owner’s goods will account for less than 20 percent of the franchisee’s total sales, then the FTC rules do not apply. They do not apply, either, to investors that invest at least $1,143,100, excluding the cost of unimproved land and any financing from the trademark owner or entities worth more than $5,715,000 and who have been in business for five or more years.
These exemptions generally apply to larger investors that have more resources to investigate a business relationship and are considered in need of less federal protection.

In addition, there are also a number of relationships that may share some similarity with franchisor/franchisee relationships but are not covered by the regulations. For example, the rules do not apply when the trademark owner leases space in a larger retailer’s store to sell their own products. The regulations do not apply if the entity buying the licensee is the officer or director of the franchisor. 

Employee/employer relationships also do not fall under the FTC’s rules, nor does a trademark owner have to comply with these regulations if they offer a license to a single manufacturer. A complete list of the exemptions and exceptions is beyond the scope of this article. 

Licensing a trademark to another can help a trademark owner expand their revenue if done properly. If not done properly, an attempt to give a third party the right to use a trademark can lead to federal fines, litigation and the loss of trademark rights.

Trademark owners would do well to consult a qualified professional before engaging in a commercial transaction giving a third party the right to use their brand.

Russell is a native of Wilmington, N.C. and has been practicing law in Eastern N.C. since 2004. Prior to that, he worked in Chapel Hill and Durham as a research technician on teams exploring RNA-based gene therapies, viral fusion inhibitors, and the role Galactocerebroside plays in protein localization near nodes of Ranvier. After passing the patent bar in 2003 and becoming a registered patent agent, Russell received his law degree from Georgetown in 2004. He began his legal career representing clients in personal injury matters but later left personal injury to provide patent prosecution services to law firms in China and Taiwan prior to joining The Humphries Law Firm in 2014. Russell helps individuals and businesses protect their innovations, creations and business information using strategies based in patent, trademark, copyright and trade secret law. His work includes both strategic planning and dispute resolution. He assists clients who want to buy and sell businesses, and license or transfer their intellectual property assets. Russell also assists with the firm’s litigation practice, particularly in insurance and employment disputes.

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