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Some businesses grow faster than others and sometimes the only
way for these companies to grow is by expanding across the country
or even the world. These expansions are sometimes referred to as
franchises.
What is a Franchise?
A franchise is a form of business expansion where you allow
others the right to sell a product or service, under your
company’s name and make a profit. The person being authorized
to use your company’s name is called a franchisee and
normally must pay a franchise fee to the franchisor, for the right
to do something under your company’s name. At the same time,
this franchisee must sometimes pay a certain percentage of his or
her profit in what is called a royalty. Common examples of
franchising companies are McDonalds and Shell—these companies
sell to individuals the right to operate a business under its
company name.
What Happens When a Franchisee Breaches a Licensing
Agreement?
Besides paying royalties and a franchise fee, a franchisee and
franchisor normally sign several contracts in order to organize
each other’s rights and duties. Normally what documents the
parties to a franchise have to sign depend on both the Federal
Trade Commission (“FTC”), the United States federal
agency which regulates franchises, and the state where the
franchise will take place in. These contracts normally include
lease agreements and other financing agreements, such as loans to
build the franchise location, make modifications, or even pay
employee salaries.
A licensing agreement, sometimes referred to as franchise
agreement, is the official document which allows a franchisee to
operate under the license of the business. There are several
consequences to violating a licensing agreement: from losing your
franchise to having to pay damages to the franchisor. An example of
this is a breach of the licensing agreement during the annual
auditing process. Most franchises do annual audits of their funds,
however the one that is most prone to conflict are the audits done
when the franchisee wants to renew his or her franchise term or
wants to sell the franchise. These audits can be a financial or a
general inspection of the business and its practices. If, during
the inspection, the franchisor learns that the franchisee has been
violating the licensing agreement, the franchisor can terminate the
entire agreement.
Examples of Franchisor Liability
It is also possible for the franchisor to be held liable for
certain breaches. An example is when the franchisor fails to comply
with the FTC. The FTC requires a franchisor to disclose certain
documents to a franchisee, such as the litigation history of the
company. If a franchisor failed to disclose such documents, the FTC
could not only freeze assets and enter injunctions, but it could
also treat the violation as a criminal offense with penalties of up
to $10,000 per day. To make things worse, the FTC could also award
monetary damages, punitive damages, and attorney’s fees to
the franchisee or even cancel the franchise agreement altogether
and order the franchisor to refund the franchising fees to the
franchisee.
To avoid any problems when entering into a licensing agreement
for a franchise, it is highly recommended to have a knowledgeable
business attorney review your franchising documents.
Originally Published 12 August 2022
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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