Commissioner's Opinion No. 73 / 10F

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.

Mr. Rodney M. Gray
Attorney at Law
6331 Hollywood Boulevard
Suite 810
Hollywood, CA 90028

Dear Mr. Gray:

The request for an interpretive opinion, contained in your letter dated January 19, 1973, has been considered by the Commissioner. Your letter raises the question whether the distributorship agreements between Jones Manufacturing Co. ("Jones") and persons referred to therein and hereinbelow as "distributors" are franchises within the meaning of Section 31005 and subject to the provisions, including the registration requirement of Section 31110, of the Franchise. Investment Law on the assumption stated below, this question is answered in the negative.

You have represented that Jones is engaged in the business of manufacturing and distributing pet foods under the name "Foods of Nature". Pursuant to the agreement, Jones grants to the distributors a nonexclusive distributorship for a specified area. The distributor agrees to make sales to markets, health food stores, pet stores and gourmet shops in that area. He pays Jones a specified amount as a "performance guarantee". Jones will credit the distributor with $1 per case purchased and paid for during the initial two year period, up to a sum equal to the performance guarantee. Jones will prepay freight charges on all orders of 350 cases or more. Distributor agrees, commencing 90 days after the execution of the agreement, to order and pay in advance for a minimum of 350 cases per month for three months and 1,000 cases per month thereafter.

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 a 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 trade mark, and the franchisee is required to pay a franchise fee. Section 31011 defines ''franchise fee" to mean any fee or charge that a franchisee or subfranchisor 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 their bona fide wholesale price is not considered the payment of a "franchise fee" pursuant to Par. 2(a) of Section 31011, and Rule 011 of the Commissioner exempts from the registration requirement of Section 31110 of the Law, an 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.

A marketing plan or system may be "prescribed" within the meaning of Section 31005, although there is no obligation on the part of the franchisee to observe it, where a specific sales program is outlined, suggested, recommended, or otherwise originated by the franchisor. Thus we have said that a sales program may be deemed "prescribed" by the franchisor where he supplies kits or detailed instructions for presentation of the product (Dept. of Corps., Release No. 3-F). In this connection you have only told us that Jones supplies the distributor with display material highlighting the product, and you have represented that the distributor is not required to account to Jones for his time, manner of selling, or his income from sales, and he may sell products unrelated to Jones' products. Jones does not conduct any formal training program.

If Jones exercises no other control, directly or indirectly, as above stated, in regard to the manner in which the distributors sell "Foods of Nature", we would be of the opinion that there is no marketing plan or system prescribed for sales by the distributors. In that event, the agreements between Jones and the distributors are not "franchises" within the meaning of Section 31005 and are not subject to the Franchise Investment Law. If by reason of facts not brought to our attention, or as the result of any of Jones activities, a marketing plan or system is originated by Jones for the distributors, the agreements, in our opinion, are "franchises" and subject to the provisions of the Law, because the distributors use Jones trade mime "Foods of Nature" in connection with their sales of the product, so that evidently these sales are substantially associated with Jones' commercial symbol.

We do not concur in your opinion that distributors are not required to pay a "franchise fee". While denominated a "performance guarantee" and subject to conditional and possibly only partial refunding on the part of Jones, this payment in reality represents a charge to the distributors for the right to engage in the business of distributing "Foods of Nature". As we have pointed out in Comm. Op. No. 72/3F, such a deposit is a franchise fee, because even if totally refunded, distributors for a period of up to two years, lose the use of the guarantee money.

Moreover, as stated in Comm. Op. No. 73/1F, to the extent that distributors under their agreement with Jones may be required to purchase prescribed amounts of products or to purchase such amounts within a specified period, the exceptional provision of Par. 2(a) of Section 31011 in relation to the purchase of goods at their bona fide wholesale price, in our opinion, is not applicable, if the amount so required to be purchased, exceeds the quantity which a reasonable businessman normally would purchase by way of a starting inventory or to maintain a going inventory. Payment for such excessive purchases is made by the franchisee not to satisfy a need for the goods, but to secure the right of selling them under the franchise agreement. For that reason it constitutes a "franchise fee" (Mattes, The Franchise Concept, California State Bar Journal, Vol. 47, P. 348).

Dated: San Francisco, California
March 12, 1973

By order of
Commissioner of Corporations

By __________________
Assistant Commissioner
Office of Policy