Who Takes What: The Parties’ Rights to Franchise Materials at the Relationship’s End
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trade secret protection. The franchise operations manual may constitute
a trade secret, or at least contain trade secrets. 22 In a
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Who Takes What: The Parties’ Rights to Franchise Materials at the Relationship’s End Clay a. TillaCk and Mark E. ashTon have laws requiring the franchisor to buy back equipment and inven- The franchise agreement governs the relationship between a franchisor and its franchisees not only dur- ing the franchise relationship but also thereafter. A key tory, and all states have statutes or focus in drafting such an agreement, therefore, should be who common law governing trade secrets takes what at the end of the franchise relationship. Because and confidential information. State the franchisor provides primarily nonmonetary consideration, statutes grant varying rights to fran- the particular question that arises is what, if any, of that con- chisees and franchisors, so choice sideration the franchisee may retain when the franchise rela- of law often becomes important. tionship terminates. For instance, some states (Hawaii,4 The most fundamental consideration exchanged in a franchise Illinois,5 and Washington6) require relationship is the trademark license that a franchisor grants its franchisors to pay their former fran- franchisee,1 and therefore most franchise agreements are devoted Clay A. Tillack chisees for local goodwill generated primarily to that license. When the franchise agreement comes during the life of the relationship in to an end, it is usually fairly clear that the franchisor retains the certain circumstances, and others rights in the trademarks and that the franchisee relinquishes any (Delaware, Indiana, Minnesota, Mis- right to use those marks.2 In addition, however, franchisors pro- sissippi, Missouri, Nebraska, New vide a host of other things of value, tangible and intangible, to Jersey, and Virginia)7 include loss of their franchisees. Some are related to the franchise trademarks goodwill as compensable damages (such as goodwill, domain names, and telephone listings), while for wrongful termination. others are not (such as trade secrets, confidential information, Federal law may also come into equipment, and intranet access). Even the most carefully crafted play. The Lanham Act, of course, and detailed franchise agreement may not clearly address the governs the trademarks at the heart rights of the respective parties with respect to such assets. For of the franchise relationship and example, what aspects of the operations manual constitute trade allows the licensing that makes a Mark E. Ashton secrets and confidential information such that a franchisor right- franchise agreement possible.8 In fully can prevent a former franchisee from using them? What the past, federal legislation has been happens if the franchisee has improved on those trade secrets? proposed that would require a franchisor to repurchase good- What can a franchisor do to stop a third party (such as a close will.9 And franchisors must comply with the Federal Trade friend or relative of a former franchisee) from using confiden- Commission’s (FTC’s) franchise disclosure rule.10 If a franchi- tial information it has received from a former franchisee? Who sor regularly fails to disclose a material obligation of its franchi- owns the local goodwill associated with a particular franchised sees with regard to materials provided during the relationship, location, and who is entitled to payment for it when a franchise the FTC could choose to initiate an enforcement action against agreement terminates? All of these issues can cause serious that franchisor. problems in any franchise termination, no matter how cordial, if Finally, the common law may be the most important source not addressed in advance. This article will address those issues of law impacting the parties’ rights in materials exchanged in a pragmatic way to assist the parties in dealing with them (or during the relationship. Any dispute is likely to boil down to at least anticipating them) before they arise. a basic question of property law: in the absence of a specific agreement, who owns which rights in the materials exchanged? Sources of Law Specific categories of state common law, especially those relat- The parties to a franchise agreement have a variety of rights aris- ing to trade secrets, will govern many of the more contentious ing from diverse sources of law. The most obvious and familiar areas, such as whether the franchisee may continue to use the source is the franchise agreement itself, which, in the absence scheme of business operation adopted by the franchise system. of statutory restrictions, governs nearly every aspect of the parties’ relationship.3 Various state franchise relationship laws Equipment and Inventory may affect what rights the parties have in intellectual property Many franchise agreements require that the franchisee pur- and materials exchanged during the relationship. Some states chase certain approved equipment and an initial (and continu- ing) amount of inventory. What happens to that equipment and Clay A. Tillack is a partner and Mark E. Ashton is an associate in the any unsold inventory when the franchise agreement terminates Chicago office of Schiff Hardin LLP. or fails to renew? The default rule for items actually sold to a Published in Franchise Law Journal, Volume 28, Number 2, Fall 2008. © 2008 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. 1
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