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“Franchise Fees” and the New York Franchise Law

Wednesday, August 24th, 2011

The New York Franchise Law defines a franchise fee as any fee or charge that a franchisee or subfranchisor is required to pay or agrees to pay directly or indirectly for the right to enter into a business under a franchise agreement, or otherwise sell, resell or distribute goods, services, or franchises under such an agreement, including, but not limited to, any such payment for goods or services.  The NY Franchise Law also contains several exclusions to the franchise fee definition, but no exemptions pertain to the purchase/sale of equipment.  Rather, the exemptions to the NY law are nearly identical to the Maryland law.

The dollar threshold for a franchise fee under NY law is $500.

Like Maryland, the scope of the New York Franchise Law franchise fee definition is construed broadly.  For example, a one-time fee or a monthly payment during a four-year period, which was characterized as a lease, was ruled a franchise fee.

The Definition of “Franchise Fee” Under the Maryland Franchise Law

Wednesday, August 24th, 2011

The Maryland Franchise Registration and Disclosure Law (“MD Franchise Law”), Section 14-201, defines a franchise as “an oral or written agreement in which: 1) a purchaser is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by the franchisor; ii) the operation of the business under the marketing plan or system is associated substantially with the trademark, service mark, trade name, logotype, advertising or other commercial symbol that designates the franchisor or its affiliate; and iii) the purchaser must pay, directly or indirectly, a franchise fee.”

Section 14-201 of the MD Franchise Law goes on to define a franchise fee as a charge or payment that a franchisee or subfranchisor is required or agrees to pay for the right to enter into a business under a franchise agreement.  The purchase of equipment is included in the definition of a franchise fee.  Section 14-201 contains several exclusions from the definition of a franchise fee, but no exclusions for the purchase of equipment by a franchisee/licensee.

Many of the Maryland exclusions are limited to products-oriented licensors, as for the sale of goods at wholesale prices.  Other exemptions are for the sale or lease of real property for use in the business, and any amounts paid for sales materials used in making sales, sold at no profit by the licensor. An additional exemption exists for the sale, at fair market value, of supplies or fixtures that are necessary in order to operate the business. 

Section 14-203 of the MD Franchise Law sets the threshold amount for the franchise fee at any amount exceeding $100.

Threshold for a Franchise Fee Under the FTC Rule Is $500 Through The First Six Months

Wednesday, August 24th, 2011

A licensing or other relationship where the trademark and system/significant control prongs of the FTC Franchise Rule are met is excluded from the scope of the franchise regulation if the total required payments by the franchisee before and during the 6-month period after the business opens do not exceed $500. 

The required fee element captures all sources of revenue paid by a licensee to a licensor for the license. The element is deliberately expansive, encompassing lump sum, installment, fixed, fluctuating, up-front, and periodic payments for goods or services, however denominated, whether direct, indirect, hidden, or refundable. 

To avoid the FTC Rule franchise fee requirement, it is possible for a licensor to defer required payments exceeding $500 for at least six months, and as a result, not be deemed a franchise under the FTC Rule and federal law.  This remains true even if the licensee signs a nonnegotiable, secured promissory note (with no acceleration clause) promising to pay the money after six months.

The deferment option is not all-encompassing however.  While the FTC Rule permits this deferment of payment option, this is applicable only in those states that do not have individual, state specific franchise laws, since in those states such license transactions are governed by the FTC Rule.  There are upwards of 15 states across the country, including Maryland, Virginia, New York, California, and Illinois, which do have specific franchise laws, and which do not grant this deferment option.  As a result, deferment is not an option in these states.  Have your franchise attorney check the franchise law of each individual state before proceeding.

 

Legal Requirements of an Existing Franchisee Sale of His or Her Outlet; Purchase of Additional Outlets; Extending the Term of an Existing Franchise?

Thursday, April 28th, 2011

An existing franchisee that sells his or her franchised business directly to a third party, without any significant contact with the franchisor does not need to abide by the federal franchise disclosure law, or any state franchise registration or disclosure law.

 The FTC Franchise Rule states, directly from the FTC website found at http://www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf

“Even if the franchisor has, and exercises, the right to approve or disapprove a subsequent sale (transfer) of a franchised unit, the transferee will not be entitled to receive disclosures unless the franchisor plays some more significant role in the sale. For example, if the franchisor provides financial performance information to the prospective transferee, the franchisor would be required to provide the transferee with its disclosure document.”

 Likewise, in the case of an existing franchisee that purchases one or more additional outlets from the same franchisor for the same brand, the franchisor is not required to provide a disclosure document to such a franchisee exercising a right under the franchise agreement to establish any new outlets.

Finally, the franchisor is not required to provide a disclosure document to a franchisee who chooses to keep its existing outlet post-term either by extending its present franchise agreement or by entering into a new agreement, unless the new relationship is under terms and conditions materially different from the present agreement.  In the case of a materially different franchise agreement, the franchisor must abide by state and federal franchise registration and disclosure laws.