INFORMAL STAFF ADVISORY OPINION 95-10
This staff advisory opinion is issued in response to your request dated August 30, 1995, for our views on the application of the Commission's Franchise Rule, 16 C.F.R. Part 436, to the vending machine industry. Your request contains eight questions, several of which contain multiple subparts. Many of these are hypothetical questions about the applicability of the Rule. Ordinarily, Commission staff will not entertain hypothetical questions. See FTC Rules of Practice, Section 1.1(b). We have determined, however, that there is a need for greater understanding of Rule coverage by business opportunity sellers and their counsel. Staff advice to the business opportunity industry is particularly warranted in light of "Project Telesweep," a recent national joint effort by the Commission, the Department of Justice, and state law enforcement agencies to combat widespread deceptive conduct among business opportunity sellers.
You should also know that, as a matter of policy, the Commission's Franchise Rule enforcement staff will not issue any staff opinion on the ultimate issue whether, under specific facts, a business relationship is covered by the Franchise Rule. We will, however, provide general guidance on the Franchise Rule that you may wish to consider in determining whether your client's business arrangements are subject to the Franchise Rule.
A subsidiary of your client manufactures vending machines ("Vending Manufacturer"). Through a sister company, the Vending Manufacturer markets its machines to retail chains ("Retailer"), which in turn sell the machines to various customers. The typical customer is a store owner who wishes to sell snack foods or other items to the public. The customer owns the vending machine, stocks it, and keeps the revenue. The sister company also markets the machines to vending machine operators ("Operators"). The Operators, who typically own multiple machines, place the machines in locations such as hardware stores or auto dealerships, stock the machines, and collect the revenue generated by the machine, usually after sharing a percentage with the store owner.
II. Definition of the Term "Franchise"
The Franchise Rule, 16 C.F.R. Part 436, applies to two types of continuing commercial relationships: "package and product franchises" and "business opportunity ventures." A package and product franchise either adopts the business format established by the franchisor and is identified by the franchisor's trademark, or distributes goods that are produced by the franchisor and which bear the franchisor's trademark. Business opportunity ventures, on the other hand, typically do not involve a trademark, and the promoter may not provide any ongoing assistance to, or control over, the investor. See Final Interpretive Guides, 44 Fed. Reg. 49966, 49966-68 (August 24, 1979).
III. The Vending Manufacturer Maintains a Continuing Commerical Relationship with Machine Purchasers
In your letter, you suggest that the Rule is inapplicable to the Vending Manufacturer because it does not maintain a continuing commercial relationship with the machine purchasers after the initial sale. For the following reasons, we disagree.
The term "franchise" contemplates a continuing commercial relationship. 16 C.F.R. Section 436(2)(a). In the Statement of Basis and Purpose accompanying the Rule, the Commission noted: "The rule does not apply to relationships which are not entered into with the expectation of profit or to commercial relationships which do not involve a course of dealing over a period of time." 43 Fed. Reg. 59613, 59700 (December 21, 1978). There is no question that the relationship between the Vending Manufacturer and the machine purchaser is commercial. The question remains whether such relationship is "continuing."
In previous advisory opinions, we stated that a relationship is "continuing" when "the parties originally anticipated a 'continuing' relationship." See Craft World International, Inc., Bus. Franchise Guide (CCH) ¶ 6439 (May 16, 1983). Thus, a continuing relationship will exist "whenever a business opportunity seller's contractual commitments and sales representations would lead a reasonable prospective investor to expect the benefits of a continuing relationship." Id; see also Sells Enterprises, Inc., Bus. Franchise Guide (CCH) ¶ 6423 (August 28, 1980).
Where a vending manufacturer sells machines only, without any additional representations of a continuing relationship, it will not be covered by the Rule. In the facts presented here, however, a machine purchaser can reasonably draw the conclusion that it is entering into a continuing relationship with the Vending Manufacturer. In your letter, you state that the Vending Manufacturer's Financing Affiliate offers financing to some customers and services the debt until it has been paid. Another affiliate, the Business Assistance Affiliate, offers to provide ongoing assistance to some customers, including site locations, machine maintenance, an assistance hotline, advice on accounting procedures and product stocking practices, occasional seminars, quarterly magazines, and mailers. Offers of ongoing services such as these(1) are more than sufficient to enable a prospective investor to conclude that it is entering into an enduring relationship with the Vending Manufacturer.(2)
IV. The Vending Manufacturer May Offer a Package or Product Franchise
The definition of a package or product franchise is as follows:
1. The investor sells goods or services which are identified by the franchisor's trademark, service mark, trade name, advertising, or other commercial symbol;
2. The seller promises to exercise significant control over, or promises to provide the investor with significant assistance in, the franchisee's method of operation; and
3. The investor is required to pay or make a commitment to pay at least $500 to the franchisor or the franchisor's affiliate at any time before to within six months after commencing operation of the franchise business, as a condition of obtaining or commencing the franchise relationship.
