Intellectual property protection in franchising

Franchising is a business model under which franchisees pay franchisors to gain access to goods or services which use specific brands and particular techniques. In essence, franchisors authorize the use of their intellectual property. This article analyses the importance of intellectual property to franchising, and the ways in which intellectual property can be protected during the course of franchising operations.

Forms of IP in franchising

Intellectual property is crucial to a number of areas of a franchise system, from the authorization of the use of a brand to the replication of a business model.

The use and protection of intellectual property is the core of a franchise agreement, and can determine the success or failure of the franchise. Typical forms of intellectual property covered by a franchise agreement include registered trademarks, patents, commercial secrets, information about supply and demand, operational know-how, product formulas, technological processes and business models, and copyright on franchise contracts, operational handbooks, advertisement materials, training manuals, documents such as standard forms, and software.

IP is the core of a franchise

Many of the articles in franchise agreements concern the use of intellectual property in the operating concessions, such as trade names, registered trademarks, patented technology and copyrighted material.

Effective protection of intellectual property allows franchisors to gain, and maintain, a dominant position. The use of technical intellectual property gives the products and services that are the subject of the franchise unique characteristics to differentiate them from the products and services of others in the market; distinctive intellectual property makes a company’s logos and product designs different from others in the market, allowing them to leave a distinctive impression.

The worldwide success of KFC and McDonalds is due in no small measure to their management, and to their excellent brand image: specifically, their success is derived from the fact that the quality of their products and services throughout the world is consistently excellent. In addition, the simple but extremely effective design of their logos and the first-rate fit-out and decoration of their premises together constitute a unique external image.

Potential negative influences

If a franchisor’s management system is not mature enough, and the franchisor has not instituted franchising policies that are sustainable in the long term, the franchising model can actually have a negative effect on intellectual property. For example, in the initial stage of development the franchisor may, in order to occupy as much market share as possible in shortest possible period of time, relax the criteria that franchisees must meet in order to join up. While an increase in the number of franchisees may be good, it may also have some negative side effects.

At the same time, if the franchisor repeatedly neglects properly to supervise the franchisees for the sake of increasing the scale of the business, both good and bad franchisees may resort to uncontrolled competition in an effort not to be left behind by the market. Some franchisees may develop new products for innovation, which may not fit the taste of customers and thereby lose their trust. Once one or more franchisees lose the trust of their customers, other franchisees may also be negatively affected. With time, the market will become less and less buoyant. Some franchisees’ illegal behaviour is likely to negatively influence the goodwill which is accumulated with great difficulty by franchisors, while also having a negative influence on the intellectual property system in franchising.

Therefore, the issue of how to increase the protection of intellectual property in franchising can constantly have a negative effect on the long term stable development of the franchise enterprise.

Protective measures

In the franchise contract, franchisors and franchisees should specify the content of the intellectual property to be licensed, its types, and the scope and method of its use, and should determine the legal liability for the abuse of intellectual property in violation of the agreement. Effective enforcement of intellectual property can thereby be ensured.

Franchisors adopt different protective measures in view of the different forms of intellectual property in franchising.

1. Protective measures for trademarks: a distinctive trademark should be chosen for registration before commencing franchising; in the course of franchising, it is also important to monitor the quality of the products and services being provided by the franchisees for the maintenance of trademarks.
2. Protective measures for trade names: ensure that trademarks and trade names are consistent; register any names that were previously used in the business as trademarks; and use any well-known trademarks as trade names.
3. Protective measures for patents: specify the scope and the term of the permitted use of patents in the franchise agreements, and ensure that rights, obligations and liabilities are consistent.
4. Protective measures for trade secrets: when compared with the protection of other types of intellectual property, the protection of trade secrets is a relatively difficult issue. Trade secrets predominantly rely on confidentiality to maintain their value, and the law does not protect trade secrets whose confidentiality is not maintained. Moreover, if the exclusivity of trade secrets is not maintained, it can be impossible to prevent others from independently developing equivalent trade secrets, and even more impossible to establish the liability of innocent third parties. In franchising, a confidentiality agreement is an important means of protecting trade secrets. A confidentiality agreement can clarify the scope of the confidential information, the time limit and the legal liability for violating the confidentiality obligations.

In order to maximize the advantages of scale and reduce operational risk, it is crucial to strengthen the protection and exploitation of intellectual property in franchising.

Harry He is a partner at AllBright Law Offices. His main practice areas are foreign direct investment, M&A and labour disputes