INTERNATIONAL FRANCHISE ASSOCIATON

ANNUAL LEAGAL SYMPOSIUM

MAY 2002

FRANCHISE DEFINITIONS AND INTELLECTUAL PROPERTY ISSUES

by
VAN ELMORE

The following is a summary of franchise definitions under US federal and state law and of certain types of intellectual property issues commonly occurring in franchising. This is intended as an introductory overview for those who are new to the subject of franchising or who are looking for basic review.

FRANCHISE DEFINITIONS

Federal Trade Commission Rule on Franchises and Business Opportunity Ventures

“(a) The term “franchise” means any continuing commercial relationship created by any arrangement or arrangements whereby:

(1)(i)(A) A person (hereinafter “franchisee”) offers, sells, or distributes to any person other than a “franchisor” … goods, commodities, or services which are:

(1) Identified by a trademark, service mark, trade name, advertising or other commercial symbol designating another person …; or

(2) Indirectly or directly required or advised to meet the quality standards prescribed by another person … where the franchisee operates under a name using the trademark, service mark, trade name, advertising or other commercial symbol designating the franchisor: and

(B)(1) The franchisor exerts or has authority to exert a significant degree of control over the franchisee’s method of operation, including but not limited to, the franchisee’s business organization, promotional activities, management, marketing plan or business affairs; or

(2) The franchisor gives significant assistance to the franchisee in the latter’s method of operation, including, but not limited to, the franchisee’s business organization, management, marketing plan, promotional activities, or business affairs; Provided, however,
That assistance in the franchisee’s promotional activities shall not, in the absence of assistance in other areas of the franchisee’s method of operation, constitute significant assistance.

(2) The franchisee is required as a condition of obtaining or commencing the franchise operation to make a payment or a commitment to pay to the franchisor, or to a person affiliated with the franchise.” Emphasis added. (Note that the Rule exempts payments that total less than $500 made at any time up to 6 months after commencing operation of the business.)

Typical State Law Definitions

Sixteen states (including Florida) have laws pertaining to offers and sales of franchises. They are listed in Appendix I. There are two typical patterns of definition in state franchise statutes: the “marketing plan or system” definition and the “community of interest” definition. These generally have in common definitional elements including use of the franchisor’s trade identity and payment of something that amounts to a franchise fee but differ on the third element of the definition.

Marketing Plan or System–California

“‘Franchise’ means a contract or agreement, either expressed or implied, whether oral or written, between two or more persons by which:

(1) A franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor: and

(2) The operation of the franchisee’s business pursuant to such plan or system is substantially associated with the franchisors’ trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the franchisor or its affiliate; and

(3) The franchisee is required to pay, directly or indirectly, a franchise fee.”

Community of Interest–Minnesota

“‘Franchise’ means (a) a contract or agreement, either express or implied, whether oral or written, for a definite or indefinite period, between two or more persons:

(1) by which a franchisee is granted the right to engage in the business of offering or distributing goods or services using the franchisor’s trade name, trademark, service mark, logotype, advertising, or other commercial symbol or related characteristics;

(2) in which the franchisor and franchisee have a community of interest in the marketing of good or services at wholesale, retail, by lease, agreement, or otherwise; and

(3) for which the franchisee pays, directly or indirectly, a franchise fee ….”

(Emphasis added.)

Remember, not all state law definitions are alike or even fit these standard patterns. Virginia for example does not have a franchise fee requirement and New York has a unique definition that includes only a trademark element and the payment of a franchise fee.

A community of interest generally depends upon a finding that the agreement between licensor and licensee created a common financial interest. A marketing plan or system determination is generally based on the existence of business operations that appear to the public to be a single commercial system or that are characterized by general business controls or assistance.

The trap for the unwary lies in the fact that the definitions cover not only what we commonly think of as a franchise–a business format or package arrangement like McDonalds–but also what is described as a product and trade name franchise–dealers, distributors, or licensees who sell a product belonging to another and use the name, marks, advertising, or other elements of the trade identity. Courts have been prone to interpret the
definitions very broadly and consequently, many inadvertent franchises have been found.

