A Ticking Time-Bomb: the Accidental Franchise

Could your license agreement actually be a franchise agreement? A licensing deal that meets the statutory definition of a franchise carries consequences most business owners never see coming.

Each licensee whose deal turns out to be a franchise can sue you for damages or ask a court to rescind the transaction, and that claim must be brought within three years after the cause of action accrues. Minn. Stat. § 80C.17, subds. 1, 5. The Act gives no such right to your customers, suppliers, or other counterparties, because no civil liability in favor of any other private party arises by implication. Minn. Stat. § 80C.17, subd. 4. A suit under the Act may recover the actual damages sustained by the plaintiff together with costs and disbursements plus reasonable attorney’s fees, which is what makes even a modest franchise claim worth bringing. Minn. Stat. § 80C.17, subd. 3.

The exposure does not stop at your company. Liability is joint and several with every person who directly or indirectly controls the violator, every partner in a firm, every principal executive officer or director, and every employee who materially aids the violation, unless that person had no knowledge of or reasonable grounds to know of the facts. Minn. Stat. § 80C.17, subd. 2. In Martin Investors, Inc. v. Vander Bie, the chairman of the board and the president were held personally liable along with the company for restitution under that subdivision. 269 N.W.2d 868, 876 (Minn. 1978).

A willful violation is separately punishable by a fine of not more than $10,000, imprisonment of not more than five years, or both. Minn. Stat. § 80C.16, subd. 3(a). Because that authorized term reaches one year or more, the offense is a felony. Minn. Stat. § 609.02, subd. 2. Civil fines run alongside the criminal provision: not more than $2,000 for each violation of section 80C.02, 80C.06, 80C.09, 80C.13, or 80C.14, and not more than $25,000 for failing to comply with a final judgment or order rendered for a violation of sections 80C.01 to 80C.22, both imposed in a civil action brought by the attorney general. Minn. Stat. § 80C.16, subd. 2. A second criminal track runs alongside the first: employing a device, scheme, or artifice to defraud, or engaging in conduct that operates as a fraud or deceit in connection with the offer, purchase, or sale of a franchise, carries the same $10,000 fine and five-year maximum, and nothing in that subdivision limits the state’s power to punish conduct that is a crime under another statute. Minn. Stat. § 80C.16, subd. 3(b), (c).

The Federal Definition

The Federal Trade Commission’s Franchise Rule, formally titled “Disclosure Requirements and Prohibitions Concerning Franchising,” supplies the federal definition of a franchise at 16 C.F.R. § 436.1(h). It is not the only definition that matters: Minnesota’s Franchises Act defines the term separately at Minn. Stat. § 80C.01, subd. 4, and the state test turns on a community of interest rather than on your control or assistance, so a licensing arrangement can be a franchise under Minnesota law without satisfying the federal definition.

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 three elements are present. 16 C.F.R. § 436.1(h).

  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 (16 C.F.R. § 436.1(h)(1));
  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 (16 C.F.R. § 436.1(h)(2)); 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 (16 C.F.R. § 436.1(h)(3)).

The label on your document does not control, because the definition reaches the relationship “whatever it may be called.” The words your sales people use count as well, because a “franchise seller” includes the franchisor and the franchisor’s employees, representatives, agents, subfranchisors, and third-party brokers who are involved in franchise sales activities. 16 C.F.R. § 436.1(j). The Rule also treats a license as one of the ways a franchise is sold: a sale of a franchise includes an agreement by which a person obtains a franchise for value “by purchase, license, or otherwise,” and a renewal on materially different terms is itself a new sale. 16 C.F.R. § 436.1(t).

