Interpretive Opinion No. 71 / 13F

State of California Department of Corporations

Anthony R. Pierno, Commissioner
In reply refer to: File No. _____

This interpretive opinion is issued by the Commissioner of Corporations pursuant to section 31510 of the franchise investment law. It is applicable only to the transaction identified in the request therefor, and may not be relied upon in connection with any other transaction.

Mr. Leon E. Warmke
Attorney at Law
Warmke & Konig
1149 North El Dorado Street, Suite C
Stockton, CA 95202

Dear Mr. Warmke:

The request for an interpretive opinion under the Franchise Investment Law submitted with your letter dated January 4, 1971, as supplemented by your letter dated January 8, 1971, has been considered by the Commissioner. Your letter raises the question whether the agreements described by you of Nugget Distributors' Cooperative of America, Inc. ("Coop"), a non-stock, nonprofit, membership cooperative corporation, incorporated under the Oregon Cooperative Corporation Act, doing business under the fictitious name of Nugget Distributors Inc. and duly qualified to transact business in the State of California, constitute "franchises" within the definition of Section 31005 of the Franchise Investment Law and as such are subject to the registration requirements of Section 31110 or the disclosure requirements of Section 31101, as well as the other regulatory provisions of that Law and the rules of the Commissioner of Corporations promulgated thereunder. Especially included in your question are agreements between Coop and its members referred to as "Distributor and Membership Agreements" and agreements between Coop and its suppliers referred to as "Licensing Agreements". In our opinion neither of these agreements constitute "franchises" within the meaning of the Franchise Investment Law.

You have represented that Coop was incorporated on July 18, 1966, and has its principal office and place of business, as well as its mailing address, in Stockton, California. The Oregon Cooperative Corporation Act and the articles of incorporation and the bylaws by which Coop is governed, provide that Coop has been organized to render services to its members by utilizing their united efforts for the efficient and economical advertising, purchase, distribution and handling of Nugget brand merchandise sold or distributed by the members through their various business establishments throughout the United States. The membership of Coop presently is composed of 102 independently owned and operated institutional wholesale grocers widely dispersed throughout the United States. Eleven members are based in California. All of these members are authorized distributors of. Nugget brand merchandise.

The Nugget brand of products has attained customer acceptance among institutional purchasers as the result of the use of that brand for merchandise processed and distributed over a period of over thirty years by a Stockton, California, cannery. Upon its organization, Coop acquired the Nugget trademarks effective October 1, 1966, at a price of approximately $240,000 Coop enters into licensing agreements with its suppliers authorizing them to use the Nugget trademark on certain of their products. Such agreements are presently in effect with 389 licensed suppliers, widely dispersed throughout the United States. 90 such suppliers are based in California. Under the license agreement, these suppliers in lieu of any other consideration, agree to pay a royalty or license fee to Coop most frequently computed as a specified percentage of the net selling price of Nugget trademarked merchandise sold or distributed by them to members of Coop or other purchasers, and in the case of some few products only, as a specified amount per quantity.

The licensing agreements provide that the merchandise produced or distributed by the licensee under the Nugget trademarks shall be of a quality at least equal to that of similar products of other major producers and to the high quality associated in the public mind with the Nugget trademarks. Coop reserves the right of inspection of merchandise produced under the Nugget trademarks and the facilities for the production thereof, as well as the right to request samples of such products from licensees. Moreover, licensees are committed to comply with all laws and regulations applicable to their operations under the licensing agreements and to use good faith and due diligence to protect the trademarks and good will of Coop by maintenance of product quality, style, and appearance.

Coop employs a color-coded grading system for the quality of Nugget brand merchandise, including the Nugget Black Label for top quality, Nugget Red Label for extra standard quality, and Nugget Green Label for standard quality. It purchase's the labels and distributes them to the licensed suppliers, and whenever it orders merchandise from the suppliers, it specified the color of the label to be used on each shipment. Coop also designs, purchases, and furnishes to the licensed suppliers all packaging materials, cartons, ovewraps, and labels used for Nugget brand merchandise. The licensing agreements are terminable by either party on 30 days written notice. In some instances Coop will pay to suppliers amounts owing them by its members and reinvoice the members on more liberal payment terms. In some instances it will place orders on behalf of members where this can be done with greater efficiency. In all instances Coop provides its members with marketing services, distributes to them crop forecasts, information as to product availability and estimates of market trends, and conducts seminars and workshops for the training of members and their staff in the proper use of the various products. Members agree to use due commercial diligence to secure maximum sales of Nugget brand product within their respective territories, provided that these products are of at least competitive quality. Coop itself produces an average of from 15% to 20% of the total purchases of members. The balance of members' purchases are not produced by Coop.

