Chapter 40
Franchises and Special Forms of
Business
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Franchising is an important
method of distributing goods
and services to the public.
In the United States,
franchising accounts for over
25 percent of retail sales and
15 percent of gross domestic
product (GDP).
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Franchise
• Established when franchisor
licenses franchisee to use the
franchisor’s trade name,
trademarks, commercial symbols,
patents, copyrights, and other
property in the distribution and
selling of goods and services.
• Franchisor and the franchisee are
usually established as separate
corporations.
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Advantages to Franchising
1.
2.
3.
4.
The franchisor can reach
lucrative new markets.
The franchisee has access to the
franchisor’s knowledge and
resources.
Franchisee runs an independent
business.
Consumers are assured of
uniform product quality.
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Parties to a Typical Franchise
Agreement
Franchisor
(Licensor)
Grant of franchise and
license to use trademarks,
service marks, and trade
secrets
Franchisee
(Licensee)
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Distributorship Franchise
• Franchisor manufactures a
product and licenses a retail
franchisee to distribute the
product to the public.
– Manufacture of automobiles
and franchises independently
owned dealers to sell them to
the public.
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Processing Plant Franchise
• Franchisor provides a secret
formula or process to the
franchisee.
• Franchisee manufactures the
product and distributes it to
retail dealers.
– Regional bottling companies to
manufacture and distribute soft
drinks under the “_ _ _ Cola”
brand name.
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Chain-style Franchise
• Franchisor licenses the
franchisee to make and sell
its products or distribute
services to the public from a
retail outlet serving an
exclusive territory.
– Franchises independently
owned restaurant franchises to
make and sell pizzas to the
public under the “Pizza _ _ _ _”
name.
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Area Franchises
• Franchisee may be granted
the authority to negotiate
and sell franchises in the
designated area on behalf of
the franchisor.
– Franchisee is also called
the subfranchisor.
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Example of an Area Franchise
Area
Franchise
Franchisor
Subfranchisor
Franchise
Franchise
Franchisee
Franchisee
Franchisee
Franchise
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State Disclosure Laws
• Many states have enacted
statutes that require franchisors to
make specific presale disclosures
to prospective franchisee.
• Most states use a uniform
disclosure statement called the
Uniform Franchise Offering Circular
(UFOC).
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FTC Franchise Rule
• The FTC requires franchisors to
make presale disclosures to
prospective franchisees.
• The franchisor must disclose
assumptions underlying any
estimates and hypothetical data.
• If projections are based on actual
data, franchisor must disclose
specifics.
• The franchisor must provide a
mandated precautionary
statement.
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Trademarks
• A franchisor licenses the use of its
trademarks and service marks in
the franchise agreement.
• Anyone who uses a mark without
authorization from the franchisor
may be sued for trademark
infringement.
• The franchisor can recover
damages and obtain an
injunction prohibiting further
unauthorized use of the mark.
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Misappropriation of Trade Secrets
• Anyone who steals and uses a
franchisor’s trade secret is liable
for misappropriation of a trade
secret.
• The franchisor can recover
damages and obtain an
injunction prohibiting further
unauthorized use of the trade
secret.
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The Franchise Agreement
• An agreement that the franchisor
and the franchisee enter into that
sets forth the terms and conditions
of the franchise.
– Quality control standards
– Training requirements
– Covenant not to compete
– Arbitration clause
– Use of franchisor’s trade name,
logo, and trademark
– Conditions for the termination
of the franchise
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Franchise Fees
• Franchise fees payable by the
franchise are usually stipulated in
the franchise agreement.
– Initial license fee
– Royalty fee
– Assessment fee
– Lease fee
– Cost of supplies
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Termination “For Cause”
• A franchisor can terminate a
franchise agreement for “just
cause.”
– Nonpayment of franchise fees
by the franchisee
– Continued failure to meet
quality control standards
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Wrongful Termination
• If a franchisor terminates a
franchise agreement without just
cause, the franchisee can sue the
franchisor for wrongful
termination.
• The franchisee can recover
damages caused by the wrongful
termination and recover the
franchise.
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Breach of the Franchise
Agreement
• Lawful franchise agreement is an
enforceable contract.
• Each party owes a duty to adhere
to and perform under the terms of
the franchise agreement.
• Aggrieved party can sue the
breaching party for rescission of
the agreement, restitution, and
damages.
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Independent Contractor Status
• If properly organized and
operated, the franchisor and
franchisee are separate legal
entities.
• The franchisor deals with the
franchisee as an independent
contractor.
– A franchisee is not the agent of
the franchisor.
– The franchisor is not liable for
the franchisee’s contracts and
torts.
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Contract and Tort Liability
• Franchisors and franchisees
are liable for their own
contracts.
• Franchisors and franchisees
are liable for their own tort
liability.
– If a person is injured by a
franchisee’s negligence, the
franchisee is liable.
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Licensing
• A business arrangement that
occurs when the owner of
intellectual property (the licensor)
contracts to permit another party
(the licensee) to use the
intellectual property.
– Trademarks, service marks, trade
names, copyrights
• Licenses are issued for distribution
of goods, services, software, and
digital information.
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Joint Venture
• A joint venture is an
arrangement where two or
more business entities
combine their resources to
pursue a single project or
transaction.
– Joint venturers have equal
rights to manage the joint
venture
– Joint ventures owe each other
the fiduciary duties of loyalty
and care.
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Joint Venture Partnership
• Joint venture operated as a
partnership.
– Each joint venturer is considered a
partner of the joint venture.
• Each joint venturer is liable for the
debts and obligations of the joint
venture partnership.
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Joint Venture (continued)
Joint
Venturer
Joint
Venturer
Investment of
capital
Investment of
capital
Joint
Venture
Partnership
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Joint Venture Corporation
• Two or more joint venturers
corporations create a third
corporation to operate a joint
venture.
• The joint venturers are
shareholders of the joint venture
corporation.
• The joint venture corporation is
liable for its own debts and
obligations.
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Strategic Alliance
• An arrangement between
two or more companies in
the same industry.
• Companies agree to ally
themselves to accomplish a
designated objective.
– Strategic alliances do not have
the same protection as
mergers, joint ventures, or
franchising.
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