Trademark licensing is a powerful tool a business can use to grow its brand. But tucked inside what appears to be a straightforward licensing arrangement may be a legal landmine: the accidental franchise.

If your business licenses its trademark to another party, you may already be exposed to significant legal liability without knowing it.

The Hidden Risk in Trademark Licensing

When a company licenses its trademark to a third party, the goal is usually simple- expand brand reach, earn royalty income, and maintain control over how the mark is used in the market. What most trademark owners do not anticipate is that this arrangement can simultaneously satisfy the legal definition of a franchise under both federal and state law.

This matters a lot. Franchise law imposes substantial obligations on the party granting the license, including financial disclosures, registration requirements, and strict rules governing how and when an agreement can be terminated. Failing to comply with these obligations does not make them go away. It simply means the licensor has broken the law, often without realizing it.

Why the Lanham Act Requires Control and Why That Control Can Create a Franchise

Under the Lanham Act, a trademark owner who licenses its mark must retain meaningful control over the quality of the goods or services being offered under that mark. Without that quality control, the mark can lose its legal protection entirely where it no longer identifies a single, reliable source of goods or services in the eyes of consumers.

This is not optional. It is a structural requirement of valid trademark licensing.

The problem is that this same element of control — the licensor telling the licensee how to operate, what standards to meet, and how to represent the brand — is one of the key factors that transforms a licensing agreement into a franchise under the Federal Trade Commission’s Franchise Rule.

In other words, doing exactly what trademark law requires can inadvertently satisfy the legal test for a franchise.

What Makes Something a “Franchise” Under Federal Law

The FTC’s Franchise Rule sets out a four-part definition. A franchise exists when:

1. There is an ongoing commercial relationship between the parties (not just a one-time deal);
2. The party receiving the license has the right to operate a business associated with the licensor’s trademark;
3. The licensor has the authority to exert significant control over, or provide substantial assistance with, how the licensee runs its business; and
4. The licensee is required to make some form of payment to the licensor as a condition of entering or operating under the agreement.

At first glance, a standard trademark license meets most, if not all, of these criteria. There is an ongoing relationship. The licensee is using the licensor’s brand. The licensor controls quality standards. And there is almost always some form of fee — an upfront payment, ongoing royalties, or both.

The fact that the agreement is titled a “License Agreement” or a “Consulting and Brand Use Agreement” does not change its legal character. Courts look past the label and examine the substance of the relationship.

A Recent Case That Illustrates the Risk

A federal court in California addressed exactly this situation. A restaurant group licensed its trade name to a hospitality operator, providing a non-exclusive right to use its brand, along with informal guidance on menu and design standards. The agreement explicitly stated that the parties did not intend to create a franchise.

That stated intention was not enough to prevent a franchise law claim from moving forward. When the licensee stopped paying fees and litigation followed, the licensee countered by alleging that the licensor had failed to comply with California’s franchise disclosure laws. The court found the franchise law claim plausible and allowed it to proceed, meaning the licensor was now defending not just a breach of contract action, but potential violations of state franchise statutes that carry their own remedies and penalties.

This is not an isolated incident. Courts across the country have reached similar conclusions in disputes involving dealership agreements, distribution arrangements, and a range of other commercial relationships that were never intended to be franchises.

The Consequences Can Be Severe

An accidental franchisor does not simply face a technical compliance issue. The practical consequences can include:

Civil liability. In a Seventh Circuit case (To-Am Equipment Co. v. Mitsubishi Caterpillar Forklift America, Inc., 152 F.3d 658 (7th Cir. 1998)), Mitsubishi entered a “dealership agreement” and found itself on the wrong side of a $1.525 million judgment after the court determined the relationship was a franchise under the Illinois Franchise Disclosure Act. The attempted termination of the agreement, which might have been perfectly valid under an ordinary contract, was deemed unlawful because franchise law required termination only for good cause.

Inability to terminate. Multiple state franchise statutes restrict a franchisor’s right to end the relationship without cause, regardless of what the underlying agreement says. A licensor who does not know it is a franchisor may try to terminate, only to discover that the “at-will” termination clause in its license is legally unenforceable.

State registration and disclosure requirements. Roughly a third of U.S. states have their own franchise laws, some of which go further than federal rules. Certain states require affirmative registration and detailed disclosure filings before the franchise relationship begins. Retroactive compliance is not generally available.

Defenses available to the licensee. A licensee who discovers that its licensor failed to comply with franchise law may be able to rescind the agreement, seek damages, or raise the violation as a defense against collection of unpaid fees, even if the licensee was itself in breach.

The Takeaway for Trademark Owners

If your business is considering licensing its trademark — or has already done so — there are several important questions to address:

• Does the license require the licensee to make any upfront or ongoing payment? Even modest fees may satisfy the “required payment” threshold under the FTC Rule.
• Does the agreement give you authority to control how the licensee operates, presents the brand, or delivers goods or services? That control, however reasonable from a trademark standpoint, may also satisfy the “significant control” prong of the franchise definition.
• In which states will the licensee operate? Each state’s franchise law must be evaluated independently, and some impose obligations that extend beyond what the FTC requires.
• Has any party relied on the relationship as a long-term business arrangement? The more the licensee’s livelihood depends on the license, the more a court may be inclined to view the arrangement as a franchise.

What to Do If You Are Already in a Licensing Relationship

If you have already entered a trademark license that may satisfy the definition of a franchise, prompt action is important. Depending on the circumstances, it may be possible to restructure the agreement, seek guidance from relevant state authorities, or take other steps to address compliance gaps before they become litigation risks.

What is not advisable is to assume that because the agreement says it is not a franchise, it is not one. Courts have made clear that the substance of the relationship, not its label, controls the analysis.

How We Can Help

We advise clients at the intersection of intellectual property and franchise law. Whether you are structuring a new licensing arrangement, evaluating an existing one, or responding to a dispute involving franchise law claims, we have the experience to help you navigate these issues strategically and protect your brand.

Contact us to schedule a consultation.