When Does a Trademark License Turn into a Franchise?

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When entering into a trademark license agreement most trademark owners do not consider the possibility that their agreement actually may be a franchise, which would subject them to specific disclosure requirements and a number of relationship responsibilities not normally present in a trademark license.    

Recently, the owner of a restaurant concept entered into what it thought was a routine trademark license agreement with a licensee to operate a “Rooh” branded Indian restaurant in Chicago. To its surprise and dismay, after filing suit in U.S. federal district court in San Francisco to enforce certain terms of the license agreement, the licensor, Good Times Restaurants, found itself entangled in the California Franchise Investment Law (CFIL) when the licensee asserted claims against the licensor under the CFIL and other state franchise laws. 

In the recent case of Good Times Restaurants, LLC v. Shindig Hospitality Group, the licensee, Shindig Hospitality, filed a counter claim alleging fraud and misrepresentation, which the licensor sought to dismiss. In its motion to dismiss, the licensor argued that the grant of the right to open a restaurant using the “Rooh” trademark and business concept did not meet the definition of franchise under the CFIL or any other franchise laws claimed by the licensee to be violated.

Unfortunately for the licensor, the court disagreed, and ruled that there were enough facts to satisfy the four elements of the definition of franchise under the CFIL. By that definition, a franchise is an agreement that:

  • Associates the franchisee’s business with the franchisor’s trademark;
  • Grants the franchisee the right to engage in the business of offering, selling or distributing goods or services;
  • Requires the franchisees to pay, directly or indirectly a franchise fee; and
  • Prescribes in substantial part a marketing plan or system. 

The California statute does not differ materially from the Federal Trade Commission Franchise Rule that governs the sale of franchises on the national level. The FTC Franchise Rule defines a franchise to be where (i) the franchisee sells goods or services that are associated with the franchisor’s trademark, (ii) the franchisor exercises significant control, or gives franchisee significant assistance in the franchisee’s operation of the business, and (iii) the franchisee pays a fee to the franchisor as a condition of obtaining or commencing business. Historically, both the FTC Franchise Rule and the California statute have been broadly applied.

In this case, the licensor claimed that not all of the franchise elements were present in its relationship with the trademark licensee. Specifically, it argued that that the license fee was not for the right to enter into a business, but was for the right to use the Rooh trademark; that the agreement as a whole did not grant the licensee the right to enter into a business; the franchise fee requirement was not met because the licensee never paid it; the agreement did not prescribe a marketing plan; and that, because the agreement was titled a “Consulting and License Agreement,” it was not covered by the franchise definition. 

The court was not persuaded by the licensor’s arguments and found that (i) the fee to be paid by the licensee gave it the right to enter into the business; (ii) the licensee was given the right to open the restaurant (whether or not it actually did so); (iiI) whether or not the licensee paid the required license fee was immaterial (the fact that the fee was required was enough to satisfy the definition); (iv) the significant control or assistance requirement was satisfied by the suggested advertising and sales program; and (v) the title of the agreement was immaterial given that “the title is not an element of the franchise definition” and “[i]f it were[,] franchisor’s could ignore the CFIL definition by simply labeling their agreement in a particular way.”

The court also rejected the licensor’s argument that claims brought under Illinois’s franchise act should also be dismissed. In response to that argument, the court noted that, like the California law, Illinois’s franchise law embraced the FTC Franchise Rule franchise definition. Specifically, it noted that “other franchise related claims all use similar definitions of what constitutes a franchise.”

The court’s decision on the motion reminds us that, when contemplating entering into a trademark license agreement, a licensor should be particularly careful in how it structures its relationship with the licensee in order to avoid the franchise tripwires, which are not always obvious. While a licensor has the right to receive a fee for the grant of trademark rights, and to control how a licensee uses that mark, those rights can easily collide with the franchising model. The definitional prong that trips up the majority of trademark owners who unknowingly find themselves to be franchisors is the significant control or assistance requirement. A trademark licensor whose license agreement contains mandatory advertising or operational requirements, or provides a licensee with operational assistance or marketing recommendations, risks its relationship becoming a franchise thus exposing it to an entire bundle of regulations, obligations, and possible liabilities.