THE UNWITTING FRANCHISOR – PART 2

The key is often the independence of the businesses entering into the arrangement – or the lack thereof. The relationship between a franchisor and franchisee is dependent; the franchisee not only sells or distributes the franchisor’s goods or services but also depends on the franchisor for advice and training, for advertising and marketing assistance, and for exclusive-territory rights. Last but not least, in some cases it depends on the franchisor to supply the goods or services it sells.

By way of contrast, licensing, dealership or distributorship arrangements involve independent business enterprises, however difficult it may be to make the distinction. Thus if you want to license your goods or services, make your deal with a business operating under its own trade name that will sell them in exchange for a percentage of the proceeds, with minimal involvement by you. If you want a dealership or distributorship arrangement, make your deal once again with a business operating under its own name that will buy your goods or services at wholesale prices for resale, also with minimal involvement by you. While you may not be a franchisor under these arrangements, you lose the opportunity to expand your brand by having multiple units operating under your trademark.

 What dangers await the unwitting franchisor? In California, police power over franchise operations rests with the state Department of Corporations, which, however, focuses its efforts primarily on fraud artists who try to sell bogus franchises to an unsuspecting public and keeps no data on its enforcement efforts regarding businesses that step over the line in all innocence.

 Even so, state law permits the department to assess penalties at $2500 per violation of franchise law, and that might prove painful enough if the danger ended there – which it doesn’t.

 Suppose you enter into five agreements with other businesses involving your trademarked goods or services, not knowing them to be franchise arrangements. You discover your error later on and at some point decide that you really do want to franchise your business. Before the Department of Corporations will let you do so, it will require that you atone for the wrongs done your original five “franchisees” by offering all of them the right to rescind the arrangement and get all their money back. Because this can mean returning not only their original investment but also any losses they may have suffered in the meantime, less any profits, it can prove painful indeed. In fact, it can wreck your plans altogether.

 These dangers aside, it’s a good idea to think twice before you set up a franchising operation in any case, even if that’s what you have in mind, since franchisors must observe many punctilios of state law that do not apply to licensing arrangements, distributorships, and most other commercial relationships.

 For example, franchisors must file franchise disclosure documents with the Department of Corporations before even discussing the opportunity with potential franchisees. Ongoing franchisors must get department approval for any “material modifications” they want to make to existing agreements before presenting them to franchisees. These include new or modified provisions covering royalties or fees, internet commerce, territory rights, and a host of other matters covered in franchise agreements.

 Franchising, in short, is a complicated business. It can prove highly profitable and, for companies intent on growing, a fruitful expansion strategy. But you must keep your eyes open.

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