Companies enter into trademark license agreements, supply agreements and branded distribution arrangements every day without giving franchise law a second thought. That can be a costly mistake.
Under the Federal Trade Commission ("FTC") Franchise Rule (16 C.F.R. §§ 436 and 437), a commercial arrangement that checks the following three boxes is a franchise, no matter what the parties call it:
(1) a grant of rights to use a trademark;
(2) payment of a required fee; and
(3) significant control or assistance over the method of operation.
A web of state franchise statutes typically apply the same three-part test, although tests under certain state franchise statutes (such as New Jersey, Minnesota and Hawaii) vary with additional or alternative prongs.
Note that a conventional trademark license will typically satisfy the first two elements (a grant of trademark rights and payment of a required fee) but not the third. That said, quality-control impositions by a trademark owner — which are not themselves treated as method-of-operation controls — can sometimes unwittingly cross the line into broader operational control, and a "licensee" could later seize on that overreach to argue that the arrangement is actually an unregistered or undisclosed franchise sale.
That can be problematic for a number of reasons. First, courts have shown zero sympathy for licensors who plead ignorance when it comes to their so-called license or other business arrangement being deemed a franchise, and franchise statutes can impose strict liability. The FTC can seek injunctive relief and civil penalties, and, in some states, an accidental franchise can constitute a misdemeanor or even a felony.
Civil claims against an accidental franchisor can include fraud, deceptive trade practices, and rescission, and plaintiffs can seek monetary damages and other types of relief. Rescission is especially dangerous for a licensee, as one adverse ruling can destabilize an entire network of similarly situated dealers or licensees. Even officers, directors and outside counsel may face personal and joint and several liability under state franchise laws.
Furthermore, the risk is growing. In July 2024, the FTC signaled heightened scrutiny on multiple fronts by publishing: (1) guidance declaring undisclosed "junk fees" unlawful, (2) a policy statement warning that gag clauses restricting franchisee communications with the government are unfair and unenforceable, and (3) an Issue Spotlight cataloging the top 12 franchisee complaints.
The agency also raised the Franchise Rule's monetary exemption thresholds. On the legislative side, the proposed Franchise Freedom Act and the American Franchise Act would expand the FTC's authority to include a private right of action for disclosure violations. As of the date of this Alert, neither bill has passed, but their principles are showing up at the state level: California, for example, recently added annual registration and pre-sale disclosure requirements for franchise brokers, effective July 2026.
With all of this in mind, practitioners drafting license, supply and branded distribution agreements need to stay alert to the franchise tripwire. Here are five tips to help you do exactly that.
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"The Accidental Franchise Trap — Five Drafting Tips for Keeping Your Commercial Agreements Out of Franchise Territory," by Charles S. Marion, Jeffrey R. Richter, and Alexander J. Dondershine was published in Westlaw Today and Reuters Legal on September 24, 2026.