16 C.F.R. Sections 436(2)(a)(1) and (2)(a)(3)(iii).
In your letter, you suggest that the Vending Manufacturer falls outside the Rule because it does not require its customers to use any specific business format or trademark, nor does it control what the customer does with the machines after the sale. We disagree.
The Franchise Rule does not require a franchisee to use the franchisor's trademark or name as a condition of coverage. Permission to associate with the franchisor's trademark or name is sufficient. Thus, as long as the Vending Manufacturer permits investors to use its mark or name, Rule coverage will exist.
Further, Rule coverage may exist even where the franchisor expressly prohibits franchisees from using its mark or name. In a previous advisory opinion, U.S. Marble, Inc., Bus. Franchise Guide (CCH) ¶ 6424 (October 9, 1980), we stated:
Where the seller's marks are displayed on the products sold by its dealers, or are displayed on products, equipment, or other items used in connection with the dealer's sale of products or services, the first coverage prerequisite is satisfied (43 Fed. Reg. 59701 n.33 (Dec. 21, 1978)), and no express contractual prohibition on the use of the seller's marks can alter that fact.
We also emphasized that use of the franchisor's commercial symbols will suffice for Rule coverage. The term "commercial symbol" includes: "display racks and other items characterized by 'distinctive shape, size and other features.'" Bus. Franchise Guide (CCH) at 9593 (citation omitted). We concluded that "[t]he determinative issue is whether such a feature 'is brought to the attention of the licensee's customers to such an extent that they would regard the licensee's [business] as one in a chain identified with the licensor.'" Id. (citation omitted).
Without a more detailed description of your client's vending machines, we cannot determine whether the Vending Manufacturer satisfies the Rule's "trademark" prong. If the Vending Manufacturer sells generic machines, for example, that do not bear any mark or name, then Rule coverage may not exist. If, however, the Vending Manufacturer's machines carry its mark or name, or are characterized by distinctive features, then Rule coverage may exist, even if the Vending Manufacturer expressly prohibits investors from using its mark or name.(3)
B. Significant Control or Assistance
Next, you suggest that the Vending Manufacturer does not offer a franchise because it does not control how the purchaser will use the machines after the sale. Significant control, however, is not required for Rule coverage. Significant assistance will suffice. In fact, no more is required for coverage than a pre-sale representation of significant assistance, even if no assistance is ever actually provided.
See Final Interpretive Guides, 44 Fed. Reg. at 49966; Statement of Basis and Purpose, 43 Fed. Reg. at 59699.
As noted above, the Vending Manufacturer offers prospective machine purchasers a wide array of assistance through its affiliates. Such assistance includes financing, site locations, accounting and product stocking advice, machine maintenance, a hotline, and occasional seminars, magazines, and mailers. The question remains, however, whether these types of assistance are "significant" to potential buyers.
Without more information about the likely purchasers of your client's vending machines, we cannot determine whether such offers of assistance are "significant." Nonetheless, it has been our experience that the assistance offered by sales personnel to close a sale is often significant to reasonable potential purchasers, especially those without prior vending experience. We can reasonably assume that many inexperienced machine purchasers would not know how to place machines or to repair them. In circumstances such as these where offers of assistance are significant to the prospective investor, Rule coverage will exist.
C. Minimum Payment Requirement
You state that the price paid for a vending machine exceeds $500. As noted above, as long as the investor pays or makes a commitment to pay at least $500 within the first six months after commencing operations, then the required minimum payment will be satisfied.
In your letter, you suggest two reasons why the required minimum payment may not be satisfied. First, the buyer may purchase machines on an installment plan, in which case the total payments actually made during the first six months of operation may be less than the $500 required minimum payment. Second, you suggest that if the investor purchases more than one machine at the outset, or additional machines during the first six months, those machines are optional purchases which should not be included in calculating the $500 threshold.
Before addressing these specific questions, we note that investors pay for more than just vending machines. As stated in your letter, the Vending Manufacturer's Business Assistance Affiliate charges certain fees for quarterly magazines, mailers, and certain location assistance. If such payments are required by express obligation or by practical necessity, then those payments must be added to any payments made for the machines when calculating the total minimum required payment. See Final Interpretive Guides, 44 Fed. Reg. at 49967.
1. Installment Plans
The Franchise Rule does not condition coverage on the existence of a front end franchise fee or other initial payment. As noted above, either a "payment" or a "commitment to pay" can satisfy the "required payment" element. 16 C.F.R. Section 436.2(a)(2). The Statement of Basis and Purpose notes:
The Commission has included the provision relating to "commitments" to include franchises with a minimal initial investment followed by a large isolated or recurring fee some months after beginning operation of the franchise. This provision intends to capture all the potential sources of revenue going to the franchisor (or an "affiliated person") as a result of the sale and opening of a new franchise outlet.
43 Fed. Reg. at 59703 n.52.
The installment payments described in your letter are "commitments to pay," and, therefore, the required payment prerequisite to coverage is met.
