Vol. 76, No. 5, May
Avoiding the Accidental Franchise
Whenever drafting licensing and dealer arrangements,
cautious practitioners should consider whether the Wisconsin Franchise
Investment and Fair Dealership laws apply. Both laws offer a potential
trap for the unwary - the creation of an accidental franchise, with
resulting severe penalties and restrictions.
by Charles S. Modell & Joseph J. Fittante
any persons who distribute goods and services
do so through distributors, dealers, and licensees. Typically, the
grantor will provide marketing materials or product training to a
licensee who, in turn, pays a fee to the grantor. If you have ever
drafted such an agreement for a client and not taken into account the
Wisconsin Franchise Investment Law (WFIL) and the Wisconsin Fair
Dealership Law (WFDL), you may be subjecting yourself and your client to
significant business and legal risks, because the WFIL provides severe
penalties for the unregistered sale of relationships falling within the
purview of the law, and the WFDL severely limits the grantor's ability
to terminate or not renew the relationship.
This article is not intended as a complete primer on the WFIL or the
WFDL. Rather, this article alerts counsel to the laws that must be
considered whenever a client grants others the right to distribute the
client's goods or services or to use its trademark. Unfortunately, the
terminology used to describe a relationship,
such as "license," "distributorship," "joint venture," or even
"partnership," will not keep the relationship from being regulated under
these laws. Moreover, once an agreement has been signed that is subject
to the WFIL, or a termination takes effect without compliance with the
WFDL, it may be impossible to "put the toothpaste back into the tube."
Under those circumstances, the client may hold the attorney responsible
for failing to provide the proper advice.
Wisconsin Franchise Investment Law
Under the WFIL,1 a license, a dealership
agreement, or any business contract can be deemed a franchise if:
1) the grantee is given the right to offer, sell, or distribute
goods or services offered by the grantor; 2) the business is
associated with a trademark, service mark, or advertising; and
3) the grantee is required to pay a fee. While these elements are
not present in every commercial transaction, they may be present in
license arrangements that one would never consider to be franchises. For
example, consider a situation in which a software developer licenses its
software to a seller who will be selling (or licensing) that software to
others. Such an arrangement is documented by intellectual property
lawyers every day. However, in Current Technology Concepts Inc. v.
Irie Enterprises Inc.,2 the Minnesota
Supreme Court concluded that one such arrangement was a franchise and
held the franchisor liable for damages in the amount of $1.3 million for
violating the Minnesota Franchise Law.
Although the Current Technology decision arose under
Minnesota law, if this same fact pattern were presented to a Wisconsin
court, the result likely would be the same under the WFIL. Any time a
grantor or licensor helps someone get into a business involving the
offer or sale of products or services generated by the grantor, the
lawyer must consider whether a franchise is present.
Although Wisconsin's franchise law provides that a franchise will
exist only if the goods or services are to be distributed "under a
marketing plan or system prescribed or suggested in substantial part by
[the grantor]," it may not take much to find that this element
exists.3 Under the Wisconsin Administrative
Code, a marketing plan will be deemed to be "prescribed in substantial
part" by the licensor if the agreement between the licensor and
licensee: 1) requires the licensee to operate a business that purchases
a substantial portion of its goods solely from sources the licensor
designates; 2) requires the licensee to follow an operating plan or
training manual the licensor issues, the violation of which may, under
the terms of the arrangement, permit the licensor to terminate the
agreement; 3) limits the type, quantity, quality, or sources of goods or
products the licensee may purchase; 4) permits the licensor, at any
time, to terminate the agreement, to repurchase the license rights, or
to refuse to renew the rights; or 5) requires the licensor to assist the
licensee in training, obtaining locations or facilities for the
operation of the business, or marketing of the licensor's products.
Once a marketing plan is found to exist, it will not be unusual to
find that the goods are identified by the franchisor's trademark, or
that the franchisor provides advertising materials for the goods or
services, thus meeting the second element of the test for a franchise.
Finally, few commercial transactions do not meet the third element, the
payment of a franchise fee. Under Wisconsin law, such a fee will be
found any time a fee or charge is paid as a condition for entering into
the business, including payment for goods and services.4 Thus, whether the fees are characterized as
development fees, training fees, marketing fees, license fees,
royalties, or fees for the purchase of products and services, they will
be considered franchise fees under the law.5
If the lawyer and client do not identify the license arrangement in
question as being a franchise subject to the WFIL, neither person will
then comply with the pre-sale registration and disclosure requirements
under that law.6 Under the WFIL, a person
who fails to comply with the registration and disclosure requirements of
Wisconsin law is liable to the purchaser for damages, rescission, and
attorney fees,7 and can be fined up to
$5,000 for each violation and imprisoned for not more than five
years.8 Clearly, neither the attorney nor
the client wants to hear "after the fact" that the arrangement was an
To ensure that the relationship does not fall within the confines of
the WFIL, attorneys and their clients must eliminate from the business
transaction one of the elements of a franchise. For example, all
marketing materials, sales programs, training programs, manuals, buying
requirements, and advertising could be eliminated so as to eliminate the
"marketing plan" element of a franchise. In the alternative, the
contract could prohibit the licensee, distributor, or dealer from using
the licensor's, manufacturer's, or grantor's trademark or trade name.