Members pay a membership fee of $10 fully refundable on termination of membership. While Coop purports not to conduct its business for profit and is supposed to return to its members all of the proceeds derived from business done with them in excess of operating expenses, it retains from charges made to members for supplies or services such amounts as the board of directors determines. Amounts so credited are referred to as "retains". The aggregate amount of the retains is designated as the Revolving Fund and is said to constitute the membership capital of Coop. You have submitted a financial statement of Coop as at December 31, 1969, purporting to show "Members Equities," apparently represented by the aforementioned Revolving Fund, totaling $728,530.06, audited subject to some reservations. You have also submitted an unaudited balance sheet of Coop as at October 31, 1970 showing such "Members Equities" in the amount of $989,699.74. In both statements, most of such "Members Equities" is referred to as "Undistributed Operating Margin".

On the books of Coop, members are credited with their retains. When the board determines that a portion of the retains is not needed by Coop, such portion is disbursed to the members in the chronological order of their credits. Such disbursements are referred to as "patronage dividends". No interest is payable with respect to retains.

Membership may be terminated by the board of directors by reason of the failure of a member to pay membership fees, membership dues, or to advance loans to Coop as determined by the board. Membership, also may be terminated for other stated causes, including violation of the distributor or membership agreement between the member and Coop, bankruptcy, insolvency or specified impairment of credit. In the event of termination of membership, members are entitled to accrued patronage dividends, but not to any payment on account of the value of the member's property interest in Coop, the bylaws providing that "the value of the property interest of such member in the Cooperative is nothing".

Annual meetings of members are held at which six directors-at-large are elected. Seven additional directors are elected, one by the membership of each of the seven districts into which Coop is divided. Each member has one vote at any member meeting. Voting by proxy is not permitted. Officers are elected annually by the board of directors immediately following the annual meeting of members. The directors and principal officers do not receive salary or other compensation. Coop is managed by a vice president who is neither a director nor a member and who is compensated for his services.

"Franchises" which are subject to the registration, disclosure, and other regulatory requirements of the Franchise Investment Law, are defined in Section 31005 of the Law, to mean "contracts or agreements, either .expressed or implied, whether oral or written, between two or more persons by which a franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor where the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the franchisor or its affiliate, and the franchisee is required to pay directly or indirectly a franchise fee."

The requirement of a franchise fee is met in the instant case, both as regards the "Distributor and Membership Agreements" and the "Licensing Agreements", by the various payments collected by Coop from its members and suppliers, respectively, as stated above. However, according to Section 31005, another essential part of the definition of a "franchise" is an agreement between two or more persons, that the business operated by one of these persons, the franchisee, employ the commercial symbol designating the other, the franchisor, or the other's affiliate, and that this business be operated pursuant to a marketing plan or system prescribed in substantial part by the franchisor. Thus not every license authorizing the use of a trademark, trade name, or other commercial symbol in return for a fee, amounts to a "franchise" within the definition of Section 31005 of the Franchise Investment Law.

As regards the "Distributor and Membership Agreements" in the instant case, they are between a body corporate and its constituent members. We need not consider whether and under what circumstances such a relationship will constitute "a contract or agreement...between two or more persons" within the meaning of Section 31005. We are satisfied that the "Distributor and Membership Agreements" do not come within the definition of "franchise" in that Section, because nothing appears in the representations made to us concerning these agreements, to indicate that the marketing plan or system of Coop's members is prescribed by Coop in substantial part or at all. Rather for all that appears in the documents submitted to us, these members conduct their several businesses in which they distribute Nugget brand merchanise and possibly other products as well, according to their own several marketing plans or systems. These marketing plans or systems may or may not be in agreement, one with the other. The only feature which we know they have in common, is that in each of them the Nugget brand is used to designate goods produced or licensed by Coop. Other commitments between Coop and its members appear to be referrable to the existing membership relationship and not specifically to the marketing plan or system prescribed by Coop. This, in our opinion, is not sufficient for a marketing plan or system within the meaning of Section 31005 (a).

We reach the same conclusion as regards the "Licensing Agreements". Like any other purchaser of merchandise, Coop in the interest and on behalf of its members, of course, is concerned with the quality of the merchandise produced and/or distributed by the licensees under the Nugget trademark. Therefore, it has reserved the right of inspection of that merchandise and of the facilities for its production, it has the right to sample products, and it has committed the licensees to maintain product quality, style, and appearance, and it provides them with labels and quality symbols. In the Commissioner's opinion, this is not sufficient to constitute "a marketing plan or system prescribed in substantial part" by Coop, as provided in Section 31005.

By reason of the foregoing we are of the opinion that the "Distributor and Membership Agreements" and the "Licensing Agreements" described by you, are not franchises within the meaning of Section 31005 of the Franchise Investment Law.

Dated: San Francisco, California
March 12, 1971

By order of ANTHONY R. PIERNO
Commissioner of Corporations

By __________________

HANS A. MAT'TES
Assistant Commissioner
Office of Policy