Growth Strategies

A Fran-What?!

Surprise! You may be involved in a franchise relationship and not even know it.
Magazine Contributor
3 min read

This story appears in the March 2003 issue of Entrepreneur. Subscribe »

If you entered into a franchise agreement, you'd know it, right? Not necessarily. In several recent cases, companies terminating distributor relationships were surprised to learn that the law considered them franchisors, subject to state franchise laws.

"Most people, including lawyers, think a franchise is McDonald's or Ramada Inn," says Edward Dunham, a partner in the New Haven, Connecticut, law office of Wiggin & Dana who specializes in franchises. But legislatures designed franchise laws to protect a wide range of small businesses that depend on their relationships with particular companies.

State franchise laws address disclosure required at the beginning of the relationship and steps required at termination, including acceptable grounds, how much notice is required, and whether the "franchisee" must be offered a chance to fix the problem.

So what's a franchise? In the typical three-pronged definition, a franchise is when one business operates in close relationship to the other's trademark, is required to follow a certain marketing plan and must pay a franchise fee.

"Most manufacturers think as long as they don't charge a franchise fee, it's not a franchise," Dunham says. But in several recent cases, courts have interpreted other payments as indirect franchise fees, including required payments to a spa manufacturer's co-op advertising fund, and the cost of required dedicated phone lines and electronic databases.

In one case, Mitsubishi's U.S. division for Caterpillar forklifts informed a Chicago dealer it would be terminating the relationship. The dealer sued for violation of Illinois' franchise laws. The U.S. Court of Appeals for the Seventh Circuit upheld a lower court's ruling that the relationship counted as a franchise. The court pointed to $1,600 the dealer had spent on required manuals over nine years, and awarded $1.5 million in damages.

If your business markets products or services through dealers or distributors, be sure you know the franchise laws in the areas you do business. "You can either recognize that it feels like a franchise and embrace it," Dunham says, "or you can structure the relationship to avoid being one." Even then, he advises, it's best to follow the franchise laws when you terminate a dealership.

If your business distributes products or services for another company, you might have significant leverage should trouble develop. "Inform yourself of the law so you know your rights," Dunham advises. "Know as much as the supplier does about relevant laws."

Steven C. Bahls, dean of Capital University Law School in Columbus, Ohio, teaches entrepreneurship law. Freelance writer Jane Easter Bahls specializes in business and legal topics.

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