Is This a Franchise, or Not?

One of the challenges commonly facing franchise lawyers is that there are several definitions of the term “franchise.” Regardless of whether the parties intend to establish a franchise relationship, if the relationship legally is deemed a “franchise,” certain federal and state laws may apply. However, the definition of “franchise” often varies from statute to statute, and it may be difficult to determine whether a particular statute applies.

For example, one of the typical definitional elements of a franchise for purposes of franchise registration law is that the franchisor must prescribe or suggest a marketing plan to the franchisee. On the other hand, under many of the franchise relationship laws, which govern franchisor's obligations upon termination of franchisee rights under the franchise relationship (among other issues), a critical definitional element of the term “franchise” often is that there must be a “community of interest” between the franchisor and franchisee. This is true under many of the general franchise relationship laws, and is also an element of a franchise under relationship laws governing specific industries.

To add to the challenge, unfortunately, often these definitional elements are vague and undefined, making it most difficult to determine whether a particular relationship will be deemed a franchise.

A 'Community of Interest'

The issue came up recently in C.N. Wood Company Inc. v. Labrie Environmental Group and Sanitary Equipment Co., Bus. Franchise Guide (CCH) '15,155 (D. Mass., June 5, 2013), which attempted to establish what exactly is meant by “community of interest.” In Wood , the putative franchisee sold and serviced products sold by the alleged franchisor. The putative franchisor terminated the relationship without notice or cause. The question was whether the alleged franchisor wrongfully terminated the relationship, which in turn turned on whether the relationship was a franchise governed by the Massachusetts Motor Vehicle Act. The Act requires a “community of interest” for the relationship to be considered a franchise. However, the relationship statutes failed to flesh out what this term means. No Massachusetts courts had yet interpreted the term, so the Wood court looked for guidance from judicial decisions in states with similar language in their franchise relationship statutes.

Looking first to New Jersey law, the Wood court noted that the Third Circuit determined that “community of interest” hinged on the degree of control over the potential franchisee, holding that “community of interest” required more than the “mere fact that the two parties share in the profits realized when a product makes its way from manufacturer to the ultimate consumer.” Colt Indus. Inc. v. Fidelco Pump & Compressor Corp., 844 F.2d 117, 120 (3d. Cir. 1988). Rather, for a community of interests to exist, the dealer/putative franchisee had to demonstrate that the dealer was “subject to the whim, direction and control of a more powerful entity whose withdrawal from the relationship would shock a court's sense of equity.”

The New Jersey Supreme Court took a similar approach in Instructional Sys. Inc. v. Computer Curriculum Corp., 130 N.J. 324 (1992), in which the court looked at the interdependence of the parties and the licensor's control over and the licensee's dependence on the licensor. The court further noted that for a community of interest to exist, the franchisee must make “such a significant investment in the franchise as to grant essentially all of the controlling power in the relation to the franchisor.”

The Wood court also looked at Wisconsin law in reaching its decision. As with the Massachusetts Motor Vehicle Act, the Wisconsin Fair Dealership Law also contains the term “community of interest.” Because the Wisconsin Act only contains a “vague and unhelpful” definition of the term, courts have established their own standards in determining whether parties share a community of interest, looking at the interdependence between the two parties, whether they share common goals, and whether the dealer (franchisee)'s financial health would be threatened if the dealer's relationship with the supplier were terminated.

The Wood court also believed that Wisconsin law required the franchisor to be able to hold the dealer “over a barrel” and be subject to exploitation at the hands of the supplier in order for there to be a community of interest. See , Home Proective Servs. v. ADT Sec. Servs., Inc., 348 F. Supp. 2d 1010, 1014 (E.D. Wis. 2004).

Ultimately, the Wood court concluded that the community of interest test in its case had not been met since only 10% of the putative franchisee's annual gross sales came from the alleged franchisor's products. Also, the relationship had lasted over six years, giving the putative franchisee the opportunity to recover its investment. Additionally, the putative franchisee carried competitor's products, and its equipment space was not restricted for use only with the purported franchisor's products.

