Are You a Secret Franchisor? - Franchise Relationships

When confronted with franchising vs. licensing, an increasing number of companies are attempting to expand using what is essentially a franchise business model, but calling it a "license." It?s a sign of our troubled economic times and the reasoning goes something like this. "If you call it a 'license,' you won't have to prepare a FDD Franchise Disclosure Document with audited financial statements and register with various regulatory agencies.

Franchising is expensive; licensing is inexpensive." It sounds good - almost too good to be true. Not surprisingly, it is too good to be true. The list of elements required to fall into the franchise box is very short and the overwhelming majority of license agreements that allow someone to operate a business turn out to be disguised illegal franchises with significant legal ramifications and risk.

Components of The Franchise vs. License Dilemma

If you help someone get into business (allowing them to use your business brand/mark) this transaction will normally be a regulated activity, subject to substantial penalties for noncompliance. If it looks like a duck and walks like a duck, it's a duck. This guiding legal duck principle (and common sense) answers most franchise vs. license questions. It doesn't matter what terms are used by the parties in contracts or other documents to describe their relationship.

For example, the contract may call the relationship a license, a distributorship, a joint venture, a dealership, independent contractors, consulting, etc., or the parties may form a partnership or a corporation. This is entirely irrelevant in the eyes of governmental regulators and the courts. Their focus is not on semantics, like what the contract is called, but whether a small number of defining elements are present or not.

A 2011-2012 Evolving Case Involving Franchising vs. Licensing

According to the company?s website, Window World is America's largest replacement window company with almost 186 offices in 45 states and still growing. Unfortunately, Window World sold these as "license agreements" without complying with franchise registration and disclosure laws. As discussed below, Window World is being shattered, coast-to-coast.

In November, 2011 the Illinois Attorney General brought an action against the company for violating the Illinois Franchise Disclosure and Registration law, resulting in a Final Judgment and Consent Decree on November 29, 2011 where Window World admitted selling illegal franchises to at least 14 "licensees" in Illinois.

That same day, on the opposite coast, the California Department of Corporations issued a Desist and Refrain Order against Window World based on failure to comply with California's Franchise Investment Law.

Jumping on the bandwagon, on January 29, 2012, a licensee filed suit against Window World for violating the Illinois Franchise Disclosure Act, seeking rescission, damages, attorneys' fees and court costs. For the attorneys representing the licensee, it's like shooting fish in a barrel. The Attorney General's action establishes liability, so the only question for the licensee?s attorneys is how high can their damage claim go? Just the attorneys? fees alone can be $200k to $500k these days, then add damages on top of this and it?s a big number for Window World to pay this licensee.

What the final financial hit to Window World will amount to after other states and "licensees" jump on the bandwagon is impossible to estimate, but it could easily be in the millions. And all this done in a vain attempt to skirt the franchise laws and save initial franchise compliance costs of $30k or so.

How Companies End Up In A Franchise vs. License Dilemma

In many cases, companies get themselves into this mess by listening to statements found on the Internet that franchising is expensive and licensing inexpensive. Just call the contract a ?license? instead of a ?franchise,? and don?t worry about all the legal red tape of franchising.

Try telling all that to Window World now. Again, if something sound's too good to be true, it usually is and this should be a big flashing red light. If it was really that easy, everyone would have done it that way. The 3,000-plus companies that are franchising may be a lot of things, but they're not stupid. Many can afford the very best legal talent available. It's not a coincidence they're all franchising and not licensing.

This has been a guest post by Kevin B. Murphy, Mr. Franchise, who is a franchise attorney and franchise expert based in San Francisco with a 30-year practice devoted exclusively to franchise law. Since 1993, Mr. Murphy has also been an Approved MCLE (Minimum Continuing Legal Education) Provider by the State Bar of California, teaching franchise law, franchising vs. licensing (franchise vs. license), and intellectual property courses to California attorneys. In 2002 -2003 he started, operated and sold a very successful franchise. Mr. Franchise holds degrees in business administration and law from the University of San Francisco and an MBA from San Francisco State University. He is the author of over 50 franchise publications, including 4 books on franchising and one book on trade secrets.

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