Nonetheless, we must determine whether the Rule's mimimum payment exemption, 16 C.F.R. Section 436.2(a)(3)(iii), is available. The exemption is available in limited instances when a franchisor can demonstrate that the total of the payments and commitments to pay made by franchisees to the franchisor (or its affiliates) prior to and during the first six months of operation is less than the $500 threshold.
This exemption reflects the Commission's recognition that in instances of de minimis investments of less than $500, the cost of disclosure may exceed its benefits. In discussing the $500 threshold, however, the Commission emphasized its intention to ensure that the protections provided by the Rule apply to any significant investment:
The record supports the proposition that the rule should focus upon those franchisees who have made a personally significant monetary investment and who cannot extricate them-selves from the unsatisfactory relationship without suffering a financial setback.
43 Fed. Reg. at 59704.
Ordinarily, any portion of a commitment to pay money that becomes due more than six months after the business is operational will not be counted in calculating the $500 threshold. As the Commission stated in the Final Interpretive Guides:
A commitment entered into during the first six months which requires a payment later than six months after commencing operation is not counted toward the $500 minimum, such as a promissory note or that portion of lease payments made after six months.
44 Fed. Reg. at 49968; see also Statement of Basis and Purpose, 43 Fed. Reg. 59704 n.56.
The promissory notes contemplated by the Commission above create no significant financial risk for franchisees because they are held by the franchisor, and franchisees can assert defenses of non-performance and set-off in collection actions brought by the franchisor. The same is not true of negotiable notes, because these defenses are extinguished when the note is sold to a good faith purchaser for value, as Commission staff recognized in an advisory opinion issued shortly after the Rule was promulgated. See Automobile Importers of America, Inc., Bus. Franchise Guide (CCH) ¶ 6382 (August 9, 1979).
Since negotiable notes expose franchisees to precisely the same risk of significant financial loss to "fly-by-night" franchisors as the Rule was designed to prevent, Commission staff concluded that the minimum payment exemption applies only to non-negotiable promissory notes or their equivalent. We stated that the minimum investment exemption would not be available for negotiable notes and other "payment devices which have the potential of frustrating or circumventing the protections afforded by the rule, or impose substantial financial risks on the prospective franchisee." Bus. Franchise Guide (CCH) at 9552; see also A.O. Smith Harvestore Product, Inc., Bus. Franchise Guide (CCH) ¶ 6431 (August 21, 1982).
In your letter, you state that investors may purchase machines "in installments if a customer elects to use the available financing," and you have attached a sample financing agreement with your advisory request. See Advisory Request, Attachment A. The financing agreement, however, does not specifically state whether the note is non-negotiable or the conditions under which it may be negotiable. The agreement provides, however, that the "Buyer will not assert against an assignee of Seller any claim, defense, set-off or counterclaim which is based on Buyer's dealings with Seller or the condition or servicing of the machines." This appears to indicate that the financing agreement is negotiable and bars the investor from raising legal defenses. Thus, by signing the financing agreement, the purchaser takes upon himself a significant investment risk from which he may not be able to extricate himself. Under such circumstances, the Rule's minimum payment exemption is unavailable.
We believe the minimum payment exemption is unavailable for another reason as well. Your client's installment financing agreement contains an acceleration clause. According to that clause, if the buyer fails to make a payment within ten days or fails to observe other financing agreement requirements, then the seller may accelerate the unpaid balance. Thus, by signing the financing agreement, the franchisee effectively takes upon himself a current obligation to pay the entire cost of the machines which, you acknowledge, exceeds $500. Such a binding commitment is sufficient for Rule purposes.(4)
2. Additional Purchases May Be "Optional"
You further suggest that an investor who purchases more than one machine at the outset, or additional machines during the six month period, does so voluntarily; therefore, those purchases should not be included in calculating the required minimum payment. There is no question that discretionary purchases by a franchisee do not count toward the $500 required minimum payment. In that regard, the Commission stated in the Final Interpretive Guides:
[The Minimum Payment Requirement] does not include payments to the franchisor which are not required (either by express obligation or practical necessity) to obtain the franchise or begin operation of the outlet. If the franchisee pays the franchisors for goods or services which are simply "optional," such payments are not included in the [minimum payment] provision.
43 Fed. Reg. at 59703.
The question remains, however, whether any additional machine purchases are really "optional." Such determinations are fact-specific. Commission staff will make its own determination, based upon the particular facts, whether the investor is obligated to purchase additional machines or must do so as a practical necessity. The standard is what the reasonable consumer would understand he has been offered. It has been our experience that many manufacturers offer vending machines in packages of 3-10 machines or more, and that first-time purchasers are rarely, if ever, offered the chance to purchase just a single machine. This is particularly true where the manufacturer sells multiple machines to new route operators. If the seller's sales presentations lead the investor to believe that he is obligated to purchase additional machines at the outset or over time, or that operating multiple machines is necessary as a practical matter in order to be successful, then we will include the purchase of such additional machines in calculating the $500 threshold.
