The recent Rhine Enters v. Refresco Beverage of the United States District Court for the Southern District of Illinois should remind licensors and manufacturers that avoiding the “pay” element of a franchise is not always as simple as it is. it seems.
Whether a business relationship meets the definition of a franchise rather than a license, agency or distribution is often a question of fact. To qualify as a franchise, the agreement must meet 3 elements: (1) trademark license; (2) fees; and (3) control.
Emphasis is usually placed on the third element of “control”, because determining whether a licensor provides a marketing plan or provides significant assistance to the licensee in carrying on its business or its mode of operation can be a very factual and subjective analysis. There are dozens of factors to consider, and many states complicate the analysis by applying an even broader “community of interest” standard. However, as the Rhine case shows, the “fresh” element can also be tricky. Here, the district court denied a vendor’s motion to dismiss a distributor’s claim under Section 19 of the Illinois Franchise Disclosure Act (IFDA) for wrongful termination of a deductible, finding that sufficient facts had been adduced to establish that the losses due to unsold inventory constituted franchise fees in excess of $500.
The distributor, Rhine Enterprises LLC, claimed Refresco Beverage’s termination was without cause, in violation of the IFDA. Unsurprisingly, for the IFDA to apply, the deal must be considered a “franchise” under the law. To do this, a franchise fee of at least $500 must be paid by the franchisee to the franchisor. Distributors often rely on the “inventory exception” to the fee element (i.e. the “purchase or agreement to purchase goods for which there is an established market at a bona fide wholesale pricee “). Rhine argued that it paid the supplier, Refresco, an indirect franchise fee because (1) Refresco failed to reimburse Rhine for all unsold product it had to purchase and (2) a portion of the product required exceeded reasonable consumer demand. because there was no established market in its territories for the products to be resold.
Refresco was denied summary judgment because the district court found:
(1) the plain language of the IFDA stating that “purchasing or agreeing to purchase goods for which there is an established market at a bona fide wholesale price” was not a franchise fee, suggested that a purchase of goods without an established market could be considered an indirect franchise right; and
(2) the corresponding regulations provide that there is an indirect franchise fee “if the buyer is required to purchase such an unreasonably large quantity of goods that these goods cannot be resold within a reasonable time”. The court relied on Wright-Moore Corp. vs. Ricoh Corp., 908 F.2d 128, 136 (7th Cir. 1990) for the proposition that “the cost of excess inventory” may constitute an indirect franchise fee in Illinois. »
This is a reminder that ALL three elements of a franchise deserve careful consideration when analyzing whether a licensing or distribution relationship meets the definition of a franchise. It is easy to accidentally trigger the fee element due to the broad interpretation by state courts and franchise examiners.