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  • Writer's pictureJoe Dye Culik

What is a Franchise and Why it is Different?

A franchise is one of the most popular types of business in the U.S. because it provides an entrepreneur with a ready-to-go business format. The operations, policies, marketing, and just about anything else you can think of has already been thought of and created by the franchisor (the company selling the franchise) to the franchisee (the person buying the franchised business). It is often a tried-and-tested business model that brings with it much more certainty of success.

Just because an entrepreneur purchases the right to use a certain business name, however, doesn't mean that the business is automatically a "franchise." It might instead be a licensing agreement, or even some other type of relationship.

There are three specific requirements that must be met for a business to be a franchise. This article explains what they are.

The definition of a "franchise" is provided by the Federal Trade Commission, or FTC. The FTC is the federal agency charged with preventing unfair, deceptive, or fraudulent commercial activity. Because of the power that franchisors often have over franchisees, the FTC's regulations govern the franchise relationship. Some states also have their own laws about franchising.

The full definition of "franchise" is provided in the FTC's Franchise Rule, published in the Code of Federal Regulations at 16 C.F.R. 436.1(h).

The full definition states as follows:

"Franchise" means any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:

  1. The franchisee will obtain the right to operate a business that is identified or associated with the franchisor's trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark;

  2. The franchisor will exert or has authority to exert a significant degree of control over the franchisee's method of operation, or provide significant assistance in the franchisee's method of operation; and

  3. As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.

What exactly does all this mean? These are the three criteria that must be met for a business relationship to constitute a franchise. If any one criterion is not present, it is not a franchise and is not subject to the FTC's franchise regulations.

In layman's terms, the three criteria for a franchise are:

  1. Use of a franchisor’s trademark.

  2. Significant control over or, assistance with, the franchisee's operations.

  3. Payment by the franchisee to the franchisor.

In short, if someone charges for the use of their business name and business methods, it's probably a franchise.

This just scratches the surface, though. There are many nuances and even some exceptions to this definition that should be reviewed with qualified legal counsel in making a correct determination.

Why does it matter if a business relationship meets the definition of a franchise? There are many legal requirements associated with the franchise relationship. For instance, the Franchise Rule published in the Federal Register contains 133 pages of regulations. The FTC’s Franchise Compliance Guide is another 154 pages. And these barely scratch the surface -- there are countless other franchise requirements, and thousands of published court decisions that elaborate on franchise law.

Violation of the Franchise Rule subjects a franchisor to legal action by the government. Violation of the Franchise Rule also counts as an automatic violation of the North Carolina Unfair and Deceptive Trade Practices Act, and could thus make a franchisor liable under both state and federal law. The remedies available for such a violation are broad and include monetary damages, equitable relief, and even rescission of the franchise agreement itself.

As you can see, it is important to understand what type of relationship meets the legal definition of a franchise. The ramifications can be significant.

DYE CULIK PC is a Charlotte, North Carolina business law firm that represents franchisees, entrepreneurs, and businesses throughout North Carolina. If you have a business law issue, contact us at 980-999-3557 to see how we can help your business thrive.

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