Franchising: The Concept, the History, and the Legal Regulation

Today franchising has come to mean a particular form of licensing of a proprietary trade or service name and/or logotype together with a unique marketing plan most commonly embodied in an "operation manual." Sometimes it is regulated by statute, and sometimes (because of lobbyist influences) it is, for all practical purposes, virtually unregulated, such as in gas stations of a given oil company. We have all come to see what total deregulation can cause as reflected by our present economy.

During the 1980's for a number of years I taught upper division business classes at Michigan State University (400 series classes) in business organizations and contracts. At that time the bulk of my private practice involved setting up new business entities, taking over legal counsel for existing businesses, and "taking their idea on the road" by making it possible to license their concept and name to sell territories to others, "franchising." I also worked in a Wall Street brokerage house for three terms of service and dealt with bonds, trade transactions and speculation accounts.

When at MSU I would begin each term with a story about the subject matter. The franchise concept is considerably older than the entity we now know as a corporation. It began its evolution to what we now know it to be with the ecclesiastical system of the early middle ages This was after the "tribute paying in exchange for law and uniform order" in the outlying provinces of Greece and Rome set an example for the church to follow. The educated people, those who could read and write, were the monks in the monasteries. People came to them for answers. This made them necessary for the fabric of the kingdom to grow. The church broke down territory into provinces, then into archdioceses, dioceses, parishes and chapels. There were traditionally two collection baskets passed during services, the first collection proceeds for keeping the local candles burning, and the second to be sent on to the next rung on the ladder, eventually leading to Rome. In return, the parish, dioceses, etc. got the official sanction of the church as far as the format of the liturgy was up to provide at point in time, inclusive of the Sacraments. Church parishioners could count on a priest marrying them and offering Last Rites when their family members were dying. The three crown Tierra banner of Rome was a "licensed" logo and the unique method of operation which was uniform to all sanctioned churches was made available to all who paid the royalties by way of the second collection. Missionaries went around the world.

Then came the nobility .. the other type of "royalty," who, incidentally, were educated by way of the monastery in nearly all cases. They copied this marketing concept and set out, with church missionaries usually on board, to plant the flag of Spain, Portugal, Holland, France and eventually Great Britain, from India to the New World. The American colonies were in fact English franchises, each with there own franchise contract called a "charter," and each paying royalties base on the produce of their territory.. cotton from the Carolina, tobacco from Virginia, timber from England, sugar from Georgia, etc. Each colony received protection from the native Americans and the French (competing franchise as Burger King is to McDonald's), the use of England's legal system (Virginia's House of Burgess), courts and unique logo type.. the Union Jack flag.

As decades passed and the French and Spanish were no longer threats, and the Indians had either been moved or were otherwise restricted, the question became louder and louder.. 'what exactly are we paying royalties for and how come we don't have representation like other citizens of Britain?' By way of example, in the early 1970's allegedly some licensees felt that their franchiser, Midas Muffler, was doing little to help their network of franchisees and a group of them quit, and, by so doing, were "disenfranchised." They gathered together and formed Tuffy Muffler. They "borrowed" much of the "uniqueness" from their Midas franchise agreement and presumably the "confidential operating manual," made a few changes, replaced the franchise symbol to their yellow logo type "Tuffy" symbol, made a few modifications to their marketing plan, and a new franchise was born. In 1776, the Founding Fathers did the same thing. They took the English common law uniqueness as a marketing plan, added a hint of difference (the Grand Jury, for example, from the left over Dutch system in New York), used a logo type of thirteen stripes with the Union Jack in the upper left corner as a first flag.. and a new franchiser was born, and thirty seven new franchises were later added. "Taxation without representation is tyranny!" [NB: the Civil War was a social and economic attempt at disenfranchisement by fifteen States.]

The churches which came about from the Protestant Reformation, to one degree or another, followed the same basic route as Rome had refined. Today's Mormon Church (LDS), for but one example, employs the tithing system as its royalty structure.

Let me say at this point that the references I use to draw analogies from, such as fast food establishments, muffler shops, and religious institutions, are all offered with due and great respect to each of them. They all have proven themselves over time to be successful and beneficial to the needs of a segment of society.

It All Begins With A Contract

It indeed all begins with a contract. So what is a contract exactly.. we all use the word daily but it is important to understand just what it is.

A contract is a legally enforceable agreement to do or not to do something which is legally possible to do between two or more natural or artificial persons for valid consideration.

