Wednesday, March 17, 2010

I sell brand name equipment for resale and enter consulting contracts to promote same. How do I avoid being deemed a franchisor in California?

Under California Law (Corporations Code §31005), a franchise means, a contract or agreement, either expressed or implied, whether oral or written, between two or more persons by which: (1) a franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor; and (2) the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the franchisor or its affiliate; and (3) the franchisee is required to pay, directly or indirectly, a franchise fee.

The California franchise law requires any offer or sale of a franchise to be registered with the Commissioner of Corporations on a detailed “Uniform Franchise Registration Application”. Certain offers and sales, however, are exempt from this requirement, if the franchisor meets minimum requirements for net worth, experience, and disclosure and has filed a notice of exemption with the Commissioner.

If registration is required, and the application is approved, the registration is valid for one year. The registration may be renewed for additional periods of one year each. The fee for filing an application for registration of a franchise offer is currently $675; the fee for renewal is $450. The fee for filing an initial notice of exemption is $450; the fee for each subsequent notice is $150. The government, or disgruntled buyers of yours, may obtain fines, rescission or reformation of the transaction, payment of refunds and damages, and/or a cease and desist order.

You can mitigate the risk of “franchising” in California by eliminating one of the three requirements first described above. The third requirement is compensation. Since getting paid is the primary reason for the transaction in the first place, this requirement cannot be eliminated.

So, there are only two further requirements that may be eliminated: (1) reducing your control to an insubstantial level over the operations and marketing of the business product or services sold or (2) licensing or selling a common trade name, trademark, or logo. Initially, you should decide whether a buyer of your business is more interested in (1) obtaining assistance in marketing the business, or (2) branding. “Branding” occurs if you license or sell to the buyer the right to use your trade name, trademark, and/or logo as the name of the buyer’s newly-acquired business and/or products and services.

If you eliminate the licensing of these branding rights, then the effect may be to eliminate this requirement of franchising, which becomes even more effective where you do not permit the buyer to use your trade name, trademark, and/or logo as the name of buyer’s business or in a substantive or primary way.

Where selling products or services can be done without branding, then allowing the buyer to operate under its own name may be the avenue to take, because you can then exert more controls on operations and marketing that assist the buyer in successfully selling your products or services. However, your control cannot reach the status of “substantial” controls.

You cannot tell the buyer substantially or explicitly how to operate (known as “design specifications”), but you can describe what generally needs to happen (known as a “performance specifications”). To the extent the buyer can do its licensed business in the manner that it chooses, it will not be deemed a franchisee. To the extent there is substantial control, the buyer may be deemed a franchisee, making you a franchisor that has not complied with the franchise laws.

An experienced business lawyer will work with you to tailor the transaction documents as much as feasibly possible away from a franchise structure. He or she would attempt to reduce either the transfer of intellectual property or your control over the business as a result of the transaction as much as possible. There is no guarantee, however, that your buyer, if unsuccessful in the business purchased from you, will not attempt to take advantage of the California franchise law remedies described above. As usual, success prevents disputes.

Important Proviso: The above material does not constitute legal advice and should not be relied on. It does not create an attorney-client relationship. Each locality has differing laws. A legal matter cannot be satisfactorily resolved without a comprehensive review and analysis of all the unique facts and laws at issue by an able attorney. Your matter may result in a loss of rights if you do not timely retain such an attorney.

Contact: If you would like to discuss this matter further in a more private forum, please feel free to contact me directly at the email address provided through my firm’s website located at

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