The third element deserves a closer look, because it is where ordinary licensing deals cross the line. A required payment is all consideration the franchisee must pay you or an affiliate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the franchise, and it does not include payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease. 16 C.F.R. § 436.1(s). The element itself sets no deadline. The six-month window practitioners often attach to that element comes from a separate provision, the minimum-payment exemption, which lifts the Rule only when required payments and commitments made any time from before through six months after the franchisee commences operation total less than $735. 16 C.F.R. § 436.8(a)(1). That figure rose from $615 to $735 effective July 12, 2024, and the Commission readjusts the monetary thresholds every fourth year. Disclosure Requirements and Prohibitions Concerning Franchising, 89 Fed. Reg. 57078 (July 12, 2024).

A fractional franchise is exempt from the Rule. 16 C.F.R. § 436.8(a)(2). Testing your relationship against the federal definition is the right starting point, but the federal test is a floor rather than the whole analysis, because Minnesota asks a different second question.

Identification with the Franchisor’s Trademark

Your licensee does not have to operate under your name for this element to be met. If the franchisee obtains the right to offer, sell, or distribute goods or services identified or associated with your trademark, the element is met. 16 C.F.R. § 436.1(h)(1). “Trademark” is read broadly and includes trademarks, service marks, names, logos, and other commercial symbols, so no federal registration is required. 16 C.F.R. § 436.1(v). Selling products that merely carry someone else’s brand does not meet the element; the mark must be the franchisor’s, and the arrangement must give the seller the right to trade on it.

Courts construing comparable state franchise statutes read the element the same way. See Wright-Moore Corp. v. Ricoh Corp., 908 F.2d 128, 135 (7th Cir. 1990) (applying Indiana law). In that case the distributorship agreement prohibited the distributor from using the manufacturer’s name or trademark in any manner, and the element was satisfied anyway, because the same clause permitted the distributor to state in writing that it was an authorized distributor and the manufacturer supplied it with advertising materials bearing the manufacturer’s trademark. Wright-Moore, 908 F.2d at 135. The distributor still lost the case: on the later appeal the court affirmed that it paid no franchise fee and therefore was not a franchisee. Wright-Moore Corp. v. Ricoh Corp., 980 F.2d 432, 435-37 (7th Cir. 1992). Under the federal Rule the Commission takes a different position: a supplier can avoid Rule coverage of a particular distribution arrangement by expressly prohibiting the distributor from using its mark. FTC, Franchise Rule Compliance Guide 2 (May 2008).

In Minnesota this element does not require a trademark license. It is met when the alleged franchisee is granted the right to engage in the business of offering or distributing goods or services using the franchisor’s trade name, trademark, service mark, logotype, advertising, or other commercial symbol or related characteristics. Minn. Stat. § 80C.01, subd. 4(a)(1)(i). The statute “requires only that the franchisee be granted the right to use the franchiser’s name, not that it be permitted to hold itself out as the franchiser.” Martin Investors, Inc. v. Vander Bie, 269 N.W.2d 868, 874 (Minn. 1978). Even a simple trademark license agreement meets this first element.

Two exclusions matter most for licensing deals: a business operated under a lease or license on your own premises where that business is incidental to the business you conduct there, which covers leased departments, licensed departments, and concessions, and any agreement requiring the franchisee to pay less than $100 on an annual basis, except motor vehicle fuel franchises. Minn. Stat. § 80C.01, subd. 4(b), (c).

Payment of a Franchise Fee

Under Minn. Stat. § 80C.01, subd. 9, a franchise fee is any fee or charge a franchisee or subfranchisor is required to pay, or agrees to pay, for the right to enter into a business or to continue a business under a franchise agreement, including but not limited to:

  1. the payment either in lump sum or by installments of an initial capital investment fee;
  2. any fee or charges based upon a percentage of gross or net sales whether or not referred to as royalty fees;
  3. any payment for goods or services; or
  4. any training fees or training school fees or charges.

Six categories are removed from the definition: goods bought at a bona fide wholesale price; consignment goods where the proceeds the franchisee remits reflect only the bona fide wholesale price; repayment of a bona fide loan made by the franchisor; goods bought at a bona fide retail price subject to a bona fide commission or compensation plan that in substance reflects only a bona fide wholesale transaction; supplies or fixtures bought at fair market value; and real property bought or leased at fair market value, the last two limited to what is necessary to enter into or continue the business under the franchise agreement. Minn. Stat. § 80C.01, subd. 9(a)-(f).

