A successful business may want to increase growth through franchising. This type of expansion has some real advantages, especially in Texas where economic activity has outpaced most other states in the last several years. Ideally, the franchise business model is a symbiotic relationship in which everyone benefits. In a franchise relationship, the franchisor allows the franchisee to operate a proven business model and marketing plan and licenses the use of certain trademarks and other intellectual property. In return, the franchisee agrees to the franchisor’s terms about operating the business and usually pays a royalty based on a percent of sales.
The Federal Trade Commission defines a franchise as “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.” 16 CFR § 436.1
Whether the relationship is labeled as a franchisor and franchisee, trademark holder and licensee, or some other term, a business arrangement that includes all three of these terms is classified by the FTC as a franchise. 13 CFR 121.301(f)(5); See Shah v. Racetrac Petroleum Co., 338 F.3d 557, 573 (6th Cir. 2003).
Business Opportunity vs. Franchise Law
While a franchise must follow federal guidelines, state guidelines may vary. Texas, for example, does not register franchises. Instead, it has passed business opportunity laws, and a franchise is governed by these laws in Texas as well as federal laws and regulations. A franchisor operating in Texas that has complied with all federal franchise laws and regulations is exempt from filing under the Texas Business Opportunity Act. Tex. Bus. & Com. Code Ann. § 51.001 (West). However, the franchisor still must file a notice of exemption with the Secretary of State. The overlap between federal and state law concerning franchises and business opportunities is extremely complex and beyond the scope of this article.
Common Clauses in a Franchise Agreement
While franchise agreements may vary depending on the business arrangement, they often include the following:
- Territory – which defines the specific geographic area of the agreement
- Grant of License and Franchisee’s Undertaking – which includes the following subtopics:
- Grant of License – in which the franchisor grants the franchisee the right to use specific processes, knowledge, expertise, and trademarks which belong to the franchisor. The agreement is generally exclusive, meaning it does not permit subfranchises.
- Franchisee’s Undertaking – in which the franchisee agrees to conform to the franchisor’s expectations for business policies and procedures outlined in the agreement.
- Franchisor’s Duties – in which the franchisor agrees to provide training and support developed by the franchisor in order to help the franchise be as successful as possible.
- Devotion of Time to Business – in which the franchisee agrees to devote a reasonable amount of time and effort toward the franchise in order to make the franchise a success. This section also usually specifies the number of hours per day and the number of days per week that the franchisee is expected to work at the franchise.
- Quality Standards – in which the franchisee agrees to meet the required specifications and standards of the product when marketing and selling the product. The product will be uniform and aligned with the expectations of the franchisors.
- Use and License of Trademarks – in which the franchisee agrees that the license is nonexclusive, that the franchisor may grant licenses to others as he or she chooses.
While templates for franchising agreements are available on-line, they do not address the complexities regarding both state and federal guidelines, nor do they address the unique needs of each business arrangement. Working with an experienced attorney who fully understands all aspects of state and national franchise agreements is always a smart business move.
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