When a trademark or service mark owner grants the right to use its mark to a third party, a license arrangement is typically created. The essential part of that arrangement is that the mark owner exercise quality control over the licensee’s use of the mark, so that the public can reasonably expect some consistent level of quality of the goods or services associated with the mark.
Lack of quality control is known as a “naked license.” Naked licensing can sacrifice the owner’s rights in the mark, when sufficient quality control over the licensee’s use is not maintained.
However, while exercising sufficient quality control in a licensing arrangement (by agreement and by actual monitoring activity), the mark owner should take care not to exercise too much control over the licensee’s operations so as to create a de facto franchise where a franchise was not intended.
Although there is no uniform definition of a franchise at the federal and state levels, the United States Federal Trade Commission (FTC) defines a franchise as any continuing commercial relationship or arrangement that contains three separate elements:
- Right to use a trademark. The franchisor must give the franchisee permission to identify or associate with the franchisor’s trademark, or to offer, sell or distribute goods or services using that trademark.
- The agreement must require that the franchisee pay royalties or fees to the franchisor/trademark owner or an affiliate.
- The franchisor must either impose significant controls over, or offer significant assistance in, the franchisee’s method of operating the business using the trademark.
Regardless of whether the parties intend the arrangement to be a franchise, distributorship, a license or some other relationship, if it meets each of the above three criteria, it will be deemed a franchise or a business opportunity. Such arrangements require certain notice and (in many cases) government filing requirements under state and/or federal law, with penalties for non-compliance.