When most of us think of a restaurant franchise, the images of golden arches along with the sounds of “Pizza! Pizza!” stream through our minds.

It’s no secret that restaurants are among the most prevalent and wildly successful franchises in the US. Just look at your local strip mall, for example.

Yet, many business owners (and their attorneys) fail to realize how franchise laws actually work. New York franchise laws, in particular, extend far beyond the traditional franchise model. As a result, numerous franchisor/franchisee relationships are created inadvertently under the law. And many accidental franchisors are far from “lovin it.”

New York Franchise Laws

Many businesses throughout New York violate the state’s franchise laws every day. In fact, it’s easy to run afoul of the laws when businesses are expanding or engaging in certain distribution or licensing activity.

New York’s Franchise laws are among the strictest in the country and were initially enacted to prevent fraudulent franchise schemes, which ran rampant many years ago. Without getting too far into the nitty-gritty of the statute, New York defines a “franchise” as any business paying a “franchise fee” (a) in exchange for the right to sell goods or services under a marketing plan or system prescribed in substantial part by the franchisor or (b) where a franchisee, in return for a “franchise fee,” is granted the right to sell or distribute goods or services substantially associated with the franchisor’s trademark, logo, advertising or other commercial symbol.

The “Franchise Fee” Requirement

So, what’s a “franchise fee”? Under the law, it’s any payment “made before, upon, or after execution of an agreement to purchase, process, resell, or otherwise distribute a manufacturer’s, a distributor’s or a licensor’s goods, services, equipment, inventory or real estate.” The law defines a payment as any form of lump sum, installments, periodic royalties, profits, or cash flow. Also, any fee reflected in the price of goods, services, equipment, inventory, or other items, falls within the definition.

Practicalities for Restaurant Operators

Moving past the above legal mumbo jumbo, the practical implications of the law, due to its expansiveness, pose problems for many business operators.

For example, restaurateurs who receive ongoing royalties for allowing the use of their logo or other commercial symbols should consider whether such royalties are actually franchise fees under the law.

Of course, there are statutory exceptions such as any payment for goods at a bona fide wholesale price, any fees not exceeding $500 annually for sales materials of equal or higher value received by franchisees and fees for ordinary/necessary business expenses, to name a few. Such payments would not be viewed as franchise fees under the law. (There are other limited exemptions to the franchise laws, but most would not apply to restaurateurs.)

Therefore, paying a distribution or licensing fee to another company for the right to sell its trademarked products could be deemed a franchise fee. That is true especially when the fee is way more than the bona fide wholesale price. Accordingly, restaurateurs should be careful when selling any spin-off related products, like bottled sauces, for example.

Accidentally Screwed? Maybe Not

If you find yourself sued by an unhappy counterparty claiming to be your bastard franchisee — stay cool. You can take steps to get back into compliance with the law.

Your first course of action should be to enlist the services of an attorney who is well-versed in NY’s tricky franchise laws. After analyzing the seriousness of your situation, your attorney should walk you through any potential defenses and remediation strategies at your disposal.

Dealing with any New York State agency is no laughing matter, so it’s crucial to show candor and sincere willingness to resolve the issue. A good attorney should help set the tone throughout the remediation process. Who knows, you might walk away with a minor fine or a mere slap on the wrist.

Awareness is Key

Restaurateurs should be aware of this issue sooner rather than later so that any potential problems stemming from accidental franchise disputes can be avoided from the get-go.

If you’re interested in learning more about this topic, check out this recent report published by the New York City Bar Association’s Hospitality Law Committee.