Safe Step Walk In Tub Co. (“Safe Step”) failed to take the requisite “safe steps” before potentially becoming an accidental franchisor. In Safe Step Walk In Tub Co. v. CKH Industries, Inc., Safe Step filed an action against a licensee, CKH Industries, Inc. (“CKH”) for breach of contract for non-payment of certain fees. CKH filed 22 counter-claims against Safe Step including violation of the Federal Trade Commission Rule on Franchising (“FTC Rule”) as well as the state franchise laws of Connecticut, New Jersey, New York and Rhode Island for illegal franchise sales and wrongful termination of the franchise relationship. Safe Step filed a motion to dismiss CKH’s counter-claims and the Court denied that motion (in part) as further outlined below.
Under the terms of the applicable licensing agreements, CKH is the exclusive licensee permitted to market the Safe Step products in designated regions. Additionally, CKH was required to pay Safe Step a licensing fee. Lastly, there were certain addenda to the licensing agreements that regulated CKH’s business plan. Specifically, Safe Step assisted CKH with a marketing plan and could makes changes to CKH’s business model. Further, the agreements forbid CKH from offering competitive products and allowed Safe Step to terminate the licensing agreements if CKH failed to complete certain training programs.
When examining whether a franchise relationship had been formed, the Court first looked to the FTC Rule. The FTC Rule of course defines a franchise as an arrangement where the franchisee obtains the right to use the franchisor’s mark, the franchisor exerts a significant degree of control over the operation of the business, and the franchisee pays the franchisor a non-nominal fee. Here, the Court easily determined that the licensing agreements fulfilled the first and third prongs of the test because Safe Step permitted CKH to offer products under Safe Step’s marks and CKH paid Safe Step a licensing fee. Additionally, the Court held that Safe Step’s alleged involvement in the business outlined in the paragraph above may rise to the requisite level of “significant degree of control”. Further, as have many courts before it, the Court noted that it did not matter that Safe Step called the arrangement a licensing agreement.
The Court then examined the state franchise laws. The definition of a franchise under each state law is similar to the definition under the FTC Rule except that the state laws are more specific with respect to the “significant degree of control” aspect of the test. Under each state law (except for New York where the statute of limitations had already run on certain of its counter-claims), CKH had proffered enough facts to argue that its Safe-Step related operations qualified as franchises.
The outcome of this case is another cautionary tale for those companies that are structuring licensing arrangements to avoid complying with federal and state franchise laws. It is important to examine federal law and each state’s law to make sure you are taking the “safe steps” to prevent the accidental franchise relationship. As this blog has often noted, many people, including otherwise experienced business lawyers unfamiliar with franchise law, are unaware of how easy it is to form a franchise relationship under federal law and many state laws.