A recent court case (Cognex Corporation v. Air Hydro Power LLC) between a distributor and manufacturer is a reminder to franchise attorneys that not all amounts paid by a licensee to a licensor qualify as a “franchise fee” for purposes of determining whether the relationship meets the definition of a franchise under the FTC Franchise Rule or state franchise laws.

Cognex Corporation (“Cognex”), a manufacturer of barcode readers gave notice to one of its distributors, Air Hydro Power, LLC (“Air Hydro”), that it did not intend to renew its agreement.  After Air Hydro filed suit against Cognex in Florida state court, Cognex filed a breach of contract claim seeking damages against Air Hydro Power, LLC for its alleged breach of the parties’ forum-selection clause and violations of the covenant of good faith and fair dealing.  In response, Air Hydro filed counterclaims, among which included alleging violations of various state franchise acts.

The United States District Court of Massachusetts dismissed the distributor’s claims that Cognex violated the Florida Deceptive and Unfair Trade Practices Act Claim, Indiana Franchise Act Claim, and Indiana Deceptive Franchise Practices Act Claim after concluding the business relationship did not meet the definition of franchise under the FTC Franchise Rule or any state franchise act as it was lacking the “fee element”.   Neither the purchase of (1) demonstration equipment or (2) recommended software constitute a “required payment” because neither purchase was a required condition of commencing operation or a practical necessity of operating the business.  Finally, the costs incurred by Air Hydro to build demonstration facilities were deemed sunken costs to further its own business goals and also not a required payment to Cognex.   

I am often counseling my clients that the fee element is intended to read very broadly to capture all sources of revenue that a franchisee must pay to a franchisor for the right to associate with the franchisor. This is especially important when analyzing potential “accidental franchise” cases.  However, the definition is not without limit.  This case shows that fees, costs or expenses that are either not (1) required to be paid to the licensor to commence operations or otherwise (2) a practical necessity to operate, will not meet the “fee” element under the FTC Franchise Rule and most state law definitions.