V. The Vending Manufacturer May Offer a Business Opportunity
The Vending Manufacturer may also offer a business opportunity venture. As noted above, the Franchise Rule covers business opportunities, as well as package or product franchises. A continuing commercial relationship will be covered by the Rule's business opportunity section if each of the following three definitional elements is present:
(1)The investor sells goods or services supplied by the seller or its affiliates, or by suppliers with whom the seller is advised to do business;
(2) The seller secures retail outlets or accounts for
the goods or services, or secures locations for vending machines or racks, or provides the services of someone who can perform either of these functions; and
(3) The investor makes a required payment, or a commitment to pay, to the seller or its affiliate of
$500 or more from any time before to within six months after the business becomes fully operational.
See 16 C.F.R. Sections 436.2(a)(1)(ii) and (a)(2).
A. Sale of Goods or Services Supplied by the Seller or Its Affiliates
In your letter, you suggest that the Franchise Rule is inapplicable to the Vending Manufacturer because it does not sell products with which to stock the vending machines. Commission staff, however, has long held that the offer and sale of vending machines is all that is required for coverage as a business opportunity:
The first [definitional] element is satisfied whenever "franchisees" sell vending services in circumstances where the vending equipment is supplied by either the franchisor, an affiliate of the franchisor or a third person from whom the franchisor directly or indirectly requires the "franchisee" to purchase such equipment.
Hermann Industries, Ltd., Bus. Franchise Guide (CCH) ¶ 6430 (August 6, 1982).(5)
The Franchise Rule expressly states that "services" can be offered, sold, or distributed through a business opportunity. In Craft World International, Bus. Franchise Guide (CCH) ¶ 6439 (May 16, 1984), we noted that the first definitional requirement is met when "a promoter supplies a service indirectly by providing essential equipment, such as vending or video game machines, as part of a business package." Id. at 9612 (emphasis added). As staff noted, "to require that a promoter play a greater role would read service ventures out of the rule."(6) Id. at 9613. Thus, by incorporating the term "services" in the Rule's definitional section, the Commission contemplated that vending machine sellers could make products or services available to the public through vending machine operators. Accordingly, the sale of vending machines, with or without the sale of additional products, is covered by the Rule.(7)
B. Location Assistance
In your letter, you pose several questions about the meaning of location assistance. These questions raise issues concerning the types of location assistance that satisfy the Rule and whether the manner in which location services are offered to potential investors affects the result. Before addressing your specific questions, we will provide additional background on the term "location assistance."
We have previously addressed the definition of location assistance in numerous advisory opinions. In particular, on July 22, 1993, Commission staff issued Advisory 93-8, Bus. Franchise Guide (CCH) ¶ 6452, a copy of which is attached as Appendix 1. In that opinion, we stated that a business opportunity seller need not literally secure locations for an investor and that both direct and indirect location assistance is sufficient for Rule purposes.(8) We noted that the Commission will consider two factors when analyzing whether a business opportunity seller provides the requisite location assistance: (1) the kinds of location assistance the seller offers; and (2) the significance of that assistance to the investor. Id. at 9630.(9)
With respect to the kinds of assistance offered, we stated that the Commission will apply a flexible standard: The second required definitional element contemplates only that the franchisor "more than nominally assist the franchisee" in finding sites or locations. Id. (citing Statement of Basis and Purpose, 43 Fed. Reg. at 59706 and n.75). Finally, the Commission will analyze the "significance" of assistance in the context of the specific business opportunity, focusing particularly on whether the seller's offer is "reasonably likely to have the effect of inducing reliance on [the seller] to provide a successful pre-packaged business." Id. Applying this standard, we previously stated that Rule coverage might be found, for example, where the seller introduces investors to an unaffiliated person who will secure locations or accounts for them; provides investors with lists of persons able to furnish location services; or instructs investors on how to find their own profitable locations. See Hermann Industries, Ltd, Bus. Franchise Guide (CCH) at 9603.
Finally, we take a dim view of efforts by business opportunity promoters to frustrate Rule coverage by attempting to circumvent the Rule's location assistance prong. The Commission recognized the potential for manipulating the Rule by stating clearly in the Final Interpretive Guides that "most business ventures will be covered by the Rule." 44 Fed. Reg. at 49968. Accordingly, we emphasize that the Commission will likely conclude that the Rule's location assistance prong is satisfied when: (1) a machine seller engages in conduct, directly or through other parties, which creates the impression that location assistance is part of the deal; and (2) such assistance is significant (likely to induce reliance on the part of the investor). We now turn to your specific questions.
1. Direct Location Assistance
First, you ask whether providing investors with pre-qualified leads who are willing to have a machine on their business premises satisfies the Rule's location assistance requirement. This is a classic example of location assistance. As noted above, a machine seller need not literally "secure" a location for the investor; referring investors to individuals or businesses who have shown an interest in providing a site for a vending machine will suffice.