The transaction also could be structured so that the only fees paid to
the manufacturer are for the bona fide wholesale price of goods for
resale so that all payments made by the licensee, distributor, or dealer
to the licensor, manufacturer, or grantor fall within one of the
statutory exceptions to the payment of a franchise fee.9 If at least one of these elements is not addressed
and eliminated, the transaction will fall within the regulation of the
WFIL and the client will need to register the offer as a franchise and
make all proper disclosures before entering into the transaction.
Wisconsin Fair Dealership Law
While the WFIL will regulate the initiation of many license and
dealer arrangements, another trap awaits the grantor later in the
relationship when the grantor seeks to exercise rights it may have under
the agreement to terminate or otherwise change the arrangement. These
traps are found under the WFDL,10 which
purports to regulate dealerships and requires that before there can be a
termination of the relationship or a change in competitive
circumstances, the dealer must be in default and must have had an
opportunity to cure that default as provided by the statute.
The WFDL defines a "dealership" as any agreement between two or more
persons by which a person is granted the right to sell or distribute
goods or services or use a trademark and in which there is a community
of interest in the business of "offering, selling or distributing goods
or services at wholesale, retail, by lease, agreement or
otherwise."11 Most arrangements that fall
within the definition of a franchise also will be governed by the WFDL,
since that law applies to arrangements whereby a person is granted the
right to sell or distribute goods or services, even absent the trademark
element required for a franchise. The key question to answer in
determining whether the WFDL applies to the arrangement is whether there
is a "community of interest" between the grantor and the grantee. The
WFDL defines that term as a "continuing financial interest between the
grantor and grantee in either the operation of the dealership business
or the marketing of such goods and services."12 Unfortunately, the definition does little to
enlighten the practitioner as to when the WFDL will apply. In fact,
Wisconsin state courts may not even agree with Seventh Circuit courts as
to the provision's meaning.
The Wisconsin Supreme Court sought to clarify the concept of a
"community of interest" in Ziegler Co. v. Rexnord Inc.13 Ziegler was a distributor for Rexnord's
products. Rexnord lost more than $8 million over a three-year span
under the relationship and decided to terminate the relationship.
Although the contract between the parties did not prevent Rexnord from
terminating the contract, nor was there any question that Rexnord made a
valid business decision in concluding that the agreement should be
terminated, Ziegler claimed the WFDL applied and the relationship could
not be terminated under that law absent a breach by Ziegler.
The Wisconsin Supreme Court held that a community of interest will
exist when there is interdependence between the parties, along with a
continuing financial interest in the marketing of goods and services.
The court established a list of 10 nonexclusive factors (the
Ziegler factors) to be analyzed, including: 1) the length
of the parties' relationship; 2) the extent and nature of the
parties' obligations under their agreement; 3) the percentage of
time the grantee devotes to selling the grantor's products; 4) the
percentage of revenue the grantee derives from the grantor's products;
5) whether a territory has been granted and, if so, whether the
territory is exclusive; 6) the extent and nature of the grantee's
use of the grantor's marks; 7) the extent and nature of the
grantee's financial investment in the dealership; 8) the number of
personnel the grantee devotes to selling the grantor's products;
9) the amount spent by the grantee on advertising the grantor's
products; and 10) the type and amount of ancillary services
provided by the grantee to consumers who purchased the grantor's
products from the dealer.14 The court then
overruled the previous court's finding that a community of interest did
not exist as a matter of law and remanded for application of these
It is arguable that the Seventh Circuit does not apply the
Ziegler factors in determining whether a community of interest
exists under the WFDL. Instead, the Seventh Circuit emphasizes that the
alleged dealer must demonstrate sizeable investments in specialized
equipment or goods related to the grantor's goods or services that the
grantee would not fully recover on termination and the generation of a
significant amount of revenue from the relationship.15 The federal courts have even criticized the
Ziegler approach, reasoning that "[t]he problem with the
'totality of the circumstances' approach involving so many factors is it
becomes easy to miss the main thrust of the statute."16
The U.S. District Court for the Eastern District of Wisconsin may
have opted for a third approach to determining whether a community of
interest is present in a relationship. In Super Natural Distributors
Inc. v. MuscleTech Research & Development,17 the district court stated: "[t]he Seventh
Circuit Court of Appeals has suggested that it may be more useful to
focus one's attention on whether a) the revocation of the dealership
would pose a threat to the company's economic health ..., or b) the
revocation would result in a loss of considerable 'sunk costs.'"18
In this case, Super Natural was granted a distributorship to
distribute MuscleTech's dietary products. MuscleTech terminated the
distributorship after learning that Super Natural had obtained
approximately $1 million of allegedly counterfeit MuscleTech product
from an offshore supplier. Upon termination of the relationship, Super
Natural sought an injunction requiring MuscleTech to continue to supply
Super Natural with product during the pendency of the lawsuit. Super
Natural claimed that the relationship was a dealership under the WFDL,
and that MuscleTech failed to comply with the WFDL termination
provisions. The court determined that Super Natural was not likely to be
able to show that termination of the distributorship would pose a threat
to Super Natural's economic health, because Super Natural's sale of
MuscleTech's products accounted for only 13 percent of its revenues. The
court also found that Super Natural was unable to prove loss of sunk
investments because its investments in items used to operate its
business, including a warehouse and tradeshow booth, were not unique to
this business and therefore could be sold or dedicated to another
product line. The court therefore denied Super Natural's motion for a
By employing all of the Ziegler factors to determine whether
a community of interest exists, Wisconsin state courts analyze all
facets of the relationship between the grantor and grantee. The federal
courts may have narrowed the inquiry. However, given the difficulty the
courts have had interpreting whether a "community of interest" will lie
in a grantor/grantee relationship, a careful practitioner should err on
the side of assuming the statute is applicable whenever consulted by a
client who wants to terminate, cancel, not renew, or substantially
change the competitive circumstances of a distributorship or license it
has granted. The grantor would then provide the grantee with notice of
its intent, and an opportunity to cure, thus protecting itself against a
claim for damages and attorney fees as a result of its failure to comply
with WFDL requirements.
