• The Accidental Franchise
  • May 2, 2003
  • Law Firm: Dinsmore & Shohl LLP - Cincinnati Office
  • Manufacturers sell products, not franchises. At least, that's what they intend. Unfortunately, the best of intentions don't always win in court. In To-Am Equipment Co., Inc. v. Mitsubishi Caterpillar Forklift America, Inc., 953 F. Supp. 987 (N.D. Ill. 1997), aff'd, 152 F.3d 648 (7th Cir. 1998), Mitsubishi found out the hard way that simply trying to recover a small amount of expenses from a dealer could cost it big time.

    Under Illinois law (as in To-Am) and under federal and most other state law, to qualify as a "franchise" a contract must require the payment of a fee (usually $500 or more) for the right to conduct business under the contract. The absence of that required payment by manufacturers provides the most common basis for excluding product dealerships as franchises under federal and most state laws. Almost all distributorships meet the other criteria used to define a franchise:

    1. Use of the manufacturer's trademarks in selling the products involved and;
    2. Significant assistance or control by the manufacturer or the use of a marketing plan prescribed or suggested by the manufacturer.

    Mitsubishi didn't charge To-Am a fee to become its dealer. However, it did require To-Am to keep a sufficient supply of service and parts manuals on hand necessary to repair the forklifts sold to its customers. Mitsubishi gave To-Am an initial copy of each manual for free but charged for making additional copies.

    Illinois law defines a franchise fee as any payment in excess of $500 which a franchisee must pay the franchisor (or its affiliate) for the right to enter into a business or to sell, resell or distribute goods or services, unless specifically excluded. Federal law and the states that regulate the sale of franchises define a franchisee fee in substantially the same way. The Illinois statute excludes items a dealer purchases for resale, but not items that it will use to conduct business (i.e., service manuals). To-Am did not purchase the service and parts manuals for resale. Unlike federal law, which looks only at payments within the first six months, Illinois law contains no express time limit and both parties had agreed that Illinois law contemplated the aggregation of payments over time.

    The total amount paid by To-Am for service and parts manuals did not exceed $500 until several years after To-Am opened its doors. Indeed, it did not exceed even $100 before the state legislature increased the qualifying fee from $100 to $500. According to the court, "It took eight years for To-am to make $1,658.75 in required purchases... for about half of its time as a Mitsubishi distributor, To-Am was not a 'franchisee' even by its own understanding." Of course, Mitsubishi had the ability to prevent To-Am from becoming a franchisee, the court stated. "For example, it could have furnished manuals for free..., it could have included the cost of manuals in the wholesale price it charged for the forklift trucks, rather than charging separately... [, or it] could have granted its dealers express permission to copy the manuals." But it didn't and, when it decided to terminate To-Am's contract, it gave To-Am 60 days' written notice as required under its contract but failed to comply with the "good cause" requirement for terminating a franchisee under Illinois' franchise law. For charging To-Am a little more than $1,500 in copying charges (and wrongfully terminating its franchise), Mitsubishi got to pay To-Am $1,525,000 in lost profits, $234,819.55 in attorneys' fees, and $19,893.21 in court costs.

    Many of the facts of To-Am make it unique unto itself and not all states have franchise laws that operate quite as broadly as Illinois. For example, Maryland, Minnesota, South Dakota, Virginia and Washington exclude from the definition of a franchisee fee the purchase at fair market value of supplies necessary to begin or continue to sell a manufacturer's products. Indiana, Michigan, Rhode Island, Wisconsin and, of course, Illinois, do not exclude those purchases. California excludes up to $1,000 per year of those type of purchases. Federal law excludes those purchases only after the first six months of operations. Manufacturers should take the lesson of To-Am to heart. The natural impulse of administrative staff to charge back to dealers "out-of-pocket" costs for seemingly inconsequential materials may detonate or start the clock ticking on a legal land mine. Manufacturers that charge dealers for required supplies, materials or services must monitor those charges constantly on a state-by-state basis or run the risk of having sold an accidental franchise.