Next, you ask whether the location assistance requirement will be satisfied if the seller sponsors seminars which instruct prospective purchasers on how they can go about obtaining locations. You describe the location assistance offered at the seminars as "self help" advice of the type provided in an attached copy of a Location Assistance Packet. This packet includes: (1) written advice, including a script, to be used when calling prospective businesses; (2) a list of the advantages of vending opportunities; (3) advice for conducting a survey of locations; (4) a survey of food items that a business might want to offer for sale; and (5) a vending services agreement. See Advisory Request, Attachment B.
Providing seminars that instruct prospective investors on how to secure shops interested in providing a site for vending machines constitutes more than nominal assistance in finding locations. See Garcia Marketing, Bus. Franchise Guide (CCH) at 9583; Hermann Industries, Inc., Bus. Franchise Guide (CCH) at 9604. The question remains, however, whether such assistance is also "significant" to the average purchaser of your client's vending machines. Your letter fails to detail the sophistication level of would-be machine purchasers. Lacking such information, we can rely only on our experience in bringing enforcement actions against business opportunities under the Rule. Our experience tells us that many prospective vending machine buyers, especially ones new to the vending industry, are unlikely to be skilled site locators and routinely rely on the seller's location assistance representations. We conclude, therefore, that in most instances providing investors with scripts, surveys, and vending service agreements and the like appears to be "significant" for many initial vending machine business opportunity purchasers. Accordingly, conducting seminars of the type described in your letter will satisfy the Rule's location assistance requirement.
2. Indirect Location Assistance
You also pose several questions about indirect location assistance. For example, you ask whether the Vending Manufacturer will be deemed to satisfy the location assistance requirement if it refers investors to location services supplied by the Vending Manufacturer's affiliate. In a similar vein, you ask whether a Retailer will satisfy the location assistance requirement if it gives prospective investors literature that contains the Vending Manufacturer's toll-free number which, when dialed, gives the caller information about the Vending Manufacturer's site location services. Offers of indirect location assistance such as these are sufficient for Rule coverage. See Advisory 93-8, Bus. Franchise Guide (CCH) at 9630 (no material difference between providing investors with a locator or referring investors to locators). Further, we see no difference between a franchisor who provides written information about the Vending Manufacturer's location assistance program or a telephone number which is used to impart similar information. The substance of the representations made to prospective investors, not the form, is the key.
Additionally, you pose the following scenario about indirect location assistance: The Vending Manufacturer wholesales its machines to a Retailer and provides the Retailer with point-of-sale promotional materials that do not contain any reference to site or location assistance. Independent locators, however, may leave their own promotional materials near the machines, for example, by posting fliers on nearby bulletin boards. You state that neither the Vending Manufacturer nor Retailer has any relationship with the locators, and the Retailer does nothing to encourage or discourage this practice.
This fact pattern is not entirely clear to us. If the Vending Manufacturer or Retailer places the machines with unaffiliated location owners, then the seller will not be covered by the Rule if a prospective investor receives unauthorized or unsolicited offers of location assistance from third parties over which the seller has no control. If, however, the Vending Manufacturer or Retailer places the machines in a show room which is open to prospective investors, controls access to the show rooms, and permits locators to post fliers offering location assistance, then our analysis may be different. By permitting access to the machines, the machine seller may effectively endorse or ratify the third parties' offers of location assistance. In such circumstances, there may be little difference between a vending machine seller who refers investors to a locator and one who permits the locator to offer its services by posting fliers near the machine. In each instance, the investor may reasonably believe that the franchisor is offering a package deal that includes location assistance.(10)
3. Post-Sale Offers of Location Assistance
Finally, you ask whether the Vending Manufacturer will be covered by the Rule if it does not refer to its Business Assistance Affiliate anywhere in its pre-sale literature or contacts with customers, but gives the customer information about the affiliate after the sale. In theory, post-sale offers of assistance are not included in determining Rule coverage. The Commission's Franchise Rule is a pre-sale disclosure Rule. Accordingly, determining whether a company is covered by the Rule is based on the company's representations at the time of the offering where such representations become part of the basis of the bargain between the parties. If the Vending Manufacturer or Retailer makes no representations, directly or indirectly, about location assistance at any time prior to completing the sales transaction, then the seller will not be converted retroactively into a "franchise" if it offers existing investors location services after the sale.(11)
We question, however, whether in practice a machine seller will be able to prevent making offers of location assistance to investors until after the sale. Where a company has a pattern and practice of providing location assistance post-sale, it is reasonable to expect that the company's sales agents -- especially commissioned sales agents -- will impart that information to prospective investors in order to close the deal. Similarly, the seller may encourage existing investors to inform would-be buyers that location assistance is available after the purchase. If potential investors obtain information about post-sale location assistance from the Vending Manufacturer or its agents under circumstances where it is reasonable for the investors to anticipate that such assistance will be forthcoming with the purchase of the machines, then the location assistance requirement will be satisfied. Commission staff will make such determinations on a case-by-case basis.