The most frequently invoked exception is the first: buying goods, or agreeing to buy goods, at a bona fide wholesale price is not a franchise fee. Minn. Stat. § 80C.01, subd. 9(a). The operative word is wholesale. An ordinary supply relationship at genuine wholesale prices does not create a franchise fee, but a required purchase at retail prices, or a markup above a bona fide wholesale price, can be treated as an indirect fee. Retailers that resell trademarked products ordinarily pay nothing for the right to sell those goods; they pay only the wholesale price of the inventory they buy for resale.

In Schultz v. Onan Corp., 737 F.2d 339 (3d Cir. 1984), the court applied the Minnesota Franchise Act and found no franchise fee on the record, for two separate reasons: the distributor’s owners attended courses at the Onan factory but paid Onan no fee or charge for them, and their travel, lodging, food, and other ordinary business expenses were not a franchise fee. The $36,000 the distributor paid the prior owner to buy the business failed for a different reason: the court found no support in the Act or in any of the cases interpreting it for treating payments to third parties as franchise fees. Schultz, 737 F.2d at 345. That case also supplies the structural point: the provisions of the Minnesota definition “are, however, conjunctive,” and “[a]ll three elements must be present for a franchise to exist,” so the court assumed the first two elements were satisfied and still found no franchise. Schultz, 737 F.2d at 344.

Most attempts by dealers to argue that the price of goods concealed an indirect franchise fee have failed, though the outcome turns on the record rather than on a categorical rule. Minimum purchase commitments and markups are indirect franchise fees only where the prices exceeded bona fide wholesale prices or the distributor was required to purchase amounts or items it would not purchase otherwise, measured by an objective reasonableness test. Upper Midwest Sales Co. v. Ecolab, Inc., 577 N.W.2d 236, 242 (Minn. Ct. App. 1998). The Eighth Circuit has since added that for sales above a bona fide wholesale price to constitute a franchise fee, “there must be evidence of compulsion accompanied by the threat of termination.” Louis DeGidio, Inc. v. Industrial Combustion, LLC, 66 F.4th 707, 710-11 (8th Cir. 2023).

In Coyne’s & Co., Inc. v. Enesco, LLC, 565 F. Supp. 2d 1027 (D. Minn. 2008), a distributor that paid a 50% markup over the manufacturer’s actual cost claimed the markup was a disguised franchise fee, and the court refused to resolve the issue on a motion to dismiss, holding that whether the markup “was a reasonable wholesale price or whether it was an indirect franchise fee is a fact-specific inquiry that is not appropriate on a motion to dismiss,” and allowing the Minnesota Franchise Act claim to proceed. On appeal from the denial of a preliminary injunction, the Eighth Circuit held that the district court did not clearly err in finding that the 35 to 50 percent markup merely represented the manufacturer’s profit at a bona fide wholesale price. Coyne’s & Co. v. Enesco, LLC, 553 F.3d 1128, 1131-32 (8th Cir. 2009).

A recital does not save you either: where a distributor agreement stated that the parties’ relationship “is that of buyer and seller only” and that nothing in the agreement creates the relationship of franchisee, the court held “this provision is not determinative at this stage of the litigation.” Coyne’s, 565 F. Supp. 2d at 1048.

The Minnesota Supreme Court restated the same three-element test in 1995, describing a franchise as an agreement granting the right to offer or distribute goods using the franchisor’s commercial symbol or related characteristics, in which the parties have a community of interest in the marketing of goods or services, and for which the franchisee pays a franchise fee. Current Technology Concepts, Inc. v. Irie Enterprises, Inc., 530 N.W.2d 539, 542 (Minn. 1995). In 2024 the court held that payments for finished products at a bona fide wholesale price, with payment for fabrication services included in that price, do not constitute a franchise fee. Cambria Co. v. M&M Creative Laminants, Inc., Nos. A22-0723, A22-0724 (Minn. Sept. 11, 2024).

