Licensing trademarks to franchisees can be a valuable and successful business model—think McDonald's, Papa John's, Dunkin', Orangetheory—but it also comes with some risks. One of those risks is naked licensing, which occurs when a licensor (or franchisor) fails to adequately control the nature and quality of the goods or services sold by the licensee (or franchisee). The consequence of naked licensing is dire: abandonment of the licensor's or franchisor's trademark and all associated trademark rights. Needless to say, a finding of naked licensing and abandonment can be detrimental to any trademark owner, particularly a franchisor whose business model revolves around trademark licensing. The issue of naked licensing in the context of franchising was at the forefront of the summary judgment decision in Endo Fitness LL, LLC v. F-19 Holdings, LLC. Fortunately for the defendant and franchise owner F19, the U.S. District Court for the Central District of California found that it did not engage in naked licensing of its "Fitness 19" brand by licensing that brand to a network of over 38 gyms.
Defendants/licensors F-19 Holdings, LLC and F19 Franchising, LLC (together, "F19") have used their "Fitness 19" mark for fitness services since 2002 and have licensed the mark to other gyms under a franchise model since around 2008. Plaintiff Endo Fitness LL, LLC operates a gym in Loma Linda, California. Endo originally intended to open that gym under the Fitness 19 name as an F19 franchisee, but negotiations with F19 soured and no deal was ever inked. Nevertheless, Endo proceeded to launch and operate its gym under the Fitness 19 name and mark without a license. After opening its gym, Endo filed a declaratory judgment action, seeking a preemptive declaration that F19 had no trademark rights in its Fitness 19 mark because F19 had licensed that mark to its franchisees without adequate quality control and had thus abandoned the mark through naked licensing. F19 moved for summary judgment on this issue, arguing that it had adequately controlled the use of its mark by its franchisees. The court agreed and granted F19's motion.
In its opinion, the court first set out the standard for naked licensing, explaining that naked licensing occurs when a licensor fails to exercise adequate quality control over a licensee. The court also identified the three alternative ways that a franchisor can exercise adequate quality control and thereby avoid naked licensing in the Ninth Circuit: (1) the licensor can include in the license grant an express contractual right for the licensor to inspect and supervise the licensee's operation; (2) the licensor can exercise actual control over the quality of the licensee's operation; or (3) the licensor can reasonably rely on the licensee to maintain quality control. The court also outlined the consequences of naked licensing: because naked licensing "deceiv[es] the public that relies on trademarks as a symbol of source and quality control," the mark loses any and all trademark significance and is deemed abandoned by the licensor. The court clarified that subjective intent to abandon a mark is not required, so a party asserting a naked licensing theory faces a "stringent" standard of proof, which Endo failed to meet.
To determine that F19 exercised adequate control over its franchisees' use of its mark, the court focused only on whether F19 exercised actual control over its licensees. Endo did not dispute that purported agents of F19 had actually conducted investigations to assure the quality of some F19 franchisees. However, Endo argued that these inspections were not bona fide quality control inspections sufficient to avoid a finding of naked licensing because they were conducted by franchisees themselves (as opposed to the franchisor) and were thus not representative of best practices in the franchise context. The district court rejected this argument. It found no binding authority holding that a licensor or franchisor must comply with best practices in order to exercise actual control. Because Endo admitted that quality inspections were performed, albeit by franchisees themselves, the court concluded that F19 exercised at least some actual control.
Endo also argued that F19 failed to provide written standards to franchisees to ensure consistency among them and thus did not exercise actual control. The court again rejected Endo's argument. Even though F19 did not seriously dispute that it did not provide a written standard or that its services, amenities, staff training, and staffing levels varied by location, these facts were not fatal to F19's trademark rights. The court held that the proper inquiry in the naked licensing context is not consistency among franchisees but overall franchisee quality. On that point, the court determined that, despite the admitted inconsistencies among F19 locations, "quality was equally high across all F19 franchisees." And even if consistency were relevant, the court found that minor discrepancies did not demonstrate a lack of actual control because "common sense dictates that any consistency requirement could not be that every location is identical in every way."
Accordingly, the court concluded that there was no dispute of material fact that F19 played a "meaningful role" in holding its franchised gyms to a standard of quality and exercised actual control over them. Because no dispute as to actual control existed, the court found it was not required to weigh the other two tests for quality control. The court thus granted summary judgment for F19, finding that it had not engaged in naked licensing and had not abandoned its Fitness 19 brand.
The case is Endo Fitness LL, LLC v. F-19 Holdings, LLC, No. 2:22-cv-03124-MEMF-JC (C.D. Cal., Dec. 1, 2023).
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