Commissioner's Opinion No. 72 / 23F

State of California Department of Corporations

Brian R. Van Camp, Commissioner
In reply refer to: File No. _____

This letter is not an Interpretive Opinion for the reasons stated below.

The request for an interpretive opinion contained in your letter dated April 21, 1972, has been considered by the Commissioner, Your letter raises the question whether the agreements between X , a Delaware corporation ( ) a wholly-owned subsidiary of y , and persons referred to therein and hereinbelow as "Operators" are franchises within the definition and subject to the provisions, including the registration requirement of section 31110, of the Franchise Investment Law. This question is answered in the affirmative.

We understand that. X is engaged in the sale of a variety of vitamin products and, to a lesser extent, of other drug items and toiletries. Pursuant to the agreement, X grants Operators the exclusive and nontransferable right to market and sell at retail x products and all future products bearing its name and trademark, as well as the right to use such trade names, trademarks, logos, copyrights and other advertising media in the marketing of x products. Operators agree to buy from X all products and/or supplies required to conduct business. In the event net purchase during any three consecutive months after the first three months of operation are less than a determined minimum amount, x and Operator have the right to terminate the agreement upon 30-days written notice. Operators are prohibited (except as specifically permitted by statute and except with the consent of X ) to directly or indirectly advertise, offer for sale or sell at retail any x product at less than X 's current list prices less the maximum discount, if any. In addition, Operators are required to maintain a "permanent x display section", as diagramed by X , in each of their retail distribution centers. Any modification of this display section must have x 's prior written approval. Operator will also prominently exhibit, promote the sale of, sell and distribute X products, including promotional literature and material in the manner and to the extent as x will from time to time request x will at all times determine the standard of quality, advertising and prices of all its products and, if Operators in any way fail to maintain these standards, it has the right to terminate the agreement on 10-days written notice. All local advertising and promotion employee by Operators must be submitted to and approved in writing by x. No signs or advertising media of any kind of which x objects shall be displayed in or upon Operators' premises or elsewhere where, in the opinion of x , such signs or advertising shall have an adverse effect upon the sale of x products.

Section 31005 of the Franchise Investment Law defines "franchise" to include an agreement, either 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 the franchisor, the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's commercial symbol, such as its trade name or trademark, and the franchisee is required to pay or agrees to pay for the right to enter into a business under a franchise agreement, including, but not limited to, any such payment for goods and services. The purchase or agreement to purchase goods at a bona fide wholesale price is not considered the payment of a "franchise fee" pursuant to section 31011 (a). Rule 011 of the Commissioner exempts from the registration requirement of Section 31110 of the Law any offer or sale of a franchise which would be subject to registration solely because the franchisee is required to pay, directly or indirectly, a franchise fee which, on an annual basis, does not exceed $100.

In our opinion the agreement between X .and Operators contains all of the essential elements of a "franchise" The representation in your letter that the agreement does not "give him the right to use the name ' X ' as a trade name or trademark" is assumed to mean that Operators may not use the name '' x. " in their business name since, the agreement does grant the Operator the right to use x 's commercial. symbol and requires them to maintain a "permanent X display section". These grants and requirements are sufficient for us to conclude that the operation of Operators' business is: substantially associated with x 's commercial symbol within that meaning of Section 31005.

As regards the question whether Operators are required to pay a "franchise fee", we note the provisions in the agreement that x will sell its products at its net trade prices for the quantity indicated, as set forth in its then current pricing manual, at a determined discount. Operators shall pay all transportation costs on orders of less than $50, and x shall pay all transportation costs on all orders over $50, as defined in the agreement. Nothing contained in or with your letter indicates that these payments are for the purchase of goods at a bona fide wholesale price. Neither can a determination by made that the amount paid does not exceed the sum of $100 under Rule 011.

Moreover, the agreement requires the Operator to pay x an initial fee of $100 which fee is to be applied as a credit against the first purchase made by Operators of x products. The determination of whether a ''franchise fee" is being paid must be made at the time of the execution of the agreement. While denominated an "initial fee" as a credit to the first purchase, this payment is, in effect, a charge to the Operator to enter into the business. Under the agreement the payment may be retained, even though the Operator never enters into business and never orders merchandise. The payment cannot be characterized as a purchase price for goods on the theory that merchandise will be delivered at some future date or that the merchandise would be sold at bona fide whole sale price.

Section 31153 of the Law provides that the burden of proof for an exemption or exception from a definition of a requirement is upon the persons claiming it. Therefore, x bears the burden of establishing as a matter of fact that the prices it charges for its products does not exceed the bona fide wholesale price. We are unable to make such a determination because this is a question of fact concerning which the issuance of an interpretive opinion, limited as it must be to the consideration of legal questions, would not be appropriate.

Accordingly, unless x is able to meet this burden of proof, it is our conclusion that, under the circumstances described by you as outlined above, the agreements between x and Operators are franchises within the definition of Section 31005 and are subject to the provisions of the Franchise Investment Law.

An exemption from the registration requirement of Section 31110, is provided if the franchisor complies with the standard as to financial condition set forth in Subdivision(a), the standard as to scope of operation in Subdivision (b) and the disclosure requirement specified in Subdivision (c) of section 31101. You have represented that x satisfies the $1,000,000 net worth requirement, but that Y, the parent corporation, does not satisfy the $5,000,000 net worth requirement. In addition, you have not indicated whether the standards as to scope of operation are met or whether the disclosure requirements will be complied with. Therefore, it is our opinion that the exemption from the registration requirement of Section 31110 provided for by Section 31101 of the Law, is unavailable for the agreements between x and Operators.