Control or Assistance

The second element of the FTC Franchise Rule asks whether you “will exert or ha[ve] 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.” 16 C.F.R. § 436.1(h)(2). Minnesota’s definition has no counterpart to this element: its three requirements are use of the franchisor’s commercial symbol, a community of interest in the marketing of goods or services, and payment of a franchise fee. Minn. Stat. § 80C.01, subd. 4(a)(1).

A detailed operating manual and a formal training program point strongly toward the federal element. Sales support by itself does not get there: the FTC’s Franchise Rule Compliance Guide states that promotional activities, in the absence of additional forms of assistance, will not be deemed “significant,” and that the control or assistance must relate to the franchisee’s overall method of operation, not a small part of the franchisee’s business. Operations manuals, formal training programs, site selection, and management or marketing advice are the kinds of assistance the agency treats as significant.

The element is disjunctive in two directions: authority to exert significant control counts even if you never exercise it, and significant assistance alone satisfies the element without any control at all. 16 C.F.R. § 436.1(h)(2). Controls that exist only to protect the mark itself, such as requiring correct display of the mark or reserving a right of inspection, are not significant control as a matter of Commission policy, but quality standards that reach production techniques or the licensee’s overall method of operation are. FTC, Franchise Rule Compliance Guide 3-4 (May 2008).

Not every licensing arrangement creates a franchise. For example, a license from the Minnesota Vikings to a clothing manufacturer to produce products bearing the Vikings name and logo falls outside the FTC Franchise Rule’s second element only if the Vikings neither exert nor have authority to exert a significant degree of control over the manufacturer’s method of operation and provide no significant assistance in it. 16 C.F.R. § 436.1(h)(2). That same license can still be a franchise in Minnesota, which asks about a community of interest rather than control or assistance, and treats a royalty set as a percentage of gross or net sales as a franchise fee. Minn. Stat. § 80C.01, subds. 4(a)(1), 9.

Community of Interest in Minnesota

Minnesota does not include “assistance or control” in its definition of a franchise. Instead, Minn. Stat. § 80C.01, subd. 4(a)(1) requires a “community of interest” between the franchisor and the franchisee in the marketing of goods or services, alongside the trade name grant and the franchise fee.

In Martin Investors, Inc. v. Vander Bie, 269 N.W.2d 868, 874-75 (Minn. 1978), the Minnesota Supreme Court affirmed a finding that a community of interest existed because the franchisor and franchisee each shared in fees from a common source, the eventual borrower, and held that the franchisor’s contractual right to 1 percent of the proceeds of each loan its consultant placed gave it a clear community of interest in the consultant’s marketing of its services. The court rejected the argument that 1 percent of total proceeds was too small to count, explaining that “[t]he statutory definition contains no substantiality requirement.” Martin Investors, 269 N.W.2d at 875. The same opinion shows how broadly the fee element sweeps: an initial $30,000 investment, the 1-percent share of loan proceeds, and the $400 the contract required for each unit of computer service purchased “all constitute a ‘franchise fee’ as that third franchise element is broadly defined in § 80C.01, subd. 9.” Martin Investors, 269 N.W.2d at 875.

Community of interest turns on the parties sharing profits from a common source, not on the fact that a dealer buys goods for resale. In Unlimited Horizon Marketing, Inc. v. Precision Hub, Inc., 533 N.W.2d 63, 66-67 (Minn. Ct. App. 1995), an exclusive distributor paid a manufacturer $15,000 up front for worldwide rights to market the manufacturer’s machine, the court found a community of interest because the parties would “each profit from a common source upon the marketing and sale” of the machines, and it held that the $15,000 payment was a franchise fee as a matter of law. Buying products for resale, standing alone, does not create a franchise, because the purchase of goods at a bona fide wholesale price is excluded from the franchise fee, as the Eighth Circuit applied in Louis DeGidio, Inc. v. Industrial Combustion, LLC, 66 F.4th 707 (8th Cir. 2023).