Some Case Examples

The U.S. Appeals Court for the 6th Circuit held that a roofing systems manufacturer had not sold a franchise under the Michigan Franchise Investment Law because there was no direct or indirect franchise fee as defined by the statute. The required initial training was free, subsequent training was optional and advertising activity was not required.

The U.S. District Court in California found that a medical equipment distributor did not operate under a marketing plan that was prescribed by “Futrex”, the purported franchisor. Futrex did provide marketing and promotional materials, but the distributor was not required to follow the materials. All other decisions regarding sales, marketing, merchandising and packaging of various types of equipment were all within the sole discretion of the distributor.

BUSINESS OPPORTUNITY DEFINITIONS

Twenty-five states have laws regulating offers and sales of what are described as business opportunities or seller assisted marketing plans. They are listed in Appendix I.

These laws are directed at arrangements that fall short of franchises but are characterized by the presence of a marketing arrangement in which i) products, equipment, supplies, or services are sold or leased; ii) to enable the buyer to start a new business; iii) the seller makes one or more of the following representations: (a) the seller will provide or assist the buyer in obtaining locations, accounts, customers, or other markets; (b) the seller will, or is likely to, purchase the products the buyer produces or grows; (c) the buyer will, is likely to, or can earn more than the buyer pays to the seller; or (d) the seller will refund all or part of the buyer’s investment if the buyer is dissatisfied.

Although the requirements applicable to business opportunities as defined under the FTC Rule are the same as those applicable to franchises under the Rule, the business opportunity and seller assisted marketing plan laws in the 25 state laws typically impose registration and disclosure requirements that are less onerous than those applicable to franchises, but also frequently control the substantive terms of the relationship and impose bonding requirements.

Federal Trade Commission Rule Definition

“(A) A person … offers, sells, or distributes to any person other than a `franchisor’ …
goods, commodities, or services which are:

(1) Supplied by another person (hereinafter ‘franchisor’) or

(2) Supplied by a third person … with whom the franchisee is directly or indirectly advised to do business by [the franchisor] where such third person is affiliated with the franchisor; and

(B) The franchisor:

(1) Secures for the franchisee retail outlets or accounts for said goods, commodities, or services; or

(2) Secures for the franchisee locations or sites for vending machines, rack displays, or any other product sales display used by the franchisee in the offering, sale, or distribution of said good, commodities, or services, or

(3) Provides to the franchisee the services of a person able to secure the retail outlets, account, site or locations …; and

(4) The franchisee is required as a condition of obtaining or commencing the franchise operation to make a payment or a commitment to pay to the franchisor, or to a person affiliated with the franchise.” (Note that the Rule exempts payments that total less than $500 made at any time up to 6 months after commencing operation of the business.)

(Emphasis added.)

State Business Opportunity or Seller Assisted Marketing Plan Statutes–The Nebraska Example

“Seller-assisted marketing plan shall mean the sale or lease or offer for sale or lease of any product, equipment, supplies, services, license, or any combination thereof which will be used by or on behalf of the purchaser to begin or maintain a business when:

(1) The seller of the plan has advertised or in other manner solicited the purchase or lease of the plan;

(2) The purchaser makes or will become obligated to make a total initial payment of an amount exceeding five hundred dollars; and

(3) The seller has represented directly or indirectly or orally or in writing that:

(a) The seller or a person recommended or specified by the seller will provide the purchaser with or assist the purchaser in finding locations for the use or operation of vending machines, vending routes, display racks, display cases, or other similar devices on premises neither owned nor leased by the seller of the purchaser;

(b) The seller or a person recommended or specified by the seller will provide the purchaser with or will assist the purchaser in finding outlets or accounts for the purchaser’s products or services;

(c) The seller or a person specified by the seller will or is likely to purchase any or all of the products made, produced, fabricated, grown, bred, or modified by the purchaser using, in whole or in part, the products, supplies, equipment, or services which were initially sold or leased or offered for sale or lease to the purchaser by the seller;

(d) The purchase will, is likely to, or can derive income from the business which exceeds the initial payment paid by the purchaser for participation in the plan;

