An issue we’ve seen cropping up with greater frequency — probably because IP brand licenses have become the cannabis deals du jour — is that of the unintended cannabis franchise. The scenario looks something like this: The intended licensee owns a marijuana retail store, and wants to use the branding and operating program of the licensor. The licensor would control not just the branding, but also the marketing and operations of the licensee. This level of control is problematic not only in that it raises true party of interest concerns under various state’s laws, but because it may trigger franchise law compliance issues.
Franchises are regulated by both the U.S. Federal Trade Commission (FTC) and by various state agencies. FTC rules always apply, while state rules generally apply, when either the franchised business or the franchisee is located in the state. Under the FTC’s rules, there are three elements of a franchise:
- The franchisee obtains the right to operate a business that is identified or associated with the franchisor’s trademark;
- The franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation; and
- The franchisee has to make required payments as a condition of obtaining or commencing operation of the franchise.
A quick reading of the FTC’s franchise elements makes them sound a lot like your standard trademark licensing deal. But the difference hinges on the franchisor/licensor’s exertion of control over the franchisee/licensee’s method of operation. In a trademark licensing agreement, the licensor will have some control over the use of the trademark – i.e. what products the mark can be used on, the quality of those products, advertising placement, sizing, color, etc. But in a traditional trademark licensing deal, the licensor will not have control over the licensee’s general business operations – i.e. accounting practices, personnel policies, etc.
With a spike in cross-state licensing deals between cannabis companies that are performing essentially the same function in their respective states, it’s understandable that this distinction is often blurry. In a situation where one retail store aims to license its brand to another retail store in a different state, it makes sense that the licensor would attempt to make the licensee mimic the licensor’s way of branding in every way possible. But this micromanagement of the licensee can land the licensor in trouble with both the FTC and with the state for failure to register as a franchisee.
Franchise registration and franchise law are cumbersome, and should not be triggered unintentionally. Washington’s laws regarding franchises and franchisee rights provide a prime example. A franchisor can be liable for damages to the FTC, to the state, and to the franchisee for failing to follow franchise formalities. See Marijuana Franchising: Don’t Let This Happen to You
And this is not to mention the problems under state law with a non-licensed entity exercising control over a licensed marijuana business. For example, in Washington State, WAC 314-55-035 requires that any person who exercises control of a licensed business must be vetted by the board and qualify under the True Party of Interest requirements. Parties to any licensing deal, whether it crosses the line into franchise territory or not, should be careful not to trigger the state’s True Party of Interest requirements, as an undeclared True Party of Interest is grounds for license cancellation.
So what level of control is typical of a trademark licensing agreement? In any licensing arrangement, protecting the integrity of the mark, as well as maintaining the consistent quality of the brand, is paramount. If a licensor does not exert sufficient control over the quality of the branded goods, its mark could be deemed abandoned or be challenged by either the licensee or a third party. A licensing agreement should stipulate that the licensee’s goods be of at least as good of quality as licensor’s goods. And the licensor should provide strict guidelines for how the mark is used, including how and where to affix the mark to prevent the licensee from creating its own version of the mark – size, spacing, color and typography are all important considerations. The licensor should also be able to routinely inspect the products for quality, and should have access to consumer complaints and reviews.
Finding the balance between control over, and the autonomy of, a trademark licensee is crucial in any IP licensing deal. Protect your brand assets, but be careful not to run afoul of state cannabis laws or state or federal franchise regulations. Far too often our cannabis business lawyers are being brought in on deals that would have caused their participants all sorts of major problems had we not counseled to change their terms. To put it bluntly, lawyers not well-versed in cannabis laws tend to be unaware of the cannabis-specific problems and they tend to let these harmful deals go through.
We have said it before and we will say it again: Don’t let your urge to cross state borders blind you to the very real legal risks of doing so. Be careful out there.