This staff advisory opinion is issued in response to your request dated November 21, 1994, for our views concerning the applicability of the Federal Trade Commission's Franchise Rule, 16 C.F.R. Part 436, to a distributorship arrangement.
I. Introduction
According to your letter, your client intends to offer "distributorships" to market and sell its computer software. The particular software program enables health care providers to order medical and office supplies and to keep track of inventory. Upon payment of a $16,000-$17,500 fee, a distributor has the right to sell the software to health care providers anywhere in the United States. Once the software is installed, the health care provider can order supplies directly from your client. Your client in turn will fulfill any orders and collect the appropriate charges. The individual distributor will not warehouse or ship any supplies. Distributors, however, will receive a commission on any supplies their accounts purchase from your client.
You ask whether this distributorship arrangement constitutes a franchise. You should 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 a specific set of 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 distributorship arrangement constitutes a franchise.
II. A Distributorship Arrangement May Be a Franchise
Whether any company constitutes a "franchise" is not dependent upon what the parties call the business arrangement. Rather, your client will be covered by the Franchise Rule if the business relationship it has created satisfies the definitional elements of a "franchise" set forth in the Franchise Rule, 16 C.F.R. § 436.2(a). As noted in the Commission's Final Interpretive Guides to the Franchise Rule:
The name which the parties give to their relationship is not relevant in determining whether the relationship is within the scope of the rule. Thus, a relationship described by the parties as a "franchise" will not be covered by the rule unless it meets the definitional
criteria of the rule; conversely, a self-described "distributorship" will be covered by the rule if the definitional elements are satisfied.
44 Fed. Reg. 49966 (August 24, 1979).
We begin our analysis by noting that the term "franchise" refers to a continuing commercial relationship. According to your letter, distributors will market and sell your client's software to health care providers. They will receive a commission from your client based upon any subsequent supply orders placed by those they have enrolled in the system. These facts are sufficient to constitute a continuing commercial relationship.
To be covered by the Franchise Rule, a business arrangement must also satisfy the three definitional elements of a "franchise"(1) set forth in the Rule: (1) the distribution of goods or services associated with the franchisor's trademark or trade name; (2) significant control of, or significant assistance to, the franchisee; and (3) a required payment of at least $500 within 6 months of signing of an agreement. 16 C.F.R. § 436.2(a)(1)(i).
The first and last of these definitional elements are clearly satisfied. As stated above, distributors will market your client's software program. From your description of the software, we infer that it will carry your client's trademark or trade name. This is sufficient to satisfy the first element. The third element is also satisfied because distributors will pay your client significantly more than $500 for the right to become a distributor. We next turn to the second definitional element.
III. Significant Control or Assistance
To be covered under the Franchise Rule, a company must also provide significant controls or assistance. In your letter, you state distributors may choose to market and sell the software program as they see fit to any health care provider, so long as a fellow distributor has not made a previous sale to that provider. Your client has no control over the sites used by the distributors for their operations, the hours of operation, accounting practices, personnel policies, promotional campaigns, restrictions on customers, or location or sales areas for the distributors. The only requirements imposed are that distributors send "appropriate personnel to an initial training class to learn about the software program" and that distributors have a computer, which they need not buy from your client.
You also state that your client offers sales and marketing assistance; however such assistance is provided under a separate independent contract. A fee for such assistance is then reduced from the distributor's commission. You state, however, that distributors are not required to use your client's marketing and sales expertise.
In the Final Interpretive Guides to the Franchise Rule, the Commission stated that the term "significant" relates to:
the degree to which the franchisee is dependent upon the franchisor's superior business expertise -- an expertise made available to the franchisee by virtue of its association with the franchisor. The franchisee, in order to reduce its business risks or enhance its chances for business success, relies upon the availability of such expertise to avoid business mistakes that it otherwise might make.
44 Fed. Reg. at 49967.
Further, to be deemed "significant," the franchisor's controls and assistance must relate to the franchisee's entire method of operation. 16 C.F.R. §§ 436.1(a)(1)(i)(B)(1) and (2). Control and assistance relating to the franchisee's business organization, management, marketing plan, or business affairs, for example, will generally be deemed significant. On the other hand, controls or assistance relating to a small part of the franchisee's business ordinarily will not be deemed significant. See Id. at 49967.
From the description of your client's business, it appears that distributors are essentially independent businesspersons who will not rely on your client's expertise in order to market the software. Your client will neither exercise control over the distributors' marketing methods nor control to whom sales may be made. While distributors must own a computer and attend an initial training class, these minimal requirements do not pertain to the distributors' "entire method of operation" and, therefore, appear to be "insignificant" for purposes of the Franchise Rule.(2)
IV. Conclusion
Based upon the information you have provided, it appears that your client neither imposes significant controls nor offers significant assistance to its distributorships. Accordingly, your client does not appear to satisfy all three definitional elements of a "franchise" set out above.
Please be advised 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: January 31, 1995
Franchise Rule Staff
(1)Another type of continuing commercial relationship covered by the Franchise Rule is the business opportunity venture. See 16 C.F.R. § 436.2(a)(1)(ii). Unlike a franchise, a business opportunity venture does not necessarily involve the use of the promoters' trademark or trade name. The most common types of business opportunity ventures are rack displays and vending machines routes.
(2)Our analysis might be different, however, if your client sells its distributorships to unsophisticated buyers. Your letter is silent on the experience level of prospective distributorship buyers. If your client markets its distributorships to individuals with no prior computer skills, or if its software program is unusually complex, distributors may rely upon your client's initial training in order to be able to market the software successfully. You also state that sales and marketing assistance is available under a separate contract. Again, if the distributors cannot readily explain and demonstrate the software to prospective clients, they may, as a practical necessity, rely upon your client's expertise. Under these circumstances, your client's offers of assistance may constitute "significant" assistance for purposes of the Franchise Rule.