(e) There is a market for the product, equipment, supplies or services which were initially sold or leased or offered for sale or lease to the purchaser by the seller;

(f) The seller will refund all or part of the initial payment paid to the seller or will repurchase any of the products, equipment, or supplies provided by the seller of a person recommended or specified by the seller, if the purchaser is dissatisfied with the
business; or

(g) The seller or a person recommended or specified by the seller will provide advice or training pertaining to the sale of any products, equipment, supplies, or services or use of any licensed material and the advice or training includes, but is not limited
to, preparing or providing (i) promotional literature, brochures, pamphlets, or advertising materials, (ii) training regarding the promotion, operation, or management of the seller-assisted marketing plan, or (iii) operational, managerial, technical, or financial guideline or assistance.”

(Emphasis added.)

The Nebraska statute has very inclusive regulatory definitions. But business opportunity laws generally apply wherever locations or accounts are provided or suggested either by the seller or a source it refers or identifies and the represents that the buyer will make money or receive a refund from the seller.

APPLYING THE DEFINITIONS: IDENTIFYING TROUBLESPOTS

The unique meaning of “prescribed” or “required”.

Despite the seemingly plain meaning of the words “required” and “prescribed” which are part of the definitional elements in most franchise and many business opportunity statutes, courts and regulators have not given those terms a strict meaning. Instead, franchise and business opportunity laws have been held to apply where actual use or expenditure occurs because of practical necessity or desirability. The fact that use of a particular method or procedure suggested by the manufacturer is so desirable or so pervasive throughout the distribution system can be the basis for a finding that it is required or prescribed.

Significant control or assistance; marketing plan or system or community of interest.

If the licensee relies on the licensor’s business expertise to assist in the operation of thebusiness or if the licensor has a right to dictate or advise the licensee on significant aspects of the business operations, the “significant control or assistance” element of the FTC Rule may be satisfied. Similarly, a finding of a community of interest or presence of a marketing plan or system can be based upon the manufacturer’s right to control or advise regarding
operational or managerial aspects of the business.

Centralized management and uniform standards are hallmarks of the existence of a franchise. Under many state laws, the fact that separately owned and operated businesses all appear to be part of a single chain can be the basis for a finding of the existence of a
marketing plan or system or a community of interest.

Some contractual provisions commonly found in license agreements that may inadvertently fulfill these requirements include:

• Specified production techniques
• Required accounting practices, procedures, or methods
• Personnel requirements
• Providing or designating promotional materials or advertising
• System wide promotional campaigns
• Restrictions on customers
• Locations or sale area restrictions
• Training programs, courses, or manuals
• Management advice or direction
• Marketing assistance or controls
• Providing operating manuals with general business advice or controls
• Price controls
• Restrictions on or designation of payment or credit terms or practices
• Designating warranties and representations to be made to customers
• Detailed instructions for product or service presentation
• Designated or suggested advertising materials or programs, signs, sales pitches,sales kits, sales aids, films, demonstration kits
• Required or permitted use of certain suppliers
• Required use of particular fixtures or equipment

Franchise Fee.

The definition of the term “required fee” quite frequently has been found to include expenditures that are a practical necessity. For example, if certain equipment is required to produce the goods and that equipment can only be obtained from the licensor or its affiliate, there could be a basis for finding that a franchise fee has been paid.

Although payments for reasonable amounts of inventory purchased at bona fide wholesale prices are generally exempted, required purchases of goods for which there is no determinable bona fide price or that are not required to fulfill the purpose of the contract or that must be purchased in quantities greater than required to meet resale or production needs can all form the basis for finding that a franchise fee has been paid.

Under state statutes, it is not uncommon for a finding that a franchise fee has been paid to be based upon:

• Rental payments for real property or equipment
• Deposits
• Training fees
• Real estate acquisition costs
• Performance fees
• Set up fees
• Advertising fees
• Bookkeeping charges
• Purchase price for sales kits, brochures, programs, fixtures, equipment, display cases, tools, supplies, linens, utensils, and other necessary or desirable goods

Providing Locations or Accounts and Other Business Opportunity Law Elements.

