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Dream to Nightmare

Written by: Robert Ball

Article Overview: A discussion of the pitfalls of licensing a trademark

Dream to Nightmare

This article is intended for companies that sell a service or provide a product by way of a specific business format. Such enterprises include everything from real estate brokers to janitorial services and include products from ice cream to pizza. The possibilities are literally endless. A cartoon in New Yorker magazine comes to mind where a kid is operating a franchised neighborhood lemonade stand.

The common factors of each of these business formats is that (1) someone has developed a way of opening and operating a business under a plan or system that has proven to be successful, and (2) the plan or system is capable of being duplicated by others with training and other assistance.

Most of these companies have certain procedures, sales methods, recipes, formulas or operating ideas that they consider to be secret, or at minimum, proprietary. Many have taken the time and effort to trademark the business name because they consider their particular system or business to be unique, or uniquely operated.

If you are one of these successful businesses you are probably considering a way to expand your market share and profits.

Any dream of expansion soon faces the need for an infusion of capital in order to open, staff and supply new locations. Additional capital is also needed to increase headquarters staff to manage and control the growing network. Whether saved, borrowed or raised, the money has to be there to support the growing period of negative cash flow. Money is needed now to support heavy expenses that will, eventually, lead to later, steadily rising profits. Selling licenses and thereby making use of capital supplied from others is one of the ways to satisfy this need.

If you are considering franchising or licensing as a way of expanding your market, there is a hidden trap for the unwary that could turn your expansion dream into a nightmare.

The easiest way to say this is to make a gross generalization that will be immediately subject to attack from a large portion of the legal community: There is no way to do it by licensing. The system will eventually be considered by federal and state agencies as a franchise. You can read all the statutes and case law if you prefer, or you can play it safe and accept the general view of anyone who has studied them. I prefer the latter course. Here is why:

1. Franchising regulators agree that if you (a) license your mark; (b) charge a fee; and (c) offer a business plan or marketing system, you are selling a franchise.

2. In some states, like New York, the regulators consider (a) and (b) to be enough to close the circle.
3. Item (c) can be satisfied by such little evidence as training, marketing assistance or operating manuals - and some authorities will conclude a franchise on even less evidence.

The above thesis, of course, contains the corollary that there is an exception that proves the rule. In this case, the exception is a situation where a trademark is licensed, for a fee, and nothing else is done; the licensee simply sells your product or service without any help from you. The challenge here would be to satisfy Lanham Act requirements to protect and preserve you trademark, without telling the licensee what to do. In a technical sense, it can be done. As a practical matter it is almost impossible.

Instead of going over the 35 different things that will inspire 35 different regulators to call the system a franchise, try to look at it in the general sense that all of the franchise laws are based upon. These laws have similarities with securities laws designed to protect the unwary and inexperienced. The basic premise is:

If the licensee can operate his business successfully by renting your mark and proceeding on to success and happiness, then it is a real licensing arrangement (except in New York).

However, if the licensee needs to rely on you for any kind of assistance in order to carry out its business, it is a franchise.

Let’s say you have a store that sells trademarked umbrellas. If you license another retail operation to exclusively offer your umbrellas in a certain territory, and nothing more, then that arrangement would not be a franchise (except in New York). The licensee is an experienced retailer that is simply adding another line of products and is fully capable of running the business without your help.

On the other hand, if you offer me a license to open an umbrella store in my hometown, I will guarantee you that I will need to know where to locate the store, how to run it and how to market the umbrellas. Without your help, I will fail. It is obvious that I would not buy the license without a commitment from you for help in becoming successful. This is a franchise no matter what your agreement says.

I know there are many licensors operating without franchise offering circulars. I also know of many who have obtained assurances from attorneys that their agreements are “license arrangements.” I also know that if the attorneys had asked about the actual practices of the licensors, instead of merely what is stated in the license agreements, the existence of a franchise would be obvious.

Trying to avoid franchising rules can be dangerous. Maybe most attempts will escape the scrutiny of state and federal regulators. Many have. But I would not recommend operating in an atmosphere of fear, looking over your shoulder, hoping to go undiscovered. All it takes is one disgruntled licensee with a bad case of “buyer’s remorse” to unravel your dream and turn it into a nightmare of fines and refunded fees. It happens.

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