Disputes With Your Franchisor: A Few Considerations

At its core franchising is the most effective way of exploiting Intellectual Property (IP). It is a sophisticated form of licensing rights for the franchisee’s use of the IP in accordance with the franchisors’ methods, generally known as the ‘System’.

In other words, franchising is really a method of systematically sharing the franchisors’ IP to distribute goods or services. The franchisor owns the IP rights over the various elements of the franchise and the franchisee pays a fee or royalty for the benefit of the IP.

At one time or another, there is the urge to want to own your own business or be the master of your domain. For many of us, taking that giant leap towards total independence is frightening. However, buying a franchise is a very lucrative option where you as the franchisee are provided with the established IP including brand name (McDonald’s, Subway, Gloria Jeans, Pack & Send etc.), know-how and systems increase the chances of success.

In a globalised marketplace, increasingly dominated by web-based content, the protection of a franchisor’s IP rights is paramount and hence the requirement to pay an upfront franchise fee for the use of the IP for the term of the agreement.

When IP rights are mentioned in a franchise agreement, those rights often relate to trademarks, know-how and systems – which essentially represent the franchise ‘brand’.

The brand is the common identity of the franchise network and is fundamental to the generation of goodwill in the marketplace. Because of the importance of the brand, the franchisor will typically exert a lot of influence over the use of that IP by the franchisee.

Franchising is attractive to franchisees because they can invest in an established brand in which goodwill is already attached to a greater or lesser extent (depending on the market). This of course means that it will be easier to attract business since the reputation of the business has already been established by the franchisor and creates a far better saleable asset.

Trademarks (the golden arches for Macca’s, Apple for Smartphones, Swoosh for Nike and their respective names) in particular are an essential part of a franchise because they indicate the source of the goods and/ or services and communicate that source to consumers. The brand is instantly recognisable to consumers and immediately communicates to the consumer the nature and quality of the services and/or goods they can expect to receive from the franchise.

There are many examples in the Australian marketplace. Muffin Break is a bakerycafé franchise whose brand is instantly recognisable to its consumers. The visual brand – the logo is used extensively and is found not only on signage but on uniforms, name tags, menus, cups and packaging.

Muffin Break has worked hard to build goodwill in the brand by ensuring consumers associate the brand with quality products and personalised service. Muffin Break has been particularly successful in enhancing goodwill in their brand via loyalty-reward programs and by maintaining a relevant and rewarding presence (for consumers) on social-media platforms. At the same time it is also very easy to tarnish the brand if mechanisms are not put in place to protect it, hence the need for numerous provisions which are included in most franchise agreements which detail the use of the IP and generally approval from the franchisor is required for the way the brand and IP is depicted in the marketplace by franchisees.

Before entering into a franchise agreement, franchisees should carry out a due diligence exercise in order to assess the IP owned by the franchisor. Franchisees should obtain details of all the IP, whether registered or unregistered. This usually includes trademarks, copyright, trade secrets, designs, systems and patents. It is important that potential franchisees check the IP clauses in the franchise agreement carefully and are thoroughly aware of, and understand their obligations with respect to their use of the franchisor’s IP.

IP rights are territorial, which means that they generally only relate to the country where the IP is registered and/or used. Various international treaties have harmonised a great deal of IP law, and there are ways of obtaining trademark registrations in international regions.
It is essential that the franchisor establishes a well thought out strategy for obtaining trademark protection overseas before entering into franchise agreements outside of Australia. And this is exactly what The Coffee Club did in the early years of its brand development. Since opening its first store in 1989, The Coffee Club has not only registered its trademark in a variety of classes across Australia, but has also registered IP in numerous countries. Registration by The Coffee Club of its trademark has proved essential with The Coffee Club now operating in many regions outside of Australia.

When a franchisor wishes to expand, if it has not protected its trademarks in overseas territories, it is possible that it will discover that another party may have coincidentally, or not so coincidentally, registered an identical trademark for identical goods/services in that overseas territory.

This means that the franchisor either has to try to purchase its own trademark in that country, or consider launching with a new brand in that country, which will mean losing the goodwill and reputation in the established brand. This was the situation that Burger King was confronted with when that company came to launching its franchise in Australia, and discovered that the trademark BURGER KING had already been registered in Australia by an unrelated third party who did not want to sell the trademark. A similar situation was encountered by Taco Bell, when it came to launch its franchise in Australia, and discovered that the same brand was already in use by an unrelated company in respect of a Mexican restaurant in Bondi. The main benefits of trademark registration both in Australia and overseas, are that the trademark owner can prevent unauthorised third party use of the trademark, and may be entitled to damages in respect of that use, an account of profits obtained through the unauthorised use and destruction of any infringing goods. Nevertheless, to protect the integrity of their brand and IP, franchisors will need to be vigilant with respect to accidental or intentional infringements of both registered and unregistered trademarks of IP by third parties and franchisees.

Usually, the franchise agreement will also contain information in relation to the fact that the IP is licensed to the franchisee for the term of the franchise agreement, that the franchisee is not entitled to sub-licence use of the IP to a third party. The purpose of this is to prevent others that are privy to such confidential information from exploiting it without consideration and potentially devaluing the value of the franchise. Although, it may seem that franchisors are at times super sensitive to the protection of their IP, it certainly has commercial and legal consequences for both the franchisor and franchisee.

Some general obligations found in franchise agreements relating to the IP include:

  • The franchisee should inform the franchisor if it becomes aware of any unauthorised third party use of the IP, so that the franchisor can take the appropriate action against that third party;
  • An acknowledgment that the franchisor is the owner of the trademark and IP, and that any unauthorised use of the trademark or IP by the franchisee will amount to an infringement and termination of the franchise agreement;
  • Any modifications or improvements to the IP will be required to be transferred to the franchisor once developed to avoid any dispute as to the ownership of such modifications or improvements;
  • Any marketing material that may include the IP must be approved by the franchisor; and
  • The use of the IP is limited to the term of the franchise agreement.

As a result of these practices, network and brand value is developed and can prove to significantly increase the overall value of the network and each of the respective businesses. Although goodwill is usually attributed to the franchisor in franchise agreements, some goodwill will be generated by the franchisee, and therefore could be attributed to the franchisee. Franchisee’s (and in turn the brand) can develop goodwill through superior personalised service as well as the delivery of consistent quality in their goods/services. Goodwill in the franchise is reciprocal, as localised goodwill flows to the franchisor and other franchisees as a result of consumer brand affinity. IP rights, including trademarks and ‘branding’, and the goodwill generated by the business and communicated to consumers by those trademarks, are a vital part of a franchise. The success or failure, and future asset value of a franchise often depends on the protection of its brands, which can be controlled by having a good IP protection strategy in place, both nationally and internationally.

Blake Palmer
Partner – Head of Litigation

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Level 1, 109 Pitt Street NSW 2000 Australia
Level 1, 109 Pitt Street NSW 2000 Australia
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