Some things that frequently trigger inadvertent coverage under business opportunity or seller assisted marketing plan laws include:

• Providing lists of suggested or existing customers or accounts
• Making projections or claims about potential earnings or profits
• Site or facility approval rights or requirements
• Inventory buy-back provisions

THE CONSEQUENCES.

The Federal Trade Commission and 16 states (including Florida) regulate the offer and sale of franchises in much the way that sales of securities are regulated. Although these statutes
are described as merely disclosure and review statutes, in practice they have come to regulate some of the substantive terms of the agreement between licensor and licensee.

These state statutes prohibit the offer or sale of a franchise without registration or, in some cases, notice filing with the applicable state regulatory authority.

Similarly, 25 states regulate the offer and sale of business opportunities without advance filing of a disclosure document with the state and delivery of that document to the offeror a
number of days in advance of the execution of an agreement or payment of any money. These statutes also commonly require posting of a bond.

Statutory remedies include recission rights, civil damages, regulatory cease and desist orders, fines, and other penalties.

INTELLECTUAL PROPERTY IN FRANCHISING

TRADEMARKS

The primary intellectual property in franchising is the trademark. In most cases, the franchise agreement licenses the franchisee to use the franchisor’s trademark. Franchisors should seek to use a strong mark that will enable the acquisition of a great deal of good will, in association with the mark, over time. Trademarks are generally divided into two types of strong marks. The first and strongest is called “fanciful”. Fanciful marks are made-up words, or meaningless symbols or logos. Exxon and Xerox are fanciful marks. The next level of strong marks is called “arbitrary”. These are words that have meaning, but the marks are not used relative to that meaning. Arbitrary marks may suffer if there are many uses of them for different products or services. Mustang is an example of an arbitrary mark that is widely used. “Fox” photos, “Apple” records and “Gateway” computers are examples of arbitrary marks. Over time, consumers will associate quality and value with these marks and they are therefore said to have acquired good will.. There is one weak type of trademark that may serve as a mark, but it will never be as strong as the first two categories. These are called suggestive marks. Suggestive marks are legally distinctive but they will never acquire the strength that the stronger categories will. “Coppertone” suntan oil and “Skinvisible” transparent medical adhesive tape are examples of suggestive marks. The weakest type of mark is merely a descriptive word or words that are not capable of being used as a mark at all, unless it is shown that the phrase has, over time, acquired “secondary meaning” which identifies the product or service with a particular source. These are merely descriptive of the product or service offered. “Investacorp” for a corporate investing consultant, “Boston Beer” or “Arthriticare” are examples of descriptive phrases that can never serve as trademarks. Finally, generic words, including slang words, may never serve as trademarks. “Hog” for large motorcycles, “cellular” for cellular telephones and “Honey Brown” for beer are examples of generic words.

Although trademarks can acquire legal protection under common law, franchisors should acquire federal registration of their marks with the United States Patent and Trademark Office (PTO). This will provide the best type of protection for the marks and may exempt coverage under certain business opportunity laws.

The franchisor should select three marks from the fanciful or arbitrary categories. The first mark selected should then be subjected to a trademark search. The search should examine federal, state, Internet domain names and business listings. No search is exhaustive. However, the search will indicate whether registration makes sense. If the search is positively indicative, the franchisor can apply for registration on the principal register for trademarks with either an intent to use application, which requires subsequent filing of proof of actual use, or an actual use application if the mark has already been used in interstate commerce. None of these uses can be mere token uses for the purpose of registration, however.

Once registration has been accomplished, the trademark owner must use the trademark in a manner to show that it is being treated as a trademark, the indication of the quality of the goods and services associated with the mark originating from a particular source, the owner. The mark should be used only as registered. The mark should be bolded and thus differentiated from the surrounding text. The ® symbol should be used, if the mark is registered with the PTO, but not before. TM or SM should be used prior to registration. The mark should always be used in text as an adjective, never as a noun. The mark, if plural, should never be used as a singular and vice versa.

The owner is responsible to police the mark and to act against infringements. Therefore, the owner should hire a trademark watching service to police the mark.

