Friday, January 22, 2010

License Agreement Was Not “Franchise” Under FTC Rule

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

An agreement that permitted a dealer to produce, sell, and install a licensor’s patented and trademarked gutters in a limited territory was not a "franchise" under the meaning of the FTC franchise disclosure rule, a federal district court in Florence, South Carolina, has ruled.

Thus, the dealer could not proceed with its claim that the licensor violated the South Carolina "little FTC Act" by failing to provide it with a disclosure statement as required by the FTC rule.

The licensor notified the dealer in 2001 that it was terminating their agreement and requested the payment of accrued royalties and the return of a gutter-fabricating machine, as required by the agreement. When the dealer failed to comply, the licensor filed the instant suit, seeking injunctive relief and asserting other claims.

Subsequently, the dealer asserted various counterclaims—including one brought under the South Carolina “little FTC Act”—and continued to use the fabricating machine without paying royalties during the eight years the suit has been pending in both state and federal court.

Caption of Agreement

The actual contract was captioned as a license agreement and had been described by both a South Carolina appellate court and the South Carolina Supreme Court as a license agreement. However, that was not determinative of whether a franchise agreement existed.

As noted by the dealer, an FTC staff advisory opinion provided that "[w]hether a business relationship constitutes a franchise, is not dependent upon what the parties call the relationship …[r]ather, a relationship is covered by the Franchise Rule if it satisfies the definitional elements of a franchise set forth in the Franchise Rule" (FTC Informal Staff Advisory Op. 98-4, 1998, CCH Business Franchise Guide ¶6493).

“Franchise” Definition

In determining whether a commercial relationship constitutes a franchise for purposes of the FTC rule, courts have looked to see (1) whether the relationship involved the distribution of goods or services associated with a franchisor’s trademark or trade name; (2) whether the franchisor had 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) whether the franchisor must pay at least $500 within six months after the franchise business began.

The first prong of the analysis was not in dispute, as the agreement involved the sale or distribution of goods associated with the licensor’s trademark. However, as to the second prong, the controls or assistance had to be related to the franchisee’s entire method of operation, not merely its method of selling a specific product or products which represented a small part of the franchisee’s business, according to the court.

Control Over Method of Operation

The dealer pointed to numerous terms from the agreement—including limitations on territory, limitations on the ability to sell the product through lumberyards and home centers, and accounting and sales reporting requirements—as evidence that the licensor exercised a great deal of control over the dealer’s method of operation. However, it was readily apparent from the terms of the agreement that these limitations only restricted the dealer’s operations with respect to the gutter product line, the court determined.

It was not disputed that the sale and installation of those gutters was but one of multiple products and services provided by the dealer. Thus, the level of control exerted by the licensor over the dealer’s method of operation was not significant for purposes of the FTC franchise rule, the court held.

Franchise Fee

There was no evidence that any franchise fee was paid to the licensor by the dealer as required by the third prong of the analysis, the court determined. Although the dealer paid the licensor a sum of money at the inception of the business relationship, that payment was made in exchange for the purchase of the gutter-fabricating machine. It was not in the form of a franchise fee as required by the rule. Thus, the agreement was not a franchise as a matter of law.

Therefore, the dealer was denied partial summary judgment on its "little FTC Act" counterclaim. Even if the business relationship between the parties was a franchise, the dealer still would be required to establish that the failure to comply with the FTC franchise rule constituted a per se violation of the Act, an issue on which the dealer failed to provide persuasive authority, the court noted.

The decision is Englert, Inc. v. LeafGuard USA, Inc., CCH Business Franchise Guide ¶14,297.

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