Too often, expansion-minded business owners opt for a strategy offering trademarked products or services through licensing arrangements or distribution or dealership systems only to discover, well into the game, that what they have really done is turn themselves into franchisors—“accidental franchisors,” maybe, but franchisors nonetheless.

This is good news for the entrepreneur who runs a sophisticated business operation capable of meeting the many punctilios of California franchise law. It is bad news for the entrepreneur who doesn’t. In fact, it can spell disaster for the unwitting entrepreneur who steps over the fine line that separates franchising from other commercial arrangements involving trademarked goods or services.

1. California law defines a franchisor as one who offers, sells, or distributes trademarked goods or services through one or more “substantially associated” business enterprises following a marketing plan “prescribed in substantial part” by the franchisor in exchange for fees collected directly or indirectly from the associated business enterprises. The second of these phrases is self-explanatory. But what does “substantially associated” mean? The test is simple. If a business enterprise uses the trademark of another company to identify its business, it is “substantially associated” with it under the eyes of the law.

But there is more to the story.  A business also may be a franchisor if it allows another business to use its trademark and it also:

  • Provides the other business with advice and training as to the sale of its products or services,
  • Exercises significant control over the conduct of the other business,
  • Grants the other business exclusive rights to sell its products or services in specific territories, or
  • Requires that the other business purchase or sell specific quantities of its products or services.

Unfortunately, expansion-minded entrepreneurs may seek to institute one or another of these practices when negotiating licensing or distributorship or dealership arrangements with other companies. This makes it crucial for attorneys involved in setting up any such arrangements to determine whether the practices push the relationship between the companies into the realm of the franchisor and franchisee.

See next week’s blog when I discuss additional potential pitfalls.


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