Back in March, I wrote a post about general partnerships in Illinois. In it, I explained that general partnerships can be formed inadvertently. Though this feature makes general partnerships unique among business organizations, there are other kinds of legal relationships that unsuspecting business owners can unwittingly create. Today, I’m going to talk about one that, when inadvertently formed, can have devastating consequences for a business: franchises.
The Legal Definition of Franchise
Most people are familiar with the concept of a franchise, and can probably name some well-known franchises-like McDonald’s or Subway-off the top of their heads. But not as many people are familiar with the legal definition of a franchise, and that’s where business owners can get themselves in trouble. So if you’re wanting to invest in a franchise or become a franchise owner, for example, such as applying for this TUTORING FRANCHISE opportunity make sure you know the laws that could possibly impact you!
In Illinois, franchises are governed by two distinct laws: the Federal Trade Commission’s (FTC) Franchise Rule and the Illinois Franchise Disclosure Act (IFDA). Here’s a simplified version of how each of those laws defines “franchise”:
|A continuing commercial arrangement in which the terms specify, or the franchise seller represents, that:||An agreement by which:|
|· The franchisee can use the franchisor’s trademark;
· The franchisor can exert a significant degree of control over, or provide significant assistance in, the franchisee’s method of operation; and
· The franchisee is required to pay at least $570 to the franchisor or its affiliate within the first six months of operations.
|· The franchisee can use the franchisor’s trademark;
· The franchisee can operate a business under a marketing plan or system suggested in substantial part by the franchisor; and
· The franchisee is required to pay at least $500 to the franchisor or an affiliate of the franchisor.
Legal Requirements for Franchises
The Franchise Rule requires franchisors to provide a franchise disclosure document (FDD) to the franchisee at least two weeks before the franchisee signs an agreement or pays anything to the franchisor. The FDD must satisfy the strict requirements described in the Rule. Violating the Franchise Rule can result in fines of up to $11,000 per violation.
The IFDA also requires disclosure. Additionally, it requires franchises to be registered with the Illinois Franchise Bureau before the franchise can be offered for sale within Illinois. Finally, the IFDA regulates the franchisor-franchisee relationship in some respects, such as by requiring “good cause” for a franchisor to terminate a franchise before its term expires.
Violations of IFDA can result in civil fines of up to $50,000 each, criminal prosecutions, and civil liability in a lawsuit brought by the franchisee. IFDA imposes personal liability on anyone who “directly or indirectly controls a person” liable for violating IFDA, including corporate directors and officers and the managers of a limited liability company.
In short, failing to comply with state and federal franchise laws can result in devastating legal consequences for the franchisor.
How Business Owners Get in Trouble
Business owners naturally want to expand the reach of their businesses. Often, they think they can do so by contracting with third parties to open new locations or serve as the exclusive distributor for the business owner’s products. But those kinds of arrangements can raise franchising concerns, and business owners should speak with a knowledgeable attorney when seeking to begin such a relationship.
Unfortunately, some people think they can outsmart the government. They think they’ve found a loophole or workaround that allows them to offer something like a franchise without complying with the Franchise Rule or IFDA. To close out this post, let me quickly discuss some of those mistaken strategies:
- FALSE: “If I don’t call it a franchise, it won’t be covered!”
FACT: If the arrangement satisfies the definition of “franchise” under the Franchise Rule or IFDA, it’s a franchise, regardless of what you call it. So, you can’t escape the reach of those laws by calling it a “license agreement” or “distributorship.”
- FALSE: “If I don’t charge a franchise fee, it’s not a franchise!”
FACT: This is true at a purely semantic level under IFDA, but IFDA defines “franchise fee” broadly, so this can be a trap for the unwary. Similarly, under the Franchise Rule, the payment element “captur[es] all sources of revenue that a franchisee must pay to a franchisor or its affiliate,” including things like rent, training, deposits, and payments for advertising.
- FALSE: “If I don’t use a written contract, it’s not a franchise!”
FACT: Both the IFDA and Franchise Rule explain that they apply to “oral” representations (under the Franchise Rule) or agreements (under IFDA). Also, while the Franchise Rule does exempt relationships in which “[t]here is no written document that describes any material term or aspect of the relationship,” the FTC interprets that exemption narrowly. For instance, if there’s a purchase invoice for goods or equipment, then the exemption doesn’t apply. Plus-and this should go without saying-it’s never a good idea to rely on oral agreements.
If you’ve found this post helpful, please leave a comment below. And if you have any questions about how you can legally expand your small business, please call me today!