Commissioner's Opinion No. 73 / 8F

State of California Department of Corporations

Brian R. Van Camp, 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.

 

The request for an interpretive opinion contained in your letter dated February 24, 1972, as supplemented by your letter dated March 2, 1972, has been considered by the Commissioner. Your letters raise the question whether the offer and sale by the shareholders of X, a California corporation ("X") of all the outstanding X shares to Y, a California corporation ("Y"), under the circumstances described by you, constitutes the offer and sale of a franchise within the meaning of Section 31005 subject to the registration requirement of Section 31110 of the Franchise Investment Law.

You have represented that X was organized in December 1970, for the specific purpose of selling, installing and servicing home securities systems, and it subsequently sold and issued shares to nine persons ("shareholders") pursuant to a permit of the Commissioner of Corporations dated February 2, 1971, as amended April 9, 1971.

On April 13, 1971, a license agreement was executed between Z, a wholly owned subsidiary W, and X by which X obtained the exclusive right to market certain home security products and systems of Z in the Los Angeles area. You have expressed the opinion that this agreement was a "franchise" within the definition of the Franchise Investment Law; however, inasmuch as the registration requirement contained in Section 31110 of that Law did not become effective until April 15, 1971, the agreement was not registered with the Commissioner.

Section 15 of the agreement restricts the right of X to assign the agreement, or any rights thereunder, without the prior written consent of Z. Furthermore, Subsection 17.11 of the agreement prohibits the sale, hypothecation, or transfer of X shares, with certain exceptions, without the prior written consent of Z.

Your have represented that after April 13, 1971 and until the present X has been continuously engaged in active business, including the marketing of Z products, we presume under the franchise, but that disagreements have arisen between it and Z concerning the agreement. You have further represented, that following negotiations, the parties have arrived at an agreement in principle, whereby Z would reimburse X for certain expenses and the relationship between X and Z would be terminated on certain terms and conditions. Moreover, Z be terminated on certain terms and conditions. Moreover Z will consent to the sale of all outstanding shares of X by the shareholders to Y for a purchase price anticipated to be based upon shareholders' investment in X. We understand that Z intends to take an active part in all negotiations between the shareholders and Y to assure that its rights are protected. Y since November 1970 has been a franchisee of Z for the counties of San Bernardino, Riverside, and San Diego.

Section 31110 of the Franchise Investment Law impose a registration requirement upon the offer or sale of any franchise in this stats, unless an exemption is available. If our representation that the relationship between X and Z is to be terminated means that a new franchise will be granted by Z to X after Y has become the purchaser and holder of the X shares, the sale of such franchise, of course, would be subject to this registration requirement. In this connection you have asked us to assume that the exemption provided in Section 31102 is unavailable.

If on the other hand, we are to understand that the franchise agreement executed on April 13, 1971, between Z and X will remain in effect after Y has become the sole shareholder of X the question is presented whether the sale by the shareholders to Y of all of the outstanding X shares constitutes the sale of a franchise, on the theory that the franchise agreement of April 13, 1971, is a material asset of X and that the sale of the X shares amounts to a sale of that asset.

Section 31210 of the Franchise Investment Law makes it unlawful for any person to effect or attempt to effect the sale of a franchise in this state, except in transactions exempted under Chapter 1 of the Law, unless the seller is identified in the application for registration or is a California licensed real estate broker or salesman or a California licensed broker-dealer or agent.

In the instant case, the shareholders purport not to effect a sale of a franchise but a sale of all of the outstanding X shares. These shares represent an equitable interest in the franchise which for the purpose of this discussion, we assume, will remain in effect. We can conceive of circumstances under which the sale of all or substantially all of the outstanding shares of a corporate franchisee would have to be considered for the purpose of Section 31210 as the equivalent of the sale of a franchise. For instance, if a corporation was formed for the purpose of acquiring a franchise and thereupon to sell it to a purchaser, and this corporation had not engaged and did not intend to engage in any other business activities, and had not acquired and did not propose to acquire any other assets, the law would look through form to substance and considering all of the facts and circumstances surrounding the purported sale of corporate shares, would determine the true intent of the parties, their mutual purposes and expectations and the potentialities of the facts and circumstances surrounding the purported sale of the facts and circumstances surrounding the purported sale of corporate shares, would determine the true intent of the parties, their mutual purposes and expectations and the potentialities of the rights acquired by the purchaser, and thus could arrive at the conclusion that what in form is a sale of corporate shares, is in substance the sale of a franchise (People v. Woolson, 181 C.A. 2nd 657).

Significantly you have represented that X will continue to be a going business. Your further representation that it possesses management, employees, offices, and other facilities, customers and customer lists as part of its assets, may suggest that it has no substantial tangible assets. In our opinions this is not sufficient to treat as sale of a franchise the sale of corporate stock which you have assured us, will be effected in conformity with the provisions of Rule 260.141.11.

In appears that X acquired the franchise and continuously engaged in active business, including the marketing of Z products under the franchise, for the better part of a year, before consideration was given to the sale of the franchise, we understand, but came into existence at a subsequent time due to problems that developed in the exercise of the franchise and the operation of X's business pursuant thereto.

Under these circumstances, we are not in a position to assert that the sale of the X shares is substantially equivalent to the sale of the X shares is substantially equivalent to the sale of the X shares is substantially equivalent to the sale of the franchise owned by X, and the sale of the franchise in our opinion is not subject to the prohibition of Section 31210 of the Franchise Investment Law.

Dated: San Francisco, California
March 15, 1972

By order of
BRIAN R. VAN CAMP
Commissioner of Corporations

By __________________
HANS A. MATTES
Assistant Commissioner
Office of Policy