The recent case of Rhine Enters v. Refresco Beverage out of the federal district court of the Southern District of Illinois should be a reminder to licensors and manufacturers that avoiding the “fee prong” element of a franchise is not always as straightforward as it appears.
Whether a business relationship meets the definition of a franchise, rather than license, agency, or distributorship is often a question of fact. To qualify as a franchise, the agreement must meet 3 elements: (1) trademark license; (2) fee; and (3) control.
Focus is typically directed to the third “control” element since determining whether a licensor provides a marketing plan or renders significant assistance to the licensee in operating its business or method of operation can be a very fact specific 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 “fee” element can be tricky as well . Here, the District Court denied a supplier’s motion to dismiss a distributor’s claim under Section 19 of the Illinois Franchise Disclosure Act (IFDA) for wrongful termination of a franchise holding that sufficient facts were pleaded to establish that losses from unsold inventory constituted a franchise fee in excess of $500.
The distributor, Rhine Enterprises LLC, asserted that Refresco Beverage’s termination was without good cause in violation of the IFDA. Not surprisingly, for the IFDA to apply, the agreement must qualify as a “franchise” under the law. To do so, 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 (ie. the “purchase or agreement to purchase goods for which there is an established market at a bona fide wholesale price”). Rhine argued it paid the supplier, Refresco, an indirect franchise fee because (1) Refresco did not reimburse Rhine for all of the unsold product it was required to purchase and (2) some of the required product was in excess of 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 “the purchase or agreement 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 may be considered an indirect franchise fee; and
(2) the corresponding regulations provide that an indirect franchise fee exists ‘if the buyer is required to purchase a quantity of goods so unreasonably large that such goods may not be resold within a reasonable time’.” The court relied upon Wright-Moore Corp. v. 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 proper scrutiny when analyzing whether a license or distributorship 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.