The “Hidden Franchise”
Most business leaders know – or think they know – when they are part of a franchise relationship. For franchisees, they have typically either responded to an advertisement offering the public a chance to purchase a franchise or have engaged a franchise consultant to help find the right franchise opportunity for them. For franchisors, their entire business is often structured around selling franchises. Moreover, franchisors and franchisees typically sign a document with the words “Franchise Agreement” prominently displayed at the top. In short, in a traditional franchise relationship, the franchise is obvious to all parties.
Sometimes, however, businesses and individuals can find themselves part of a “hidden franchise” – a business relationship that does not check all the boxes for being a stereotypical franchise, but nonetheless is considered to be a franchise under New Jersey or other state law. This is the essence of the “hidden franchise.” Indeed, retailers, distributors, authorized dealers, and suppliers across the country may be in a “hidden franchise” relationship, even despite language in their business contracts specifically stating the relationship is not a franchise.
Why does it matter if your business is a franchise?
The “franchise” designation has very real consequences. For example, under New Jersey law, a franchisor generally cannot terminate a franchisee without good cause and proper notice, even where terminating the franchisee would be perfectly acceptable under the parties’ contract. For example, if an authorized paint dealer of a paint brand is abruptly terminated as an authorized dealer, that dealer may have legal recourse against the paint manufacturer. New Jersey franchise law – known as the New Jersey Franchise Practices Act -- also generally prohibits a franchisor from imposing “unreasonable standards of performance” on a franchisee. Accordingly, this law can be a powerful tool for those businesses that fall under its umbrella.
Are you part of a “hidden franchise”?
Hidden franchises can appear in virtually any industry where products or services are sold using a network of independent businesses, including, for example: packaged goods, jewelry, technology, general retail, and automotive. The following are the general requirements to be a protected “franchise” under the New Jersey Franchise Practices Act:
a “written arrangement” between the franchisor and franchisee;
the grant of a “license” of intellectual property by the franchisor to the franchisee
a “community of interest” between the franchisor and franchisee;
the contemplation or requirement that the franchisee would establish or maintain a New Jersey “place of business”
more than $35,000 in annual gross sales of the franchisor’s products by the franchisee; and
generally, more than 20% of the franchisee’s gross sales from the franchise
Notably, there is nothing in the above requirements that says a franchise relationship must be publicly or privately considered to be a franchise, even by the parties themselves.
Rauchway Law has extensive experience with “hidden franchises,” having represented businesses who seek the protections of the New Jersey franchise law, as well as those who seek to avoid the law’s reach. Ms. Sverdlov has also been published in the New Jersey Law Journal and presented on the implications of the “hidden franchise” in New Jersey to other attorneys.