Commissioner's Opinion No. 73 / 7F

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

Dear Mr. Seal:

The request for an interpretive opinion contained in your letter dated July 14, 1972, 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 "consultants", "distributors", and "executive distributors" are franchises within the definition of Section 31005 and or area franchises within the definition of Section 31008, and subject to the provisions o£ 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. To distribute these products, it engages independent contractors to become consultants, distributors or executive distributors.

A consultant 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. She purchases from distributors or executive distributors at 30% below retail price. The distributor purchases at the same price and thus also earns 30% on her retail sales. In addition she recruits and supervises consultants and earns a "Performance Incentive Percentage" on their sales. The executive distributor performs services similar to the distributor, except that she spends little time on direct retail sales on which she also earns the 30% discount; her earnings are based largely on the retail sales of the consultants and distributors under her supervision.

Dynasty provides training to consultants, distributors, and executive distributors at no charge with one exception. Executive distributors must attend an "Executive Distributor School" in Dallas usually lasting three days for which Dynasty presently charges $250, a sum which, you have advised, does not cover its expenses for operating the school.

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 our opinion, the arrangements between Dynasty and the consultants, distributors, and executive distributors contain all of the essential elements of a "franchise" as set forth in the aforementioned definition, subject to the following observations.

In connection with the requirement of a franchise fee, you have represented that the consultants and distributors make no payments to Dynasty except for products purchased at their bona fide wholesale price or for equipment, such as sample cases, guides, catalogs, and other sales aids at prices reflecting Dynasty's cost. Please note that the exceptions in section 31011(a) and Rule 011 are based on bona fide wholesale price and not on the franchisor's cost, You have specifically invoked the exception in Section 31011(a) from the definition of "franchise fee" to the effect that the purchase or agreement to purchase goods at a bona fide wholesale price shall not be considered the payment of a franchise fee.

This exception is based on the rationale that no substantial prejudice will come to a person buying a business and paying only the bona fide wholesale price for goods which he proposes to sell in that business, since he can readily turn goods of established value into cash, should the franchisor fail, in any way, to provide the promised support. Well-known trade marked goods, of course, can be liquidated much easier than little-known products manufactured by a new franchisor not having a substantial market identity.

Therefore, in considering the availability of the exception and in comparing what Dynasty may assert to be the bona fide wholesale price of its products to other items in the field, the relative value of the respective trademarks, trade names, and market identification must be considered. It is reasonable to assume that Dynasty's products with little or no market identification, have a lower bona fide wholesale price than items, though of comparable quality, which have a marketing history and a ready identity in the market. In. this connection, sales to consultants, distributors, and executive distributors who are all within the common enterprise or marketing system, do not suffice to substantiate the ultimate marketability and market identification of the products being sold.

Moreover to the extent, if any, that these persons under their agreement with Dynasty are required to purchase specified amounts of products or to purchase such specified amounts within a specified period, the exceptional provision of section 31011(a) in our opinion is not available, 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 because he has a present need for or wants to acquire the goods; it is understandable only as intended to secure the right of selling them under the franchise agreement, and for that reason it constitutes a franchise fee (Mattes, The Franchise Concept, California State Bar Journal, Vol. 47, P. 348).

We also note that while the definition of "franchise fee" in Section 31011 contemplates a payment required of the franchisee, and while, therefore, an optional payment which a distributor might make for sales aids or literature, would not be a "franchise fee", nevertheless if the sales aids are essential for the successful operation of the distributorship or if they are suggested or recommended to the consultants, distributors, or executive distributors by Dynasty as essential for that purpose, payment therefor, in our opinion, is "required" within the meaning of section 31011 for the right to enter into the business and is a franchise fee (Mattes, ibid., P. 349).

In case any of the franchise fees discussed above as representing the bona fide wholesale price do not exceed the sum of $100 on an annual basis, the exemption of Rule 011 would be available. However, this rule provides an exemption solely from the registration requirement of Section 31110, and does not affect the nature of the fees as being franchise fees.

Moreover Section 31008 defines "area franchise" to mean an agreement between a franchisor and a 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 the franchisor. Since pursuant to section 31010, the word "franchise" in Section 31110 includes "area franchise", area franchises granted by Dynasty are also subject to the registration requirement of that Section. If Dynasty's arrangements with any of the consultants, distributors, or executive distributors constitute franchises, its arrangements with persons on each higher level constitute an "area franchise" within the definition of Section 31008 of the Law, since each level makes a payment to Dynasty for the right to designate lower level persons and to sell products and such payment, in accordance with the principles above set forth, constitutes a franchise fee.

In accordance with the foregoing we are not in a position to express the opinion that, under the circumstances described by you as outlined above, the arrangements between Dynasty and its consultants, distributors, and executive distributors are not "franchises" or "area franchises" within the meaning of Sections 31005 and 31008 subject to the registration requirement of Section 31110 of the Franchise Investment Law. We are moreover of the opinion that the arrangements between Dynasty and the executive distributors calling for a $250 payment to Dynasty for attendance at the "Executive Distributors School", are ''franchises" and "area franchises" subject to the registration requirement of Section 31110, inasmuch as that payment unquestionably constitutes a franchise fee for which neither the exception provided in Section 31011(a) nor the exemption of Rule 011 is available. Since in accordance with Section 31153, Corporations Code, Dynasty has the burden of proof with respect to the exception provided in section 31011(a), and since it would appear doubtful whether it is able to meet this burden with respect to any of the three classes, it is our recommendation that application be made for registration of the proposed arrangements with consultants, distributors, and executive distributors as franchises and area franchises in accordance with the provisions of the Franchise Investment Law.

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

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
February 2, 1973

By order of
BRIAN R. VAN CAMP
Commissioner of Corporations

By __________________
HANS A. MATTES
Assistant Commissioner
Office of Policy