VI. Retailers May Be Covered by the Franchise Rule
You state that the Vending Manufacturer may sell its machines to a Retailer, who in turn sells the machines to route operators or to businesses who will own and operate the machines themselves. You further state that the Retailer typically does not maintain an inventory of machines. Rather, it uses models for display purposes only. If a sale is made, the Retailer places an order with the Vending Manufacturer, and the Vending Manufacturer then ships the machine directly to the purchaser. You add, however, that title to the machine does pass through the Retailer to the ultimate purchaser.
You ask several questions about the applicability of the Rule to such Retailers. For example, you ask if the Retailer is covered by the Rule if it uses the Vending Manufacturer's point-of-sale materials that refer to site location services provided by the Vending Manufacturer's Business Assistance Affiliate.
Retailers will be covered by the Rule if they act as "franchisors" or "franchise brokers," as those terms are defined in the Rule. The term "franchisor," means a person "who participates in a transaction covered by the rule . . . as a franchisor; that is, the person offering the business described [in the definition of the term franchise.]" See 16 C.F.R. Section 436.2(c); Final Interpretive Guides, 44 Fed. Reg. at 49969. If a Retailer acts as a franchisor by: (1) supplying investors with vending machines;(12) (2) providing location assistance or referring investors to others who can provide such location assistance, and (3) charging the minimum required payment, then the Retailer will constitute a "franchisor" for Rule purposes.(13)
In the alternative, the Retailer may have compliance obligations under the Rule as a "franchise broker." A "franchise broker" is defined as "any person other than a franchisor or franchisee who sells, offers for sale, or arranges for the sale of a franchise." 16 C.F.R. Section 436.2(a)(j). A key distinction between a franchisor and franchise broker in the vending context is ownership of the machines. If the Retailer acts as a sales agent for the Vending Manufacturer, but does not own the machines at the time of their sale, then the Retailer may be a "franchise broker," rather than a "franchisor." When a Retailer qualifies as a franchise broker, it is jointly liable along with the Vending Manufacturer for any failure to provide the investors with the required disclosures. See Final Interpretive Guides, 44 Fed. Reg. at 49969.
VII. The Fractional Franchise Exemption
Next, you ask about the application of the Rule's fractional franchise exemption. The fractional franchise exemption is one of four exemptions provided by the Franchise Rule. See 16 C.F.R. Section 436.2(a)(3). The exemption is available to a franchisor if it can prove the following two conditions are met: (1) the franchisee with whom it enters a relationship has been "in the type of business represented by the franchise relationship for more than 2 years;" and (2) the parties anticipate at the time of they enter their relationship that the "sales arising from the relationship would represent no more than 20 percent of the sales in dollar volume of the franchisee." Id. at Section 436.2(h).(14)
In your letter you ask whether the fractional franchise exemption is applicable in the following scenario: The Vending Manufacturer sells a vending machine to a law firm ("Law Firm") for its own use. Two years later, the Law Firm invests in 20 more machines and relies on the Vending Manufacturer's Business Assistance Affiliate for help in locating other law firms that might be interested in purchasing the machines. You ask us to assume that the Law Firm's profits from the machines are less than twenty percent of the profits from its law practice.
For the following reason, we believe that the fractional franchise exemption is inapplicable in this instance. While the Law Firm may have operated a vending machine for two years before it invests in additional machines, it cannot reasonably be said that the Law Firm, or one of its employees, was in the "vending business." Merely having a vending machine for private use is not the same as being in the business of offering and selling vending machines or related services to the public. See Advisory 94-8, Bus. Franchise Guide (CCH) ¶ 6464 (December 21, 1994) (independent chauffeur driver is not in the same business as an affiliate of a chauffeur service). In that regard, the Final Interpretive Guides state:
The first condition is that the franchisee or any of its current directors or executive officers has more than 2 years of prior management experience at any time in the past in the business represented by the franchise. The required experience may be in the same business selling competitive goods, or in a business that would ordinarily be expected to sell the type of goods to be distributed under the franchise. For example, the experience requirement would be met in a franchise for tires, batteries and accessories granted to a service station dealer, but not by a truck rental franchise granted to the dealer.
44 Fed. Reg. at 49968.
Thus, in order for the Vending Manufacturer to qualify for the fractional franchise exemption in this instance, the Law Firm must have had at least two years of experience in the management of a business that offers vending machines or comparable devices, goods, or services. Accordingly, the fractional franchise exemption would be unavailable in this scenario.
VIII. Compliance with the Rule
Finally, you ask several questions about how the Vending Manufacturer or Retailer can comply with specific Rule requirements. These questions concern the time for making disclosures under Section 436.1(a) and disclosing statistical information on franchisees under Section 436.1(a)(16).
A. Time for Making Disclosures
In your request, you pose the following scenario: The Vending Manufacturer sells machines at wholesale to a Retailer, along with point-of-sale literature describing its location assistance services. The Retailer displays one machine in each of its stores. Prospective customers may ask salespersons in the store about the machine, its price, delivery terms, etc. The salesperson answers the questions and suggests the customer take a copy of the Vending Manufacturer's sales brochures, which are displayed with the machine. The customer leaves, but returns several days later and states that she would like to purchase a machine. You ask when should the customer obtain a disclosure document. For purposes of this question, you ask us to assume that the Vending Manufacturer is covered by the Rule. We will further assume that the Retailer functions as a franchise broker.
