Advisory Opinion 95-6
This staff advisory opinion is issued in response to your request dated March 10, 1995, for our views concerning the minimum payment exclusion of the Franchise Rule, 16 C.F.R. § 436.2(a)(3)(iii).
Your client is an authorized agent of a cellular telephone carrier. Under an agency agreement, your client sells mobile cellular telephones and related telephone and automotive equipment. The agency agreement includes a non-exclusive license to use the carrier's trademark. As compensation, your client receives commissions for each telephone activated on the carrier's system, a portion of the customer's cellular telephone bill, and, under certain conditions, funds to purchase advertising.
Your client now wishes to enter into sub-agency license agreements.(1) Your client will pay the sub-agents commissions and other remuneration for each telephone sold by the sub-agent that is activated on the carrier's system under your client's own agreement with the carrier. In effect, for each telephone activation, your client will be paid by the carrier and pass along a portion of those payments to the sub-agents.
Further, you state that your client will charge sub-agents a license fee for the use of its trademark. Such payments will begin, however, more than six months after the sub-agents start their business: you state that the sub-agent will have no obligation to make these payments during the first six months of its operation "in order to give the sub-agent a change to build up working capital while in its start-up phase." In addition, more than six months after the start of a sub-agency agreement, a sub-agent will pay your client royalties equal to 5% of certain merchandise sold at the sub-agent's business location.
Finally, you note that your client is considering offering certain inventory to the sub-agents "at a nominal profit to cover handling costs, and at a price competitive with prices available to the sub-agents in the marketplace." You add that the sub-agents would be free to buy from others at their own discretion.
You now pose two questions:
- Whether the exemption under 16 C.F.R. § 436.2(a)(3)(iii) for payments of less than $500 applies under the facts presented; and
- Whether the optional sale of inventory to sub-agents constitutes a "required payment" under the Rule.
II. THE MINIMUM PAYMENT REQUIREMENT
The Franchise Rule does not apply to a franchise "where the total of the payments . . . made during a period from any time before to within 6 months after commencing operation of the franchisee's business, is less than $500. 16 C.F.R. § 436.2(a)(3)(iii). In the Final Interpretive Guides to the Rule, the Commission made clear that:
[i]f the payment which the franchisee is required to make to the franchisor or an affiliate of the franchisor from any time before to within six months after commencing operation of the franchised business is less than $500, then the relationship is exempt from coverage under the Rule.
44 Fed. Reg. 49965, 49968 (August 24, 1979).
Further, 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.
III. The Sub-Agents Do Not Make a Required Payment Within the Time Required by the Franchise Rule
From the facts presented, it does not appear that the sub-agents will pay a required license fee any time before to within 6 months after commencing operation of their business.(2) We note, however, that it is possible that the sub-agents will satisfy the required payment element through the payment of royalties.
In your letter, you state that "more than six months after the commencement of a Sub-agency agreement, the Sub-Agent will commence royalty payments to the Company." The determining factor under the minimum required payment exemption is not when the franchisor and franchisee "commence an agreement," but when the franchisee actually "commences operation" of its business. In some instances, a franchisee can possibly commence business a year or more after signing an initial franchise agreement, especially if the franchisee must find a location or construct a shop outlet. Thus, if there is a delay in starting the franchised business, a sub-agent may actually begin paying royalties(3) to your client more than six months after commencing its agreement, but within six months of actually commencing operation of its business. If such a scenario occurs, it is possible that the sub-agent's royalty payments might satisfy the Franchise Rule's $500 minimum payment requirement.
IV. Voluntary Purchases of Inventory Generally Do Not Constitute a Required Payment
The Commission interprets the term "minimum payment" broadly to include all sources of payments such as initial franchise fees, rents, advertising fees, required equipment and supplies, security deposits, escrow deposits, and other non-refundable charges. See Statement of Basis and Purpose, 43 Fed. Reg. 59613, 59703-04 (December 21, 1978). Thus, when considering whether the "minimum payment" requirement is satisfied, the Commission will consider all sources of payments, direct or indirect, that franchisees may make to the franchisor.
The Commission, however, does not consider the purchase of reasonable amounts of inventory at a bona fide wholesale price for resale to constitute a "minimum payment." The policy underlying this view is set forth in the Final Interpretive Guides:
The Commission recognizes that it is, as a practical matter, virtually impossible to draw a clear line between start-up inventory that is purchased at the franchisee's option, and that which is purchased as a matter of practical or contractual necessity. In order to minimize the ambiguity in this respect, but consistent with the Commission's objective that "required payment" capture all sources of hidden franchise fees, the Commission will not construe as "required payments" any payments made by a person at a bona fide wholesale price for reasonable amounts of merchandise to be used for resale. The Commission will construe "reasonable amounts" to mean amounts not in excess of those which a reasonable businessman normally would purchase by way of a starting inventory or supply or to maintain a going inventory or supply.
44 Fed. Reg. at 49967.
Thus, if a franchisee pays the franchisor for only reasonable amounts of inventory for resale at a bona fide wholesale price, then the parties' business arrangement may not constitute a "franchise" as that term is defined in the Franchise Rule.
Please be advised that our opinion is based on all the information furnished in the request. This opinion applies only to your company 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: June 29, 1995
Franchise Rule Staff
(1)You also state that sub-agents will obtain a non-exclusive right to use your client's trademark. Further, your client will exercise control over the business operations of the sub-agent (such as the right to approve a sub-agent's business location) and provide assistance (such as marketing, sales and advertising training, and advice). Accordingly, it appears that your client satisfies the first and second definitional elements of a "franchise." See 16 C.F.R. § 436.2(a)(1)(i)(A)(1), (B)(1), and (B)(2).
(2)Because the sub-agents apparently do not make any payment during the first six months of operation, they are effectively operating as independent agents during that time. The fact that your client will obtain payment from consumers and remit only a portion as commissions or other remuneration to the sub-agents does not appear to constitute an indirect, required payment of a fee by the sub-agent for the right to operate the business. In the Final Interpretive Guides, the Commission specifically noted that "[a]gency relationships in which independent agents, compensated by commission, sell goods or services are excluded, since there is no 'required payment.' " 44 Fed. Reg. at 49967-68.
(3)Royalty payments in excess of $500 will constitute a minimum required payment. See Final Interpretive Guides, 44 Fed. Reg. at 49967 (forms of required payments include "continuing royalties on sales."). See also Advisory 93-12, Business Franchise Guide (CCH) ¶ 6456 (January 28, 1994).