Commissioner's Opinion No. 73 / 36F

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.

Mr. Roger W. Blakely, Jr.
Attorney at Law
Spensley, Horn, Jubas & Lubitz
Suite 500, 1880 Century Park East
Los Angeles, CA 90067

Dear Mr. Blakely:

The request for an interpretive opinion contained in your letter dated July 5, 1973, as supplemented by your letter dated July 12, 1973, has been considered by the Commissioner. Your letters raise the question whether the Distributor's Purchase Agreements ("Agreements") between Scionics Corporation, a California corporation ( "Scionics") , and persons referred to therein and hereinbelow as "distributors" are "franchises" within the definition of Section 31005 of the. Franchise Investment Law. This question is answered in the affirmative. The question also raised in your letters whether these Agreements are "securities" within the meaning of Section 25019 of the Corporate Securities Law of 1968, and subject to the qualification requirements of that Law, is answered in a separate opinion issued under that Law contemporaneously herewith.

You have represented that Scionics has developed a proprietary dispensed french fried potato mix ("product") and dispensing machines for mixing and extruding the product into a french fry form, which, on deep frying, results in a potato product similar to conventional french fries. Under the agreement, the distributors will agree to purchase a certain amount of additional product to be delivered at later dates when specified. The initial payment required by the distributor is payment in full in advance for the dispensing machines and initial quantity of product, plus a non-refundable advance payment of $1 per case of additional product set forth in the Agreement. The price to be charged for each of the machines initially will be equal to the sum of their purchase cost, shipping and import duties, cost of parts added and amortization of tooling for the parts added, and holding costs.

The agreement further provides that the distributors will actively promote the sale of product and additional items under the trademark and trade name "FastFries". The distributors may use Scionics promotional literature, brochures and direct mail materials as long as such materials are used in connection with the sale and promotion of the product. Any collateral use of such trademark shall be first submitted to Scionics for approval of the intended use. In the event distributors fail to purchase product from Scionics for a period of 12 calendar months, Scionics, at its sole option, shall have the right to refuse to sell additional machines to the distributors. Distributors shall not use the trademark as an identification for any product or service not directly associated with the Scionics product.

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, included, 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.

We do not concur in the opinion expressed by you that the agreement does not prescribe a marketing plan or system in substantial part. You represent that Scionics has distributed product for a number of years utilizing a general sales program whereby machines were placed in retail outlets without a specific charge therefor and the product then sold for use in the machine. You further represent that the previously used marketing plan will be described to the new distributors, identifying its advantages and problem areas and supplying specific assistance should the distributor choose to do business in the similar manner.

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. In making the determination whether there is a prescribed marketing plan or system, it is necessary to keep in mind the objective of the Law to deal with a multiplicity of business establishments created by the franchisor for all of which he ostensively assumes responsibility by causing them to be operated with the appearance of centralized management and uniform standards as regards the material incidents of the operation. The marketing plan or system is prescribed by the franchisor as one of the important means by which the appearance of centralized management and uniform standards is achieved. Such a plan or system may be deemed "prescribed" by the franchisor where he supplies the franchisee with sales aid or detailed instructions, especially when it is supported by elaborate training material, courses or seminars. Significant factors in making this determination include provisions contemplating a nation or area-wide distribution grid system on an exclusive or semi-exclusive basis, as well as the appearance of the licensee's business premises and the fixtures and equipment utilized therein, housekeeping and similar decor (Dept. of Corps. Rel. No. 3-F, pages 3 to 5). On the basis of uniformity of operation which is accomplished through the use of the trademark "FastFries", as well as the promotional literature, brochures and direct mail materials which the distributors may use and which would appear to be essential in connection with the sale and promotion of the machines and the product, together with the recommendations for storage of product supplied by Scionics, the required approval for the collateral use of the Scionics trademark and the limitation on the sale of machines to the distributor for failure to make product purchases within 12 calendar months, it is our opinion that Scionics is prescribing a marketing plan or system in substantial part within the meaning of Section 31005.

We also do not concur in your opinion that the distributors are not required to pay a "franchise fee" within the meaning of Section 31011. Section 31053 of the Franchise Investment Law provides that the burden of proving an exemption or an exception from the definition is upon the person proving it. Whether the price that the franchisee under an agreement is required to pay for goods, exceeds their bona fide wholesale price (or exceeds it by an amount in excess of the tolerance allowed by Rule 011) is a question of fact which the Commissioner will not resolve in an interpretive opinion since such Opinions are limited to interpreting legal questions arising under the law (Dept. of Corps. Rel. No. 2-F). From your letters and the agreement submitted there with, we are unable to conclude that the payments made by distributors for machines and products, do not constitute a "franchise fee" within the meaning of Section 31011. Further, the agreement provides that there is a $1 non-refundable advance payment of product included in the total initial expenditures with 100 cases being the minimum order for product. This payment deprives the distributors of the use of their funds and is, in our opinion, a payment of a "franchise fee" (see Comm. Op. 72/3F). The agreement also provides that Scionics will provide initial training to two persons designated by the distributor. The distributors will be responsible for the payment of all expenses incurred in connection with any such training, including cost of travel to and from Scionics place of business. In our opinion, such a payment is a "franchise fee" which is paid for the right to enter into a business tinder a franchise agreement.

The agreement provides that distributors are required to purchase a specified amount of machines and product at the time they sign the agreement. In our opinion, the exceptional provision of Section 31011(a) is not available if the amount so required to be purchased, exceeds the quantity which a reasonable man would purchase by way of a starting inventory or to maintain a growing inventory. Payment for such excessive purchases is made by the franchisee not because he has a present need or wants to acquire the goods; it is understandable only as intended to secure the right of selling them under a franchise agreement and, for that reason, it constitutes a "franchise fee." (see Comm. Op. No. 73/7F).

Accordingly, it is our opinion that, under the circumstances described by you as outlined above, the agreements between Scionics and distributors are "franchises" within the meaning of Section 31005, and subject to the registration requirements of the Franchise Investment Law.

Inasmuch as interpretive opinions are issued for the principal purpose of providing a procedure by which members of the public can protect themselves against liability for acts done or omitted in good faith in reliance upon the administrative determination made in the opinion, and since there can be no such reliance where the Commissioner asserts jurisdiction with respect to a particular situation or determines that a legal requirement is applicable, advice to that effect, as contained in this letter, does not constitute an interpretive opinion.

Dated: San Francisco, California
September 19, 1973

By order of
BRIAN R. VAN CAMP
Commissioner of Corporations

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