The Rule states that a franchisor must provide a prospective franchisee with a disclosure document at the earlier of the first "personal meeting" or the "time for making of disclosures." The term "personal meeting" means a face-to-face meeting between a prospective franchisee and a franchisor, franchise broker, or their representatives which is held for the purpose of discussing the sale, or possible sale, of a franchise. 16 C.F.R. Section 436.1(a). The Final Interpretive Guides elaborate further:
Even where a face to face meeting occurs, it is not necessarily a "first" personal meeting. In interpreting this term, the Commission will consider such factors as whether the franchisor clearly indicated at the outset of the discussion that it was not prepared to discuss the possible sale of a franchise at that time, whether the meeting was initiated by the prospective franchisee rather than the franchisor, whether the meeting was limited to a brief and generalized discussion and whether earnings claims were made.
44 Fed. Reg. at 49970.
Whether a Retailer's sales agent is engaging in a face-to-face meeting is a question of fact. If a consumer poses general questions about a vending machine or the vending business, then the required "face-to-face" meeting may not exist. If the parties, however, engage in more specific discussions about an opportunity to buy and operate vending machines -- in particular about potential earnings -- then the Retailer must provide the consumer with a disclosure document at that time. See Final Interpretive Guides, 44 Fed. Reg. at 49970. If not required to do so previously, the Retailer must furnish a disclosure document at the "time for making of disclosures," which means 10 business days before the prospective franchisees signs any contract or makes any payment. Thus, in your example, the customer must receive a disclosure document and wait at least ten days before purchasing a vending machine from the Retailer.
Finally, we note that there is no harm in giving a prospective investor a disclosure document before the required time frame set forth in the Rule. If a question arises about whether or not to make disclosure, we advise erring on the side of caution. The Retailer's representative can simply advise interested consumers that they are free to take a copy of the disclosure document, along with other promotional literature offered.
B. Disclosures Concerning Franchisees
Finally, you ask how the Vending Manufacturer can comply with Section 436.1(a)(16) of the Rule, which requires the disclosure of the number of existing franchisees, as well as the number of terminations, cancellations, and non-renewals during the previous year. This Section also requires the disclosure of the names, addresses, and telephone numbers of prior purchasers. You state that while the Vending Manufacturer has sold machines over many years, it does not maintain any continuing relationship with the customers after the sale. You contend, therefore, that the Vending Manufacturer has no way of knowing how many of the machines it sold remain in operation, or how many were taken out of the marketplace in the previous year.
As noted above, there must be a continuing commercial relationship between the machine seller and customer in order for Rule coverage to exist. If the Vending Manufacturer sells generic machines only and has no subsequent dealings with the final purchasers, then the Vending Manufacturer is not covered by the Rule and this issue is moot. As noted above, however, the Vending Manufacturer in this instance appears to offer potential purchasers an ongoing relationship. If so, the Vending Manufacturer must disclose the statistical data required by the Rule.
In order to disclose the required statistical data, vending machine sellers who are covered by the Rule should maintain appropriate records, including the purchasers' names, addresses, and telephone numbers.(15) The Rule does not prescribe specific recordkeeping requirements, and we will not attempt to do so here. Rather, we encourage business opportunity promoters to develop cost-effective recordkeeping systems which are best suited to their particular business. Because the Rule requires disclosure of the franchisees' status for the previous fiscal year only, this recordkeeping burden should be minimal.(16)
Please be advised that our opinion is based on all the information furnished in your request. This opinion applies only to your client and to the extent that actual company practices conform to the material submitted for review. Please be advised further that the views expressed in this letter are those of the FTC staff. They have not been reviewed, approved, or adopted by the Commission, and they are not binding upon the Commission. However, they do reflect the opinions of the staff members charged with enforcement of the Franchise Rule.
Date: December 8, 1995
Franchise Rule Staff
(1)The mere offer of ongoing services may be sufficient for Rule coverage. The definition of the term "franchise" makes clear that "[a]ny relationship which is represented either orally or in writing to be a franchise," is subject to the Rule. See 16 C.F.R. Section 436.2(a)(5). Thus, any vending manufacturer which represents to investors that it, or its agents, will provide ongoing services after the initial sale will be covered by the Rule, even if it, or its agents, ultimately fails to provide such assistance.
(2)In determining whether a continuing commercial relationship exists, we will look at the underlying facts, not the legal formalities. Because the Vending Manufacturer refers potential investors to its affiliates for a variety of financing and support services, the investor can reasonably infer that it is entering into a relationship with a single enterprise. In short, Rule coverage cannot be frustrated by dividing company functions among various affiliates.
(3)Several of the Project Telesweep cases based Rule coverage on the use of prominently displayed unique marks.
See, e.g, United States of America v. Global Gumballs, Inc., Civ. No. 95-0539 (S.D. Ala., filed July 10, 1995); United States of America v. Protocol, Inc., Civ. No. 3-95-640 (D. Minn., filed July 10, 1995).