Different Facts, Different Outcome

The court hearing Wholesale Partners, LLC. v. Masterbrand Cabinets Inc., Bus. Franchise Guide (CCH) '15,136 (E.D. Wis. Oct. 4, 2013), was not as convinced as the Wood court that a community of interest did not exist under the Wisconsin Fair Dealership Law. In this case, the plaintiffs had bought its business from a third party. Within a year, the supplier terminated the relationship without advance notice. Nor did the supplier point to any problems that would have given the supplier grounds for termination. According to the court, a community of interest may exist under one of two circumstances: 1) when a large proportion of an alleged dealer's revenues are derived from the dealership; or 2) when the alleged dealer has made sizable investments specialized to the grantor's goods or services, and thus not fully recoverable when the relationship terminates. Here, the court determined that a dealership relationship could exist as, unlike in Wood, 43% of the dealer's revenues related to sales of the alleged franchisor's products. In addition, the dealer had made substantial investments in goods, inventory, fixed assets, advertising and training that were customized to the alleged franchisor's product line. As such, a genuine issue of material fact existed; the court therefore denied motions for summary judgment filed by both of the parties.

Conclusion

Although there may be some guidance in these cases based on the degree of reliance the franchisee's business has on the franchisor, neither of these cases gives clear vision as to what a “community of interest” is. Thus the battle between dealers' and suppliers' rights and obligations in Wisconsin and Massachusetts continues, leaving the business world in a state of uncertainty in these jurisdictions as to whether a franchise relationship exists between litigating parties.

Rupert M. Barkoff is head of the franchise practice at Kilpatrick, Townsend & Stockton. He is a former chair of the American Bar Association's Forum on Franchising, and co-editor-in-chief of Fundamentals of Franchising, a primer on franchise law. He can be reached at [email protected] or 404-815-6366. Lindsay A. Victor is an associate with Kilpatrick, Townsend & Stockton and can be reached at [email protected] or 202-508-5860.

One of the challenges commonly facing franchise lawyers is that there are several definitions of the term “franchise.” Regardless of whether the parties intend to establish a franchise relationship, if the relationship legally is deemed a “franchise,” certain federal and state laws may apply. However, the definition of “franchise” often varies from statute to statute, and it may be difficult to determine whether a particular statute applies.

For example, one of the typical definitional elements of a franchise for purposes of franchise registration law is that the franchisor must prescribe or suggest a marketing plan to the franchisee. On the other hand, under many of the franchise relationship laws, which govern franchisor's obligations upon termination of franchisee rights under the franchise relationship (among other issues), a critical definitional element of the term “franchise” often is that there must be a “community of interest” between the franchisor and franchisee. This is true under many of the general franchise relationship laws, and is also an element of a franchise under relationship laws governing specific industries.

To add to the challenge, unfortunately, often these definitional elements are vague and undefined, making it most difficult to determine whether a particular relationship will be deemed a franchise.

A 'Community of Interest'

The issue came up recently in C.N. Wood Company Inc. v. Labrie Environmental Group and Sanitary Equipment Co., Bus. Franchise Guide (CCH) '15,155 (D. Mass., June 5, 2013), which attempted to establish what exactly is meant by “community of interest.” In Wood , the putative franchisee sold and serviced products sold by the alleged franchisor. The putative franchisor terminated the relationship without notice or cause. The question was whether the alleged franchisor wrongfully terminated the relationship, which in turn turned on whether the relationship was a franchise governed by the Massachusetts Motor Vehicle Act. The Act requires a “community of interest” for the relationship to be considered a franchise. However, the relationship statutes failed to flesh out what this term means. No Massachusetts courts had yet interpreted the term, so the Wood court looked for guidance from judicial decisions in states with similar language in their franchise relationship statutes.