NAKED LICENSING

Naked licensing describes the situation that occurs when a trademark licensor grants permission to a licensee to use a mark without exerting sufficient control over the quality of the products and services offered under the mark. The penalty for creating trademark licenses without sufficient quality control provisions is abandonment of the trademark. The burden of proof is on the party challenging the license.

The bases for the rule against naked licenses are §§ 5 and 45 of the Lanham Act. Particularly, the Lanham Act states that “a registered mark or a mark sought to be registered may be used legitimately by related companies . . . provided such mark is not used in such manner as to deceive the public.” “The term ‘related company’ means any person whose use of a mark is controlled by the owner of the mark with respect to the nature and quality of the goods or services on or in connection with which the mark is used.” When a licensor allows a licensee to use a different standard of quality on goods or services than that which is normally associated with them in the eyes of the public, the mark loses its significance as a source of origin and is abandoned.

The sufficiency of a licensor’s control is an important element in determining whether a license is naked. A court will find adequate quality control when the licensor shows that it sufficiently policed and inspected its licensee’s products and/or operations to ensure the quality of the goods and services sold under its trademark. Therefore, it is very important that franchisors regularly inspect the franchisee’s quality of goods and services, enforce quality standards and retain sufficient records to document these efforts.

TRADE DRESS

Trade dress is the appearance and image of a product or service, as presented to the public. Shapes, colors, and textures of the products, and of their packaging and labeling, create the products’ trade dress. The design of a location and its signage also contribute to the trade dress of the services sold by the business. A restaurant’s trade dress, is a compilation of appearance including its exterior, signage, lay-out, interior decorations, menu, uniforms, and serving arrangement.

A franchisor perfects exclusive rights to its trade dress in so far as the total image portrayed is capable of associating its products and services as originating from a specific source. Distinctive trade dress is protectable under Sec. 43(a) of the Lanham Act. This protection is based on principles similar to those applicable to trademarks and service marks. The U.S. Supreme Court in Taco Cabana held that a restaurant’s inherently distinctive trade dress was protectable without proof of secondary meaning. Secondary meaning is an association, which grows over time, in the minds of the consumers with a particular trademark or image despite the fact that that trademark is merely descriptive. However, “functional” decor was not protectable.

TRADE SECRETS

The Restatement of Torts defines a trade secret as “Any formula, pattern, device or compilation of information which is used in one’s business, and which gives him an opportunity to obtain an advantage over competitors who do not know how to use it.”

The Uniform Trade Secrets Act defines a trade secret as:

[I]nformation, including a formula, pattern, compilation, program, device, method, technique, or process that:

derives independent economic value, actual or potential, from not being generally known, and not being readily ascertainable by proper means by other persons who can obtain economic value from its disclosure or use, and

is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

The state laws are usually based upon the uniform act quoted above and the state common law. Some things that have been found to be trade secrets include the following:

• Cost and pricing data
• Marketing techniques and demographic data such as site requirements for restaurants
• Unpublished promotional material
• Methods of teaching ballroom dancing
• Customer lists
• Names of customers’ decision makers
• Computer programs

Franchisors may have recipes and business methods as well as computer programs to protect, for example. Protection is usually by physical isolation, labeling as “trade secret” (applicable for operations manuals) and significantly by contractual confidentiality obligations with vendors, manufacturers, employees and franchisees. The degree of the efforts toward protection is governed by the “reasonableness” requirements of the statute and by the governing cases.

Trade secrets are usually subject to fact driven analysis under state law. However, there is also a new federal trade secret law. This legislation became effective in October of 1996 and is called the Economic Espionage Act of 1996. Its primary purpose is to provide criminal sanctions against the theft of trade secrets as part of espionage activities. However, it does have prohibitions against the theft in relation to trade secrets in interstate commerce. Enforcement is by the U.S. Attorney’s Office. This act has been used in the business context.

COPYRIGHTS

The United States Constitution gives the Congress the power to “[P]romote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” This power has been exercised by the Congress beginning in 1807 and now includes the Copyright Act of 1978, the Software Computer Act of 1980, The Berne Convention Implementation Act of 1989, the Visual Artists Rights Act of 1990 and the Computer Software Rental Amendment Act of 1990. (Hereinafter collectively referred to as the “Copyright Act”.)