(4)This comports with the Commission's view that a "[p]ayment required by contract . . . include[s] not only those required by the franchise agreement, but also those required in any companion contract," such as a financing agreement. Final Interpretive Guides, 44 Fed. Reg. at 49967.
(5)See also Advisory 93-8, Bus. Franchise Guide (CCH) ¶ 6452 (July 22, 1993); Interstate Vending Services, Bus. Franchise Guide (CCH) ¶ 6418 (July 1, 1980); Yasmin Enterprises, Inc., Bus. Franchise Guide (CCH) ¶ 6406 (March 27, 1980); Langlois, Bus. Franchise Guide (CCH) ¶ 6402 (January 24, 1980); Coin-Op Sales Co., Inc., Bus. Franchise Guide (CCH) ¶ 6394 (October 19, 1979).
(6)This analysis is consistent with our analysis of the required payment element in the sale of vending machines. In Hermann Industries we stated:
We have concluded previously that vending machines should be viewed as equipment used in the operation of the business since they provide the necessary mechanism by which the vending service is provided. The Final Interpretive Guidelines for the Franchise Rule state the Commission's view that "among the forms of required payments are those for required equipment and supplies." 44 Fed. Reg. 49,967 (August 24, 1979). . . . Accordingly, this definitional element would be satisfied if an investor's payment for vending machines is at least $500 during the relevant period.
Bus. Franchise Guide (CCH) at 9603.
(7)This comports with the Commission's view that most business opportunity ventures will be covered by the Rule. Final Interpretive Guides, 44 Fed. Reg. at 49968.
(8)See Federal Trade Commission v. Showcase Distributing, Inc., Civ-95-1368-PHX-SMM, Memorandum of Decision and Order (August 11, 1995) at 12-14 ("The FTC has determined that the [location assistance] element is an elastic concept that will likely apply if the seller introduces the investor to a third party to secure locations or sites or merely provides the investor with a list of such persons. . . . An agency's interpretation of its own regulations must be afforded substantial deference.").
(9)See also Garcia Marketing, Bus. Franchise Guide (CCH) ¶ 6415 (May 29, 1980)(setting forth the two-part analysis in the context of offers to provide accounts).
(10)It is not unreasonable for us to believe that a sales agent of the Vending Manufacturer or Retailer, if asked about the availability of locations, might refer to the fliers as examples of location services that are available in the community. Further, a sales agent may even recommend a particular locator who has posted a flier based upon the sales agents' knowledge of previous purchasers' experiences with that locator. In short, a machine seller will not frustrate Rule coverage by providing locators with a forum with which to target potential machine purchasers.
(11)You also ask whether the Rule applies if the Vending Manufacturer references its Business Assistance Affiliate, and the services it provides, but such services are available only where the $500 payment or fractional franchise exemptions apply. The existence of location assistance causes a vending machine seller to be covered by the Rule. An exemption from the Rule's disclosure requirements may be available, however, under the minimum payment exemption, the fractional franchise exemption, or any other Rule exemption. We note, however, that it is the seller's burden to prove that it qualifies for any of the exemptions provided in the Rule.
(12)As noted above, the second part of the Franchise Rule's definition of the term "franchise" (the business opportunity venture section) does not require the sale of trademarked goods or services. Thus, a Retailer may be covered by the Rule as a business opportunity when purchasers offer vending services through machines provided by the Retailer. In the alternative, if the Retailer customizes the vending machines or puts on its own logo or name, then the Retailer may also be covered by the first part of the definition (the package or product section).
(13)We note that there may be instances where the relationship between the Vending Manufacturer and the Retailer is so close as to constitute a common enterprise. Even though it may appear that the Vending Manufacturer is not acting as a franchisor, its knowledge of, and involvement in, the Retailer's activities may demonstrate that it is acting as a franchisor. In situations where the relationship between the Vending Manufacturer and Retailer is simply a sham to avoid Rule coverage or amounts to a common enterprise, the Vending Manufacturer will be covered as a franchisor.
(14)See Informal Advisory Opinions 94-8, Bus. Franchise Guide (CCH) ¶ 6464 (December 21, 1994); 94-4, Bus. Franchise Guide (CCH) ¶ 6460 (May 12, 1994); 93-5, Bus. Franchise Guide (CCH) ¶ 6440 (April 2, 1993).
(15)Where a vending machine sellers has failed to keep records of prior purchasers, it is possible to recreate records based upon information contained in purchase agreements, bills of sale, or financing agreements.
(16)One possibility is for the Vending Manufacturer to survey purchasers at the end of its fiscal year to ascertain the purchaser's current status. Where a franchisor cannot obtain accurate information about an investor's status, the franchisor may be well advised to count that investor as having voluntarily terminated the relationship. We caution that false or unsubstantiated claims about the number of prior machine purchasers who continue to be in business may be deceptive in violation of Section 5 of the FTC Act, as well as the Franchise Rule.