Clients seeking to distribute goods or services to others need
counsel who can advise them on the applicability of the WFIL to their
transaction and the alternatives available to them to avoid application
of that law. Clients also need to understand their obligations under the
WFDL. The recent Super Natural case confirms that the
applicability of these laws may sometimes represent a moving target.
Some aspects of the franchise and dealership definitions contained
within these laws are imprecise, making it difficult to render an
opinion to a client that an arrangement does or does not fall within the
definition of a franchise or dealership under these laws. In those
instances, it may be prudent to retain special franchise counsel to
analyze all the facts and determine whether compliance with these laws
is necessary. Unless counsel is reasonably certain the relationship does
not fall within these laws, counsel should advise the client to comply
with the laws in order to avoid liability for failure to do so. Clearly,
the consequences of being held subject to these laws but failing to
comply with them are substantial both for the grantor and for
Charles S. Modell, Univ.
of Florida 1977, is head of the franchise practice group at Larkin,
Hoffman, Daly & Lindgren Ltd., Minneapolis.
Joseph J. Fittante, William Mitchell 1996, is an associate in
the same group, and a native of Wisconsin.
Stat. § 553.01 et seq.
2 Bus. Franchise
Guide (CCH) ¶10,673 (Minn. 1995).
Admin. Code § DFI-Sec 31.01(4).
Stat. § 553.03(4), (5m).
5 One significant
exception is for the purchase of goods at a bona fide wholesale price.
Wis. Admin. Code § DFI-Sec 31.01(1)(b)2.
6 Although the
discussion centers around the Wisconsin Franchise Investment Law, the
federal franchise law, the FTC Franchise Disclosure Rule (formally
titled the Disclosure Requirements and Prohibitions Concerning
Franchising and Business Opportunity Ventures) contains a similar
definition of a franchise, and a similar disclosure scheme. 16 C.F.R.
part 436 (2001).
Stat. § 553.51.
8 Wis. Stat.
9 The two most
common types of payments that do not constitute payment of a franchise
fee are bona fide wholesale price payment for goods and payment of the
bona fide retail price for goods, subject to the payment of a commission
that results in the transaction constituting a bona fide wholesale
transaction. See Wis. Admin. Code § DFI-Sec
10 Wis. Stat.
11 Wis. Stat.
§ 135.02 (3)
12 Wis. Stat.
§ 135.02 (1).
13 139 Wis. 2d
593, 407 N.W.2d 873 (1987).
Farm Equip. v. Van Dale Inc., Bus. Franchise Guide (CCH)
¶10,109, at 23,769-70, citing Michael Bowen & Brian Butler,
The Wisconsin Fair Dealership Law §3.34 at 3- (Supp.
Beverage Co. v. Winterbrook Corp., Bus. Franchise Guide (CCH)
¶ 10,783, at 27,355 (E.D. Wis. 1995).
Franchise Guide (CCH) ¶12,039 (E.D. 2001).
Franchise Guide (CCH) ¶ 12,039, at 34,041 (E.D. 2001); see
also Cabintree of Wis. Inc. v. Kraftmaid Cabinetry Inc.,
Bus. Franchise Guide (CCH) ¶ 10,938, at 28,236 (E.D. Wis.
1996) (parties' efforts arguing over Ziegler factors were
misplaced because Ziegler factors are not "elements;" the court
is not required to consider each factor and consideration of every
factor is not "necessarily dispositive of the issue."); Beloit
Beverage Co., Bus. Franchise Guide (CCH) ¶ 10,783, at
7,355 (E.D. Wis. 1995) (Ziegler factors, although relevant,
should not be applied in a way to broaden scope of statute). But see
Beer Capitol Distributing Inc. v. Guinness Bass Import Co., Bus.
Franchise Guide (CCH) ¶ 12,155 (E.D. Wis. 2001) (employing
Ziegler factors, but focusing on percentage of alleged dealer's
business attributable to grantor's products and amount of alleged
dealer's sunk investments).