Under the Copyright Act, this protection is provided to the authors of “original works of authorship.” Generally it is available for literary (including software), dramatic, musical; pantomimes and choreography; pictorial, graphic and sculptural; audio-visual; sound recordings; and architectural works. The author (or her designee) generally has the exclusive right to:i. Reproduce the copyrighted work in copies or phonorecords,

ii. Prepare Derivative Works based upon the copyrighted work,

iii. Distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending,

iv. Perform the copyrighted work publicly, in the case of literary,
musical, dramatic, and choreographic works, pantomimes, and
motion pictures and other audiovisual works, and

v. Display the copyrighted work publicly, in the case of literary,
musical, dramatic, and choreographic works, pantomimes, and
pictorial, graphic, or sculptural works, including the individual
images of a motion picture or other audiovisual work.25

An author/franchisor of a copyrighted manual, advertising video or software, therefore has the exclusive right to do all of the above unless license agreements provide otherwise, in whole or in part. (CAVEAT: See First Sale Topic Below.)

Copyright protection subsists from the time the work is created in a fixed tangible form. Therefore, a graphic created in some application software is protected as soon as it is printed or the file is saved to a floppy disk or hard drive. Similarly, copyright subsists in a newsletter or manual when it is printed or saved in the computer or on a disk.

Copyright does not cover an idea. Public policy compels that ideas should not be locked up under copyright protection. Ideas are rather to remain the property of everyone. Copyright does, however, apply to the expression of an idea. This distinction between an idea and its expression, although easy to conceive, has proved difficult to apply.

Judge Learned Hand framed this dilemma in Peter Pan Fabrics, Inc. v. Marti Weiner Corp., when he ruled that “[N]o principle can be stated as to when an imitator has gone beyond copying the `idea’ and has borrowed its `expression.’ Decisions must therefore inevitably be ad hoc.” This case involved whether the defendant had infringed upon the plaintiff’s ornamental dress design.

Generally, copyright may not be obtained in any work, which is not fixed in a tangible form of expression such as an improvisational speech which has not been written or recorded. In addition, copyright does not apply to titles, names, short phrases, and slogans, familiar symbols or designs, mere variations of typographic ornamentation, lettering, coloring or mere listings of ingredients or contents.

Ideas, procedures, methods, systems, processes, concepts, principles, discoveries, or devices are not copyrightable, as distinguished from a description, explanation, or illustration.

Works consisting only of information that is common property and containing no original authorship; such as, standard calendars, height and weight charts, tape measures and rulers, and lists or tables taken from public documents or other common sources, are also not copyrightable.

The Public Domain is the accumulation of all works which for one reason or another are not protected by copyright. This includes all works which are:i. Originally non-copyrightable,

ii. Subject to a copyright which has been lost or which has expired,

iii. Authored by the federal government, and

iv. Specifically granted to the public domain.

The First Sale Doctrine prevents an owner of copyright in a work from controlling subsequent transfers of copies of that work. Once the copyright owner transfers ownership of a specific copy, a book for example, the copyright owner’s right to further control the distribution of that particular book is extinguished. Therefore, the buyer of the book may sell it or rent it to others without infringing the owner’s copyright. The Copyright Act states:

Notwithstanding the provisions of section 106(3) [which grants copyright owners the exclusive right to distribute copies or phonorecords of a work], the owner of a particular copy or phonorecord lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy or phonorecord.

The first sale doctrine does not allow transmission of a work, through the internet for example, because a transmission would necessarily also involve a reproduction of the work and that is not exempted by the foregoing Section 109. There is also a limitation on the buyer’s right to dispose of her copy in regard to computer programs and phonorecords of a sound recording. These may not be rented, leased or lent for direct or indirect commercial advantage.

