Advisories & Insights

Franchising is booming in the United States, and it's easy to understand why. Not only does franchising permit a business to grow at a more rapid and less capital intensive pace than through corporate expansion, it shifts many typical business risks and responsibilities to the contractual partner, the franchisee. According to the International Franchise Association, there are over 760,000 franchised operations doing business in the United States, providing jobs for more than eighteen million people.

Nearly every business is capable of franchising. In short, if you have a trademark, a business that can be replicated, and a person willing to pay for use of your trademark and for your support, you can franchise your business. However, the real issue for businesses considering franchising is not if it's possible, but whether it makes business sense. Franchising is heavily regulated by federal and state legislation and, because trademarks are involved, implicates intellectual property law. Through a little due diligence up front, business owners can gauge their legal fitness for franchising, and avoid potentially devastating and expensive legal conflicts in the future.

The purpose of this article is to discuss basic legal issues every business should consider before electing to franchise. It is not an exhaustive discussion, and there are a number of other important franchising legal considerations not discussed in this article.

Trademarks are some of the most valuable assets of any franchised business. They are what establish the business's brand, helping to build widespread recognition in the consumer public. People tend to patronize brands they know, which is why trademarks are so critical to franchisors and franchisees alike. If a business's trademark is not worthy of protection, or, if expansion of the trademark into new areas would cause infringement of another's mark, serious legal and business consequences can arise. Trademarks are also an indispensable asset in franchise sales. A franchisor is hard-pressed to sell a franchise if they cannot assure the buyer that a competing business cannot set up shop with the same name or logo across the street.

Even if a business has been using its mark for years, or has a federally-registered trademark(s), it is well-advised to conduct a comprehensive trademark search prior to franchising. The search, which costs around $500, will reveal all operations doing business under the same or similar marks domestically, and some internationally. The search will enable the business's trademark attorney to evaluate the risk of trademark infringement through expansion into new areas as well as ascertain the likelihood the mark will qualify for federal registration (assuming it is not already registered). If it appears the risk of infringement is high, or the mark incapable of registration, the business may elect not to franchise, avoid franchising in the risky area, or elect to adopt a new trademark that does not present a risk or is more likely to qualify for federal registration.

If the business elects to franchise, it is well-advised to apply for federal trademark registration of all marks it intends to use in its franchise business. Federal registration confers the invaluable benefit of, among other things, a legal presumption of the businesses' exclusive right to use the mark nationwide in connection with its goods or services. Thus, with a federally-registered trademark, the risk of facing an infringement claim is significantly reduced, and, more importantly, the business can better preclude others from adopting marks similar to its own.

Franchising in the United States is governed by federal law and a variety of state statutes. The purpose of these laws is to protect potential franchisees by requiring franchisors to disclose information to them so that they can ascertain whether they should purchase the franchise. Franchising does not require the filing of documents with the federal government, but in fourteen states, often referred to as "registration states" (including Washington and California), state regulators analyze a non-exempt franchisor's financial statements, franchise agreements, and other documents and make value judgments about them. If the documents fail to satisfy the regulators, bonding requirements may be imposed or the states may refuse to register the franchise.

Although Oregon is not a registration state, franchising in Oregon is regulated by statute (ORS 650 et seq.) and falls under the jurisdiction of the Director of the Department of Consumer and Business Services, who may require filings at his or her discretion. Moreover, in Oregon, as in every state, civil and potentially criminal liability may attach to any franchisor who makes a false statement of material fact or omits to state a material fact in the sale of a franchise.

Franchisors disclose the required information to franchisees through a comprehensive disclosure document called the Uniform Franchise Offering Circular ("UFOC"). The UFOC requires a franchisor to provide prospective franchises with detailed information across twenty-three different categories (referred to as "Items"), as well as to include audited financial statements of the company, and copies of any agreements that franchisees are required to sign.

The good news is that every franchisor has the ability to comply with state and federal law by carefully following UFOC guidelines and by disclosing complete and accurate information in all communications with prospective franchisees. Businesses are advised to work with a franchise attorney in preparing an offering circular and when applying for franchise registration in a registration state. The disclosure items and application process require an understanding of franchise law, and the penalties for non-compliance with these laws can be severe.

For individualized advice about trademark and franchising matters, please consult an attorney experienced in these areas.