Today's modern concept of economic franchising is built on this principal understanding. The "Franchise Contract," more commonly referred to as the "Franchise Agreement," is at the heart of everything. Other than the automobile dealerships, gasoline stations, and other exempt areas that Congress has seen fit to bestow immunity to, the system today is broken up into the "registration" States and the "disclosure" States as far as regulated marketing of investment opportunities is concerned. In registration States these investments are treated as securities, to wit: As "risk capitol," as in stocks and bonds. These States afford their citizens protection from swindlers by taking a SEC (Security and Exchange Commission) approach to the marketing tools being reviewed and registered by the State before being offered to the public. Non compliance results in large fines, sanctions and potential jail time. These States are called "UFOC States" because they have to follow a uniform franchise offering circular strict guideline telling the investor, in plain English, what is contained in the franchise agreement before any contract signing or money changes hands. In non UFOC States, these are called "FTC States" and they follow a method which reflects, in a diluted way as far as investor protection, what the uniform franchise offering circular States mandate. They call it a "disclosure statement." It is not reviewed by the State or anyone other than perhaps the investors lawyer beforehand, and is provided as a notice (of sorts) to the potential investor. It carries with it merely paper type sanctions for any misrepresentation, fraud or deceit which may result which are similar to what the FTC (Federal Trade Commission) might hand out in the form of "penalties." Michigan was the hallmark State when it came to franchise law in the 1970's thru the mid 80's. It was one of the founders of the fifteen UFOC States, and our citizens were among the best protected. As Michigan's economy grew and swindles occurred in the non UFOC jurisdictions, there came a call for the federal government to stop the wave of white collar crime in franchise investment in the other thirty five States. There came the concept of the weak disclosure requirement, due to business lobbyists, becoming law within the FTC. Due to the economic realities and the political persuasions in favor of "deregulation," Michigan no longer requires registration, and hence is no longer a UFOC State by deregulating this marketing method.

The Williams Law Firm has created over sixty franchise entities both in and outside Michigan. We have always built the UFOC guideline structure for our clients as this is the best form of immunity as to after-the-fact claims of fraud and misrepresentation and this measure has always proven effective. No franchise client of our making has ever been challenged on such issues. The rule is: UFOC documents work in all jurisdictions because they provide more disclosure, better financial background, and more documented essentials about the franchiser than do the FTC disclosure State materials. FTC disclosure statements only work in FTC States. Ours work in all and bring about less chance of claims of misrepresentation and fraud which tax the entire franchise network when such occurs.

So why not create one document rather than two? Why not create a healthier network if your motivation is not just to get rich quickly?

Our businesses which have chosen licensed others to use their protected trade/service marks and marketing plans are among those who provide goods or services in a uniform fashion. We also represent national and international franchisee associations in their representation efforts to broaden and evolve the franchiser with the changing of times and in the face of marketing competition. On rare occasion we have been "in house counsel" or certain entities but as a rule, but due to our position as a Michigan law firm, we prefer to train local counsel to what must be done for the sake of compliance and network diplomacy.

The time frame of developing a franchise varies from six months to perhaps a year because of issues necessary to licensing, to wit: ownership of the trade/service names, on a national or international level at the Office of Patents and Trademarks in Washington, D.C. before the same can be licensed for use by others. Also, certified tax statements at the highest grade, need to be secured, manually signed and included. We use experience artists to do the bristol board mock ups for the trade/service mark submissions, search via specialized companies for similar or conflicting names and marks nationwide, and arrange when necessary for entities to act as agents for the receipt of service of process in States which we will wish to market in. The price for our legal service varies based upon what aspirations come to us and the ability to fund a structure once the engine is completed. Usually this is in the fifty to one hundred thousand dollar range but, again, this varies with the particulars. Some successful franchisers initially came to us without themselves being incorporated.

In matters of franchising an existing business, we usually meet with potential clients three times, each time for an hour or so, without charge. Most existing businesses choose to set up a "sister" entity so as to keep safe their existing business as a "company run" entity, perhaps where franchisee training will occur. The sister entity then will become the marketing company (as GMAC is to GM, for example) and in fact will be the franchiser.

We also employ in house development by use of Michigan's Blue Sky Act which regulates the offer and sale of securities by use of exemptions such as the Section 402 b (9) (D) 2 and b (10) (if a to-be corporation or if re-incorporation is desirable) to legally raise investment capital beforehand without having to register stock prior to bring in new money to fund the expansion effort. This service is a separate legal matter with respect to retention.

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