Prior to 1989, the copyright notice was required. Under the current Copyright Act the copyright notice is not required; however, it is strongly recommended. An infringer may try to defend her act of infringement by claiming that she is an “innocent infringer”; that is, that she had no knowledge of the copyright in the work copied. This defense can be countered by applying copyright notices to all copyrightable works. The notice may be affixed in a number of different locations and methods. Computer software for example may display the notice on the disk, on the screen, in the source code, in a pop up screen and on the printouts.

The recommended form of notice for literary works is as follows:Copyright © 1996 Law Offices of Van Elmore
All Rights Reserved

Copyrights may be registered with the Library of Congress in Washington, DC. The filing fee for registration is $30.

Registration provides prima facie evidence of validity and ownership if filed within five years of the first publication. An owner can not sue to enforce copyrights until registration has occurred. In addition, registration makes statutory damages available for infringements that take place after registration. This can be particularly beneficial in the event that actual damages are small or difficult to prove. For works registered after the adoption of the Berne Convention, the statutory damages range from $500 to $20,000 for the infringements involved in a case relative to a single registered work. This may be increased to $100,000 if the court finds that the infringement was willful. In addition, owners of copyrights may recover attorney’s fees and costs at the court’s discretion. Statutory damages may be elected in lieu of actual damages at any time prior to final judgement. The Copyright Act also provides for injunctions, impoundments and destruction of copies as possible remedies.

Registration may be done at any time during the life of the copyright. It is best to register the work within three months of the first publication. This will make statutory damages and attorney’s fees potentially available, even if the infringement occurs during the three month interim. Registrations after the initial three month period enable possible statutory damages and attorney’s fees in regard to infringements that occur after registration. There are several different filing forms depending on what type of work is to be registered.

Both franchise manuals and software programs may be registered with the copyright office under a procedure that protects trade secrets. Indeed, since part of the proof of a trade secret is the extent to which the owner protects it as a trade secret, copyright registration, that is pursuant to trade secret protection procedures, adds to the strength of the trade secret claim.

Copyright registration of franchise manuals containing trade secrets can be accomplished by providing a cover letter stating that the manual contains trade secrets along with the registration application. The trade secret material may then be blocked out. A blocking mechanism such as stripes or other such mechanism should be used so that more unblocked text remains than is blocked. There is also a procedure to do this for software programs.

A work made for hire arises under one of two circumstances. A work is a work made for hire if it is created by an employee, as opposed to an independent contractor, within the scope of employment. A work is also a work made for hire if it is (i) specially commissioned, (ii) is one of the following types of works; (a contribution to a collective work, a part of a motion picture or other audiovisual work, a translation, a supplementary work [such as illustrations or a foreword for a book], a compilation, an instructional text, a test, answer material for a test, or an atlas), and (iii) the parties agree in writing that it is to be considered as a work made for hire.

The work made for hire doctrine can also create trouble when dealing with advertising agencies which create radio, television or newspaper advertisements for a franchise system; consultants, or franchisees, who create software, signs, newsletters or manuals for franchise systems; and any other service provider who creates copyrightable materials for the franchise system.

The solution to these problems is to acquire assignments of copyrights in all works to be created before they are started. It is very important that such assignment agreements be signed before any work has begun. Such assignments should require the consultant to also sign confirming assignments in the future.

A franchise system should protect its various manuals, brochures and software under copyright registrations. In addition, newsletters, training or other videos should be evaluated for registration. Advertising for various medias should be contemplated in relation to the ease of registration versus the potential damage as a result of copying. Blank forms are generally not protectable, however, instructional material on the form is. Therefore it is suggested that blank forms containing instructional material be registered as a whole. Databases can also be protected within the guidelines set forth for compilations and collective works.

INTERNET

Franchise systems need to provide for Internet use. The recommended approach is to require that all website activity be conducted on the Franchisor’s site. Franchisees may, for example, place websites there provided that they conform to the standard. If termination occurs, the franchisor will have control of the website. The franchisor may also wish to provide an Intranet site that franchisees access by use of a password. The franchisor needs to be aware of liabilities for franchisee postings in this area. Liability for copyright infringement, infringements of publicity rights and for tortious defamation can be limited through various practices and through compliance with federal statutes. Additionally, the franchisor should carefully consider the placement of any trade secrets in this password area.

