Commissioner's Opinion No. 73 / 31F

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. James L. Seal
Attorney at Law
Musick, Peeler & Garrett
One Wilshire Boulevard
Los Angeles, CA 90017

Dear Mr. Seal:

The request for an interpretive opinion, contained in your letter dated May 10, 1973, asking for reconsideration of the views expressed in Commissioner's Opinion No. 73/7F, has been considered by the Commissioner. Your letter raises the question whether, under the circumstances described by you, the arrangements between Dynasty Industries, Inc. ("Dynasty"), and persons referred to by you and hereinbelow as "distributors" and "executive distributors" are franchises within the definition of Section 31008, and subject to the provisions of the Franchise Investment Law.

You have represented that Dynasty, whose principal place of business is in Dallas, Texas, causes to be designed and manufactured and sells fashion jewelry. Your letter dated May 10, 1973, contains no references to the "consultants" referred to in your letter dated July 14, 1972, and in the aforementioned opinion. Accordingly, we assume that Dynasty engages only distributors and executive distributors as independent contractors to distribute its products.

You have further represented that a distributor typically is a woman devoting part time to the sale of Dynasty products at an informal party at which she displays the line, using both samples and catalogs. Under the revised plan, outlined in your letter dated May 10, 1973, she purchases directly from Dynasty at 30 percent below retail price and thus earns 30 percent on her retail sales. In addition to this commission, a distributor receives a "monthly performance incentive," which is a graduated percentage of the retail sales made by other distributors whom she has "introduced" to the Dynasty organization. Thus, a distributor's total compensation is based exclusively on retail sales of Dynasty products made by her or other distributors she has recruited. A distributor earns or receives no compensation merely for "introducing" or "recruiting" new distributors.

The executive distributor performs many of the same functions as a distributor. In addition, she is responsible for administering the "distributor organization" and for training new distributors. She holds periodic assemblies for established distributors under her auspices and conducts orientation classes to train new distributors. Like a distributor, an executive distributor earns the basic 30 percent commission on her own sales, receives monthly performance incentives based upon retail sales of other distributors and executive distributors which she has developed, and earns no money merely for recruiting. In addition to the commission, Dynasty pays a $20 training bonus to an executive distributor to help defray the cost of training new distributors. The training bonus is paid for each distributor she trains, regardless of whether the new distributor was recruited by her or a distributor under her supervision. You have expressed the opinion that, since the training bonus is paid only after the new distributor has received training and made retail sales, and is paid regardless of whether or not the executive distributor directly recruited the new distributor, the training bonus does not represent consideration for introducing a new participant into the Dynasty organization.

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 trademark, 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 a bona fide wholesale price is not considered the payment of a "franchise fee" pursuant to Section 31011(a), and 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 this connection, you have represented that distributors and executive distributors make no payments to Dynasty other than for the purchase of goods at their bona fide wholesale price. These goods, you have advised us, have an established value and can be readily converted into cash because they are not purchased from Dynasty until a retail. order has been obtained by the distributor or executive distributor. Moreover, you have represented that the distributors and executive distributors are not required to make any payments to Dynasty for sales aids or other equipment in order to engage in business under the Dynasty name. Distributors are required to "earn" a "showcase", including demonstration jewelry and sales aids. A showcase is received by a new distributor when she, in conjunction with an established distributor, gives a party and obtains a minimum of $150 of retail orders for which the 30 percent discount is not received. If the new distributor holds four additional parties within the next two weeks, for which there are no minimum sales requirements, the showcase becomes her property.

Section 31153 of the Franchise Investment Law provides that the burden of proving an exemption or an exception from a definition is upon the person claiming it. Accordingly, the burden of establishing the fact that Dynasty is selling its products at their bona fide wholesale price is upon Dynasty. Since we understand you to represent that the products, which are purchased at 30 percent below their suggested retail price, are purchased at their bona fide wholesale price, it is our opinion that distributors are paying a "franchise fee" when they purchase products to fill the orders received at their first party because they do not receive the 30 percent discount on these purchases. The fact that purchases are made only to fill outstanding orders does not enable us to conclude that distributors are not paying a "franchise fee" in connection with their initial orders.

Accordingly, it is our opinion that the arrangements between Dynasty and the executive distributors and distributors are "franchises" within the definition of Section 31005. If Dynasty is in the position to prove that executive distributors and distributors make all future purchases of products at their bona fide wholesale price and that, the amount of discount, which distributors do not receive on the initial order, is less than the $100 amount tolerated by Rule 011, and if it meets that burden of proof, it is our opinion that the "franchises" are exempt from the registration requirement of Section 31110 of the Law by virtue of Rule 011.

You have represented that executive distributors may recruit other executive distributors and distributors and that distributors may recruit other distributors. Section 31008 defines "area franchise" as an agreement between a franchisor and subfranchisor whereby the subfranchisor is granted the right, for consideration given in whole or in part for such right, to sell or negotiate the sale of franchises in the name or on behalf of a franchisor. According to Section 31009, a "subfranchisor" is a person to whom an area franchise is granted. Section 31010 provides that the term "franchises'' where used in the Law, unless especially stated otherwise, includes "area franchises". Since Dynasty's arrangements with the executive distributors and distributors constitute franchises, its arrangements with executive distributors and distributors whereby executive distributors and/or distributors may be recruited, constitute "area franchises" within the definition of Section 31008 of the Franchise Investment Law. However, since under Section 31010 the term "franchise" includes "area franchise", the exemptive provision of Rule 011 is applicable to the aforementioned "area franchises".

Because of certain features of the arrangements, your attention is called to Section 327, Penal Code.

Dated: San Francisco, California
July 18, 1973

By order of
BRIAN R. VAN CAMP
Commissioner of Corporations

By __________________
J. DOMINIQUE OLCOMENDY
Supervising Corporations Counsel
Office of Policy