The question of whether a relationship between a watch manufacturer, Swatch, and a watch shop operator amounts to a “franchise” was answered in the negative by the U.S. Court of Appeals for the Third Circuit in Philadelphia in Orologio v. Swatch Group (U.S.) Inc. Here, after Swatch terminated its relationship with the operator, the operator brought suit against Swatch under the New Jersey Franchise Practices Act (“NJFPA”) claiming that Swatch’s termination of the relationship violated the NJFPA for termination of a franchise relationship without good cause.

Copyright: vician / 123RF Stock Photo
Copyright: vician / 123RF Stock Photo

Under the NJFPA, it is illegal to terminate a franchise relationship without good cause. However, in order to bring a lawsuit under the NJFPA, the parties must first establish that a franchise relationship exists. In determining whether a franchise relationship existed between Swatch and the operator, the Court utilized the community of interest balancing test, which focuses on the following four factors: (i) licensor’s control over licensee; (ii) licensee’s economic dependence on the licensor; (iii) disparity in bargaining power; and (iv) the presence of a franchise-specific investment.

First, the Court found that the operator was economically independent from Swatch because the operator derived only 25% of its revenue from Swatch and the operator still thrived after the termination of the relationship due to its relationship with other watch suppliers.

Second, the Court analyzed the “franchise-specific investments” submitted by the operator, including Swatch inventory as well as marketing, advertising and training costs. The Court determined that the inventory costs were irrelevant because Swatch offered to buy back the operator’s remaining inventory of Swatch required products. With respect to the marketing, advertising and training costs, the Court reasoned that these types of costs are inherent in the type of business the operator owns. Further, the operator failed to demonstrate that such investments were mandatory and the skills were not transferable to other inventory carried by it.

The Court also reasoned that there was not a significant disparity in bargaining power due to the absence of required, non-refundable investments. Lastly, the Court determined that Swatch did not exert the requisite level of control over the operator despite certain rules and limitations in place in connection with the sale of its watches. The Court determined these rules and limitations did not rise to the level of “unfettered control” over the operator, which is typical of a franchise relationship.

As such, the Court ultimately upheld the District Court’s grant of summary judgment in favor of Swatch ruling that no franchise relationship existed between the operator and Swatch. If you are creating a business relationship that you do not want to be considered a “franchise”, it is important to keep the community of interest factors in mind. Specifically, you want to ensure that each party maintains a significant degree of autonomy when structuring any relationship.