The Brevard Technical Journal

Beanstalks and Franchises
BY Joel I. Rosenblatt

Everyone knows The Beanstalk, as in “Jack and the.” No copyrights or patents here; the original seed and its genetics have been lost for ages. As the story went, Jack (a foolish boy), funded and instructed by his mother (a venture capitalist), went in search of a milk cow. On the way he met with an evil doer (in today’s legal parlance, a fraud), who convinced Jack to spend his (really his mother’s) capital on the Beanstalk franchise. It was a turnkey operation as all Jack had to do was plant the seeds (mother took care of that, throwing Jack and the seeds out), and climb the stalk.

As things turned out, there was something to the Beanstalk franchise. The operation turned out to be a stairway or vine way to the Giant’s kingdom and (I think) a chicken that laid solid gold eggs (or maybe that was a duck or goose or turkducoose). While Jack got the first franchise, we are never told if Jack was given a one of a kind opportunity or there were other Jacks and Giants.

Assuming Jack’s venture was one of a kind, and for that reason, was not a true franchise and would not come under the Federal Trade Commission Rules expressly written to protect franchisees. To the FTC, a franchise means a commercial relationship where a franchiser engages with a franchisee to sell the franchiser’s trademarked products or provide services or sell the products of other suppliers, under the franchiser’s service mark. For example, think of an illustrative clothing store with the mark “The Jean’s Place.” It sells men’s and women’s casual clothing made by other suppliers. That’s a service mark because it is in the business of providing retail services.

As those who regularly read this column will know (and not have forgotten), for a trade or service mark owner to allow an arm’s length party to use its mark (as in license where the arm’s length party becomes the licensee, leaving our franchiser with the title of licensor), it must control the quality of the products or services provided with that mark. That’s a license.

What makes a franchise different from an ordinary license is the franchiser’s authority to exert a significant degree of control over the franchisee's method of operation, including but not limited to, the franchisee's business organization, promotional activities, management, marketing plan, or business affairs, or the franchiser gives significant assistance to the franchisee in the method of operation, including, but not limited to, the franchisee's business organization, management, marketing plan, promotional activities, or business affairs.

What makes a franchise a money maker for the franchiser (not the case in Jack’s fable), is the legal duty placed on the franchisee to pay an initial and a continuing franchise fee for the “significant” assistance in business management, or to purchase the franchise equipment and goods from the franchiser.

If the franchise is a Midas Mufflers shop, selling genuine Midas products and providing genuine Midas service, and where the franchiser extensively advertises, the mark is well known. However, and as we know, franchisers sometimes oversell the franchise and do not meet its franchiser commitments. It may be innocent or by deceit. Franchisers, as a rule, are self-prejudiced, always thinking the franchise will “take off.” There is no other option. While our free market proponents will say the franchise market if left to itself, will be self regulating, it has no record. Given the likely franchisee prospect, likely with minimal or negligible business experience, looking to a franchise to provide startup and operations expertise, the franchise has the information and the prospective franchisee is an open book with blank pages. This is not a good situation where swindles, frauds, and cheats, may prosper. After all, if the cheats gets the honest but simple prospects money, there will be nothing remaining for the “good franchiser.”

While some states, but not all, have franchising laws, Florida, one of the states that may have as many fraudulent franchise schemers as any other, has a franchise law. The Florida Franchise Act (FFA) covers franchises of goods and services, but for services, is limited to the services as a component of franchiser's distribution system and where the operation of the franchisee's business franchise is substantially reliant on franchisers for the basic supply of goods. That would be a Midas, Burger King, or a Dunkin’ Donuts, franchise. Limited to civil remedies, it makes the unhappy franchisee meet a criminal law like burden of demonstrating intentional misrepresentation. Compare that to the first degree misdemeanor penalties for falsely holding oneself out as having a degree from an accredited institution, while franchisees in used and new farm equipment get special protection from their franchisers.

Now for the true story. It happened in the restaurant business where a specialty diner, operating with fair success, was considered ripe for “franchising.” The franchise value was in the service mark and intellectual property in the trade secrets, recipes, menus, and confidential information, including a confidential operations manual. Because there was only one restaurant and in the initial franchise, the franchisee got the assets, a sublease of the premises and a license to use the mark. That was over a year ago and no other franchises have been sold, leaving a franchise of one (1) franchisee. That would be an ordinary license and not a franchise, except the franchisee has franchiser assistance and franchisee control written into the agreement. There was no supply contract and franchisee was not restricted to any supplier or brands.

There was only one problem. The franchiser represented there was an application for the mark, pending at the U.S. Patent & Trademark Office, and there was none. Under the Florida Franchise Act, that would be a “knowing misrepresentation.” Anywhere else, with or without a franchise act, couple an explicit statement made in an agreement signed by the franchiser, and it’s hard to argue it is not a statement made with knowledge or in reckless disregard of the truth. I don’t think specific intent to deceive is required or if it is it may be implied by conduct. Or the franchiser could have relied on the Kenny Boy Lay (of Enron) defense: he relied on his accountants and managers.

But there’s worse yet. Except for a few hours it took for the franchiser to show the new franchiser how to order prepackaged meal packs and their use in food preparation, there was no management services and none of the information was anywhere near confidential or amounted to intellectual property.

Here’s the predicament. The franchisee paid over $400,000 for the franchise and got nothing in return he could not have purchased as an operating restaurant management for about $100,000, without the franchise agreement and the ongoing license fees. Now he was caught. If stopped paying the license fees, the franchiser would say “breach.” If the franchisee continued, the rightful owner of the mark would say “infringement”. What could the franchisee do?
What’s the answer? We all know it. Call an attorney at law, to sort it out -- something our franchisee should have done at the beginning. But then again, the attorney would have spotted the fraud and there would be no story.

Mr. Rosenblatt, a Registered Patent Attorney with the U.S. Patent and Trademark Office, practices in the e commercial law of technology and the Internet and the law of patents, trademarks, and copyrights. He is a Florida Supreme Court Certified Mediator, a Florida Bar Certified Approved Mediator for Computer Law Disputes, and is admitted to the Northern, Middle, and Southern, U.S. District Courts for Florida. Any questions or comments may be directed to Mr. Rosenblatt at (321) 727-7626; FAX: (321) 821-1922 or by email to jirosenblatt@earthlink.net. Past articles may be viewed at http://www.joelirosenblatt.com