During the ABA Forum on Franchising in Florida, I attended a session on managing regulatory mistakes. While reflecting on the session, I briefly commented on regulatory misstep that is not unusual—creating an “accidental” or “inadvertent franchise.” This inspired several Insights visitors and NY franchise clients to ask: “What is an accidental franchise?”
It is a great question, and we will provide the answer today. We will also explore legal consequences for NY franchisors who engage in accidental franchising.
What is an Accidental or Inadvertent Franchise?
Many business owners want to expand their brand through licensing relationships. They may have some franchising knowledge but want to avoid the legal complexities associated with the process. Instead, they attempt to create simple licensing arrangements or partnerships with third parties who will operate a business using the licensor’s trademark or tradename. This can unintentionally lead them into the world of franchising and a phenomenon often called “accidental” or “inadvertent franchising.”
A franchise relationship has three elements: (i) the right to operate a business using the licensor/franchisor’s trademark; (ii) the use of the licensor’s business system (or joint marketing efforts between the parties) in the operation of a business; and (iii) the payment of a fee by the licensee. Different states have different technical definitions, but generally, if those three elements exist, a franchise relationship has been created.
While a company may think it is merely entering a licensing or distribution deal, as soon as it imposes operational controls (e.g., manuals, training, territory restrictions, marketing requirements) beyond those necessary to protect the licensor’s trademark, it may have crossed the line into franchising and triggered franchise laws.
Risky Business
If a business sold an accidental franchise without complying with franchise sales laws, the consequences can be serious. For example, the franchisor may be required to pay the putative franchisee damages, and may face injunctions, as well as civil or even criminal penalties for non-compliance.
In addition, in some states, a franchisee who purchases without first receiving a franchise disclosure document (FDD) may bring a claim against the franchisor for rescission and restitution (which would annul the transaction and require a refund of their investment). For a NY franchise lawyer or business lawyer advising a client considering licensing its business model, this is a red flag: simply calling the agreement a “license” does not avoid franchise laws if the underlying deal meets the legal definition of a franchise. More on that shortly.
What Makes New York Distinctive
New York is a high-risk state for accidental franchising because of its statutory definition of “franchise.” Business owners and licensors who operate in New York or contract with New Yorkers or others who will operate businesses in the state must be especially careful when they create a “licensing” business relationship. Why? Because the line between licensing and franchising is thinner in New York than in many states.
New York’s Broad Definition of “Franchise”
Under New York General Business Law § 681(3), a “franchise” means a contract or agreement (expressed or implied) by which the franchisee is granted to right to:
(a) … engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by the franchisor, and the franchisee pays a fee; or
(b) … engage in the business of offering, selling or distributing goods or services substantially associated with the franchisor’s trademark, service mark, trade name, etc., and pays a fee.
Importantly, New York’s definition means that either the “marketing plan/system” prong or the “trademark-association” prong can trigger the franchise law when combined with a fee. Other states often require all three elements– the trademark, system, and the fee.
Registration and Disclosure Obligations
New York mandates substantial pre-sale registration and disclosure for any “offer or sale” of a franchise in the state. For example:
§ 683 states that it is unlawful “to offer to sell or sell in this state any franchise unless and until there shall have been registered … a written statement … known as an ‘offering prospectus,’” i.e., a franchise disclosure document.
The state’s regulatory agency is the New York State Attorney General’s Office (NYAG), and as previously discussed, has published a Franchise Registration Guide which explains how franchisors must file with the NASAA depository, submit annual clean and red-lined FDDs and advertising materials for review.
Ultimately, a business that believed it was just licensing a trademark might have inadvertently entered into what New York law recognizes as a franchise relationship.
Risk Mitigation and Ensuring Franchise-Wide Health
For franchisors and businesses considering expansion and licensing, first discuss with your NY franchise lawyer if the following will be part of the deal:
- The recipient will pay a fee
- They will be required to follow certain operating controls
- They will use the business’ trademark or tradename
If yes to any, a franchise analysis is likely required.
If you suspect you’ve already entered into what may be an inadvertent franchise relationship, consult with your NY franchise lawyer to help you determine whether to self-report to the NYAG. This level of self-reporting or remediation often improves outcomes when dealing with regulators. Failure to comply with registration and disclosure obligations can have consequences even where the parties did not intend to create a franchise relationship
By focusing on these strategies with your NY franchise lawyer, clear contractual structures will be created in the event you do want to only enter licensing agreements, or conversely, intend to franchise.
Contact Lusthaus Law
Lusthaus Law’s website is a resource for New York franchisors and franchisees. You can read our consistent coverage of the legal and regulatory updates that impact franchising, including roundups of Q3, Q2 and Q1 of 2025.
We have published two downloadable and complimentary e-books and our Insights blog is regularly updated to reflect industry trends and recent achievements in client representation.
Contact us today to learn more about how Lusthaus Law P.C. can help you navigate a clear path for your franchise’s successful future.
