New York Law Journal: The Exceptionally Broad Reach of New York’s Franchise Law

Manufacturers, distributors, patent holders, consultants, retailers and others similarly situated often find themselves in business relationships that may trigger the broad reach of franchise laws. Indeed, those businesses who operate in New York would be wise to be particularly careful in light of New York’s exceptionally broad statutory language.

Members of the New York business community enter into business relationships on a daily basis, often without thinking twice as to whether such arrangements are “franchises,” with significant legal repercussions. Indeed, most individuals presume that a “franchise” only exists where a self-proclaimed “franchisor” enters into a contract labeled a “franchise agreement,” with all parties fully intending to create a franchise relationship.

This is not the case, and such a misconception can become a costly mistake, particularly in New York, which has one of the broadest definitions of a “franchise” in the country.

The Federal Franchise Law and the Definition of a “Franchise”

On a national level, the Federal Trade Commission (FTC) regulates the franchise industry, and specifically defines which relationships constitute “franchises,” which must comply with the FTC’s Franchise Rule, 16 C.F.R. 436.

Why does this matter? For one, for those arrangements that fall under the umbrella of the federal Franchise Rule, the franchisor must prepare a (often) voluminous, 23-chapter disclosure document to every prospective franchisee, unless a narrow exception applies. The FTC Rule also generally prohibits franchisors from entering franchise agreements with franchisees until franchisees have had 14 days to review the franchise disclosure document. Furthermore, franchisors must provide (with limited exceptions) audited financial statements to prospective franchisees, and annually update their disclosure documents.

All of the above requires covered businesses-namely putative franchisors-to incur significant costs to their operations, and can be a legal minefield if not properly monitored.

Pursuant to the FTC Franchise Rule, a franchise is “any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:

(1) The franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark;

(2) The franchisor will exert or has 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) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.

Notably, the FTC broadly defines a “‘trademark,” referenced in subsection (1) above, as including “trademarks, service marks, names, logos, and other commercial symbols.” The required payment, referenced in subsection (3), is also broadly defined, as “all consideration that the franchisee must pay to the franchisor or an affiliate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the franchise. A required payment does not include payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease.”

Nowhere in this definition is there any requirement that the parties consider their relationship to be a “franchise,” nor will a disclaimer of any existence of a franchise avoid the application of the FTC Franchise Rule.

Notably, while the federal government can bring an enforcement action against anyone who violates the FTC Franchise Rule, no private right of action exists under the FTC Franchise Rule.

New York Franchise Law and Its Even Wider Net

While the FTC Franchise Rule provides a broad definition of a “franchise,” the New York Franchise Sales Act (NYFSA) goes even further. Specifically, the NYFSA defines a “franchise” as follows:

“Franchise” means a contract or agreement, either expressed or implied, whether oral or written, between two or more persons by which:

(a) A franchisee 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 a franchisor, and the franchisee is required to pay, directly or indirectly, a franchise fee, or

(b) A franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services substantially associated with the franchisor’s trademark, service mark, trade name, logotype, advertising, or other commercial symbol designating the franchisor or its affiliate, and the franchisee is required to pay, directly or indirectly, a franchise fee.

NY Gen. Bus. 681.

Accordingly, unlike the FTC Franchise Rule, New York only requires two elements for a franchise relationship to form, namely (1) either a marketing plan/prescribed system or branding/logo; and (2) a fee.

In other words, under New York’s exceedingly broad definition, a company that simply offers marketing consulting services in exchange for a fee-without the supply of any branding/intellectual property-could technically fall under the umbrella of a “franchise” under the NYFSA. Similarly, a traditional licensor who simply charges a fee for the use of its brand-without more-could also be considered to be a “franchise” under New York law.

Critically, not only does New York’s franchise law cover far more business relationships than its federal counterpart, the consequences for violating the NYFSA can be even more costly. If a business is a “franchisor” under the NYFSA, not only must the business comply with a host of disclosure requirements, but, unlike under the FTC Franchise Rule, the franchisor must register its disclosure document with New York. Additionally, unlike the FTC Franchise Rule, the NYFSA provides a private right of action to an aggrieved franchisee, permitting a franchisee to seek damages from a franchisor who violates the NYFSA’s requirements.

Moreover, if a franchisee can establish that such violations were willful, a franchisee may seek, inter alia, rescission of the franchise agreement, along with additional amounts, such as attorney fees (“A person who offers or sells a franchise in violation of section six hundred eighty-three, six hundred eighty-four or six hundred eighty-seven of this article is liable to the person purchasing the franchise for damages and, if such violation is willful and material, for rescission, with interest at six percent per year from the date of purchase, and reasonable attorney fees and court costs”).

Conclusion

Manufacturers, distributors, patent holders, consultants, retailers and others similarly situated often find themselves in business relationships that may trigger the broad reach of franchise laws. Indeed, those businesses who operate in New York would be wise to be particularly careful in light of New York’s exceptionally broad statutory language.


Reprinted with permission from the December 12, 2023 issue of the New York Law Journal. © 2023. ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

Related Services

LitigationPatent

Related Industries

Franchise Law