Looking first to New Jersey law, the Wood court noted that the Third Circuit determined that “community of interest” hinged on the degree of control over the potential franchisee, holding that “community of interest” required more than the “mere fact that the two parties share in the profits realized when a product makes its way from manufacturer to the ultimate consumer.” Colt Indus. Inc. v. Fidelco Pump & Compressor Corp., 844 F.2d 117, 120 (3d. Cir. 1988). Rather, for a community of interests to exist, the dealer/putative franchisee had to demonstrate that the dealer was “subject to the whim, direction and control of a more powerful entity whose withdrawal from the relationship would shock a court's sense of equity.”

The New Jersey Supreme Court took a similar approach in Instructional Sys. Inc. v. Computer Curriculum Corp., 130 N.J. 324 (1992), in which the court looked at the interdependence of the parties and the licensor's control over and the licensee's dependence on the licensor. The court further noted that for a community of interest to exist, the franchisee must make “such a significant investment in the franchise as to grant essentially all of the controlling power in the relation to the franchisor.”

The Wood court also looked at Wisconsin law in reaching its decision. As with the Massachusetts Motor Vehicle Act, the Wisconsin Fair Dealership Law also contains the term “community of interest.” Because the Wisconsin Act only contains a “vague and unhelpful” definition of the term, courts have established their own standards in determining whether parties share a community of interest, looking at the interdependence between the two parties, whether they share common goals, and whether the dealer (franchisee)'s financial health would be threatened if the dealer's relationship with the supplier were terminated.

The Wood court also believed that Wisconsin law required the franchisor to be able to hold the dealer “over a barrel” and be subject to exploitation at the hands of the supplier in order for there to be a community of interest. See , Home Proective Servs. v. ADT Sec. Servs., Inc., 348 F. Supp. 2d 1010, 1014 (E.D. Wis. 2004).

Ultimately, the Wood court concluded that the community of interest test in its case had not been met since only 10% of the putative franchisee's annual gross sales came from the alleged franchisor's products. Also, the relationship had lasted over six years, giving the putative franchisee the opportunity to recover its investment. Additionally, the putative franchisee carried competitor's products, and its equipment space was not restricted for use only with the purported franchisor's products.

Different Facts, Different Outcome

The court hearing Wholesale Partners, LLC. v. Masterbrand Cabinets Inc., Bus. Franchise Guide (CCH) '15,136 (E.D. Wis. Oct. 4, 2013), was not as convinced as the Wood court that a community of interest did not exist under the Wisconsin Fair Dealership Law. In this case, the plaintiffs had bought its business from a third party. Within a year, the supplier terminated the relationship without advance notice. Nor did the supplier point to any problems that would have given the supplier grounds for termination. According to the court, a community of interest may exist under one of two circumstances: 1) when a large proportion of an alleged dealer's revenues are derived from the dealership; or 2) when the alleged dealer has made sizable investments specialized to the grantor's goods or services, and thus not fully recoverable when the relationship terminates. Here, the court determined that a dealership relationship could exist as, unlike in Wood, 43% of the dealer's revenues related to sales of the alleged franchisor's products. In addition, the dealer had made substantial investments in goods, inventory, fixed assets, advertising and training that were customized to the alleged franchisor's product line. As such, a genuine issue of material fact existed; the court therefore denied motions for summary judgment filed by both of the parties.

Conclusion

Although there may be some guidance in these cases based on the degree of reliance the franchisee's business has on the franchisor, neither of these cases gives clear vision as to what a “community of interest” is. Thus the battle between dealers' and suppliers' rights and obligations in Wisconsin and Massachusetts continues, leaving the business world in a state of uncertainty in these jurisdictions as to whether a franchise relationship exists between litigating parties.

Rupert M. Barkoff is head of the franchise practice at Kilpatrick, Townsend & Stockton. He is a former chair of the American Bar Association's Forum on Franchising, and co-editor-in-chief of Fundamentals of Franchising, a primer on franchise law. He can be reached at [email protected] or 404-815-6366. Lindsay A. Victor is an associate with Kilpatrick, Townsend & Stockton and can be reached at [email protected] or 202-508-5860.