In recent blogs, I’ve talked about three critical facts to know about franchise law.  Here are the final two of which to be aware.

4. The state exercises little or no oversight over licensing, distributorship, or dealership arrangements; however, it exercises a great deal of oversight over franchisors and franchisees. In my last two blogs, I’ve discussed three critical facts to know about franchise law.  Here are the final two of which to be aware. It is precisely because the state does so that attorneys must make sure their expansion-minded client companies do not step over the line into franchising inadvertently. If that happens, companies must take on burdens not imposed on firms entering into licensing, distributorship, or dealership arrangements. Among other things, franchisors must:

  • File franchise disclosure documents with the Department of Corporations outlining the franchising opportunity in detail along with the franchisor’s own background and business experience, among other matters, before entering into any discussions with potential franchisees, and
  • Obtain Department of Corporations approval for any “material modifications” they want to make to existing franchise agreements before presenting them to franchisees, including any new or modified provisions regarding royalties, fees, Internet commerce, and territory rights.

5. The Department of Corporations closely polices franchisor-franchisee arrangements, and it has authority to assess penalties of $2500 per violation on companies operating in violation of the many details of franchise law. Even here, however, there is more to the story. Suppose that a company enters into arrangements with half a dozen other companies involving trademarked products or services, unaware that the details of the arrangements establish franchisor-franchisee relationships. At some point, the first company discovers its error but, having profited by the arrangements, decides that it really wants to be a franchisor after all.

Before it can square things with the Department of Corporations, it must give its half dozen inadvertent franchisees the right to rescind the original arrangement and get their money back—meaning not only their original investment but also any losses they may have incurred less any profits. This can prove painful, even ruinous to the inadvertent franchisor.

Clearly, the better idea is to avoid the pain. Franchising is a complex business, and although it can prove a highly effective expansion strategy, entrepreneurs must know beforehand whether the arrangements they enter into with other firms do or do not constitute franchisor-franchisee agreements—and if so, of course, whether this is what the parties want.


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