A client sent us a trademark licensing agreement last week. The client, as the licensee, would be opening up a retail store, but would be using the branding and operations plan of another company, the licensor. Our client would, in effect, be putting money into the operation, but all of the operations and marketing would be directed by the licensor. Alarm bells immediately went off — this wasn’t really a licensing agreement; it was a franchising agreement. Not a huge difference for our client in legal risk, but a giant issue for the licensor/franchisor.
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 3 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.
What distinguishes a trademark license from a franchise, then, is the second point — the level of control. This is a subtle distinction, as trademark licenses all have some restrictions on how the licensee can use the mark that is being licensed so there is always at least a whiff of control. The distinction is one that legal practitioners get a feel for over time. In a trademark agreement, control is centered on the licensee’s use of the mark: don’t use our mark in XYZ way, only use these colors, only use it on these high quality products, etc. The goal of the restrictions is to protect the reputation of the brand. In a franchising agreement, control or guidance is centered on the operations: adopt these specific hours of operation, clean your machines exactly like this, use these accounting procedures, use these personnel policies, etc.
That distinction is easy for companies that are licensing their mark to be used for areas outside of their expertise. When Disney licenses Star Wars trademarks to toy companies, it doesn’t tell the toy company how to operate, it tells the toy company what restrictions go with using the mark. What we see in the cannabis space, however, are companies that are licensing their trademarks for the exact same things that they are currently doing. A retailer in Colorado creates a brand and a following, but that retailer can’t open in Washington State. So, that Colorado retailer licenses its brand across state lines and it mandates use of its operating procedures by the Washington retailer to whom it grants the license. In exchange, the Colorado retailer gets payments from the Washington retailer based either on royalties or as a flat fee. Without regard to whether this sort of deal complies with marijuana regulations, the Colorado company could be in trouble with both the FTC and the state of Washington for not registering as a franchise.
Franchise registration, and franchise law, is why the distinction matters. As an example, take a look at Washington’s laws regarding franchises and franchisee rights. There are bunches of record-keeping requirements, bunches of protections, and bunches of forms that need to be filed. The franchisor can be on the hook for huge damages to the FTC, to the state, and to the franchisee for failing to follow franchise formalities. In general, franchising is a significant and expensive step for a business; not one you want to fall into accidentally.
Bottom Line: if you want to license your marijuana trademark, make sure you don’t go too far on the control side or you may run into big problems down the line. Marijuana franchising: don’t let this happen to you, at least not by accident.