Additionally, the Internet can be used as a method of alternative distribution for franchisors. However, this requires careful franchise agreement drafting because of the issue regarding encroachment on existing franchisees. The award in the Drug Emporium arbitration, enjoined the respondent, franchisor, from selling through the website drugs and related goods or products at retail to any customer or purchaser physically within the claimant’s, franchisees’, granted territories pursuant to their franchise agreements. Two franchise agreements were involved. One agreement granted the franchisees the exclusive license to use the Drug Emporium service mark in their respective territories. The second clause provided the franchisees the exclusive right to build and operate drug stores within the territories. The arbitrators decided that the franchisor’s use of an “online drug store” was prohibited by both types of agreement. The franchisor was required to place a notice on the website regarding its inability to ship orders to destinations within franchisee owned territories.

In a second arbitration, the arbitrator ruled that a franchisor did not breach the terms of its flower shop franchise agreement, nor did it frustrate the agreement’s purpose, or breach the agreement’s implied covenant of good faith and fair dealing by using Internet and telephone sales. The franchisee argued that the franchisor’s toll-free telephone and Internet brands competed with the original flower shop brand under which the franchisee had begun its operation. The franchisee contended that the franchisor’s Internet and telephone marketing infringed on the shop’s exclusive territory and constituted an abandonment of the original brand, entitling the franchisee to rescission of the agreement. The arbitrator found that the franchisee had agreed to a 1995 amendment to the franchise agreement that co-branded the franchise with the franchisor’s toll-free telephone brand and also specifically reserved to the franchisor the right to develop and use other systems and technology. The arbitrator found this agreement supported the franchisor’s development and marketing of telephone and Internet sales which were fulfilled through its franchisee shops and other affiliates.

The arbitrator stated that Drug Emporium decision was not persuasive under all the circumstances of this case. The arbitrator awarded the flower shop franchisor over $150,000 in past due royalty payments and $45,000 in attorney fees.

Careful drafting of reservations regarding alternative channels of distribution is, therefore, indicated by the two arbitration decisions, despite their limited value as precedents. As technology continues to provide new media for communication, the draftsman’s challenge will only increase.
APPENDIX I

STATES AND TERRITORIES WITH LAWS REGULATING FRANCHISE
RELATIONSHIPS

Arkansas

California

Connecticut

Delaware

Hawaii

Illinois

Indiana

Iowa

Maryland

Michigan

Minnesota

Mississippi

Missouri

Nebraska

New Jersey

North Dakota

Virginia

Washington

Wisconsin

District of Columbia
Puerto Rico

Virgin Islands

South Dakota’s disclosure law includes a provision prohibiting unfairness in franchise relationships.

STATE FRANCHISE LAWS DISCLOSURE AND REGISTRATION

CALIFORNIA1
HAWAII2
ILLINOIS1
MARYLAND1
MINNESOTA2
NEW YORK
NORTH DAKOTA1
RHODE ISLAND1
SOUTH DAKOTA2
VIRGINIA
WASHINGTON1

DISCLOSURE BUT ONLY NOTICE FILING

INDIANA1
MICHIGAN1
WISCONSIN1
BUSINESS OPPORTUNITY LAW DEFINITIONS THAT REQUIRE
EXEMPTION FILINGS

FLORIDA
KENTUCKY
NEBRASKA
TEXAS
UTAH

DISCLOSURE REQUIREMENTS BUT NO REGISTRATION

FLORIDA
OREGON

1 Marketing plan or system definition
2 Community of interest definition

BUSINESS OPPORTUNITY

ALABAMA
CALIFORNIA
CONNECTICUT
FLORIDA
GEORGIA
ILLINOIS
INDIANA
IOWA
KENTUCKY
LOUISIANA
MAINE
MARYLAND
MICHIGAN
MINESOTA
NEBRASKA
NEW HAMPSHIRE
NORTH CAROLINA
OHIO
OKLAHOMA
SOUTH CAROLINA
SOUTH DAKOTA
TEXAS
UTAH
VIRGINIA
WASHINGTON