Registration, Disclosure, and What Happens If You Get It Wrong

If the relationship is a franchise, no one may offer or sell it in Minnesota unless an effective registration statement is on file with the commissioner of commerce, or the franchise or transaction is exempt. Minn. Stat. § 80C.02. The exemptions include the offer or sale of a fractional franchise and a franchisor’s single sale of a non-area franchise during any period of 12 consecutive months, conditioned on no general advertising, escrow of all franchisee fees within two days of receipt, and written notice to the commissioner no later than ten business days before the sale. Minn. Stat. § 80C.03. Those provisions reach your deal when the sale or offer to sell is made in Minnesota, when an offer to purchase is made and accepted here, or when the franchise is to be located here, and an offer directed into Minnesota and received here is made in this state whether or not either party is physically present. Minn. Stat. § 80C.19, subds. 1, 2.

Federal law adds a separate duty: unless the transaction is exempt, you must furnish the current franchise disclosure document at least 14 calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to, you or an affiliate in connection with the proposed franchise sale, and failing to do so is an unfair or deceptive act or practice in violation of Section 5 of the Federal Trade Commission Act. 16 C.F.R. § 436.2(a). A second clock runs on changes: if you unilaterally and materially alter the terms of the basic franchise agreement or a related agreement, you must furnish each revised agreement at least seven calendar days before the prospective franchisee signs it, though changes arising out of negotiations the prospect initiated do not start that period. 16 C.F.R. § 436.2(b). Delivery counts on the day you hand-deliver, fax, email, or provide directions for accessing the document online, and a paper or tangible electronic copy sent by first-class mail must go out at least three calendar days before the deadline. 16 C.F.R. § 436.2(c). Minnesota adds its own delivery rule for a franchise subject to registration: you must present the current public offering statement together with all proposed agreements at least seven days before the prospective franchisee executes any franchise or other agreement or pays any consideration, whichever occurs first, obtain a signed receipt before execution and before payment, and keep that receipt for three years subject to the commissioner’s inspection. Minn. Stat. § 80C.06, subd. 5.

The two systems assign consequences differently. That federal violation is the Commission’s to enforce rather than the franchisee’s, because the FTC Act “nowhere purports to confer upon private individuals, either consumers or business competitors, a right of action.” Holloway v. Bristol-Myers Corp., 485 F.2d 986, 988-89 (D.C. Cir. 1973). A trade regulation rule cannot supply a private remedy Congress withheld, because language in a regulation “may not create a right that Congress has not.” Alexander v. Sandoval, 532 U.S. 275, 291 (2001). The Commission may commence a civil action to recover a civil penalty against a person who violates a rule respecting unfair or deceptive acts or practices with actual knowledge or knowledge fairly implied on the basis of objective circumstances. 15 U.S.C. § 45(m)(1)(A). The franchisee’s own money claim runs through the state statute: a person who violates the Minnesota Franchises Act is liable to the franchisee, who may sue for damages caused thereby, for rescission, or for other relief as the court may deem appropriate. Minn. Stat. § 80C.17, subd. 1.

One practical consequence arrives before any damages case is tried. Irreparable harm to the franchisee is presumed where a person required to register under section 80C.02 fails to register and then violates section 80C.14, the unfair-practices section, which makes an injunction easier for your licensee to obtain. Minn. Stat. § 80C.14, subd. 1.

Recognize this issue before you sign, not after. If you are a manufacturer, a licensor, or a supplier expanding through dealers, price the payment terms, the assistance you promise, and the marks you let the other side use against these definitions while the deal is still on the table.

This article is general information about Minnesota and federal franchise law, not legal advice for any particular situation.

Written by Andrew Hunstad, law clerk.