Informal Staff Advisory Opinion 01-1

This staff advisory opinion addresses whether your client's proposed business arrangement qualifies as a "franchise" under the Franchise Rule.

I. INTRODUCTION

You represent Global Holdings Group, Inc., and its affiliate, Global Staffing, Inc. ("GSI"). GSI recruits and places computer and other information technology professionals into temporary or permanent staff positions. GSI would like to share its industry and management expertise with others who are interested in providing contract personnel and employee recruitment and placement services.

To that end, your client has created Global Holdings, Inc. ("GHG"), which was formed to develop and share the Global companies' business model with third parties, whom you refer to as "strategic partners." For each strategic partner, GHG will form a new limited liability company to be named "Global Staffing Solutions of [a location], LLC." GHG will contribute all start-up capital required for each Global Staffing Solutions entity, up to $500,000. For its contribution, GHG will receive 75% of the ownership interest in each Global Staffing Solutions entity; the strategic partner will own the remaining 25% interest. For its interest, the strategic partner will have onsite, day-to-day management responsibility for his/her Global Staff Solutions office. You state that neither GHG nor the strategic partner will draw a salary. Rather, at every year end, profits (or losses) will be paid (or allocated) between the parties in proportion to the 75/25 ratio.

Your client contemplates that strategic partners will sign contacts with GHG, in the form of a standard limited liability corporation. The salient features of the contract are as noted above: (1) GHG will contribute all of the start-up capital and that no capital contribution is required of the strategic partner; and (2) GHG and the strategic partner will split profits, losses, and voting rights in proportion to their 75/25 ownership interest.

In addition to this contract, each Global Staffing Solutions entity will sign a contract with GSI, GHG, or other Global affiliate for support services, which you describe as "back office services." These services include marketing and sales leads, accounting, various accounting reports, insurance, payroll services, legal and contract reviews, among other support services.

You now inquire whether the proposed business relationship would be deemed a franchise under the Commission's Franchise Rule. You acknowledge that the proposed business relationship will satisfy the Rule's trademark element, but you maintain that there is neither significant control or assistance over the business operations or a required payment.

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 company's arrangement constitutes a franchise.

II. DEFINITION OF THE TERM "FRANCHISE"

A business arrangement will be covered by the Franchise Rule if it creates a continuing commercial relationship that satisfies the three definitional elements of a franchise set forth in the Rule: (1) the distribution of goods or services associated with the franchisor's trademark or trade name; (2) significant control over, or significant assistance to, the franchisee; and (3) a required payment of at least $500 within 6 months of starting business operations. 16 C.F.R. §§ 436.2(a)(1)(i).

From your letter it is clear that your client intends to maintain an ongoing relationship with the strategic partners. As noted above, you also acknowledge that the proposed relationship satisfies the trademark element. Accordingly, we need only address significant control or assistance and the minimum payment requirements.

A. SIGNIFICANT CONTROL OR ASSISTANCE

In numerous advisory opinions, Commission staff has made clear that to be "significant," the controls and assistance offered to a prospective franchisee must relate to the franchisee's entire method of operation:

[I]t should be emphasized that in order to be deemed "significant" the controls or assistance must be related to the franchisee's entire method of operation -- not its method of selling a specific product or products which represent a small part of the franchisee's business. Controls or assistance directed to the sale of a specific product which have, at most, a marginal effect on a franchisee's method of operating the entire business will not be considered in determining whether control or assistance is "significant."

Final Interpretive Guides, 44 Fed. Reg. at 49966, 49967 (August 24, 1979).

Further, "significance" is a "function of the degree of reliance which franchisees are reasonably likely to place upon the controls or assistance." Id. This is especially true of investors who are inexperienced in a particular business. The Commission addresses "significant control and assistance" issues on a case-by-case basis. Among other things, the Commission considers the nature of the particular industry, the level of sophistication of the investors, as well as the importance of the assistance or control to the investors. Id. See also Statement of Basis and Purpose, 43 Fed. Reg. 59614, at 59701 (December 21, 1978).

In our opinion, your client's proposed offers of assistance are likely to have a direct and immediate affect on the strategic partners' business operations. According to your letter, GHG intends to offer a wide array of comprehensive services, which you describe as follows:

We provide financial and administrative services designed to help you maximize your earnings potential without compromising your independence. . . . We strive to provide you with a constantly growing package of benefits, as well as the information and tools necessary to be successful in a rapidly changing world. . . . With our combined purchasing power, we reduce your costs of operations while enhancing critical benefits including group medical insurance, dental insurance, and pension/401-K programs. We also administer all of your expense accounts and provide you with all the business insurance coverage clients require. With a simple phone call or e-mail our partners have access to management with over 180 collective years of contracting experience to help them with strategic on the job tactical business situations.

We find that these types of services are more than just "back office" or administrative functions. Marketing, providing leads, and reviewing contracts, for example, go to the very heart of operating a staff recruitment and placement service. Accordingly, these support services are more that sufficient to satisfy the Rule's significant assistance requirement.

B. MINIMUM REQUIRED PAYMENT

In your letter, you state that strategic partners make no required payment to the GHG in order to enter into the business relationship.(1) Nor do they receive any salary. Apparently, the strategic partners are expected to contribute their labor for an entire fiscal year before they may receive any compensation. While the strategic partners obviously risk the loss of their labor contribution, that alone is insufficient to satisfy the Rule's payment requirement. Nor does GHG's anticipated benefitting from the strategic partner's contribution of labor constitute a payment. While the Commission interprets the term "payment" broadly to include all sources of revenue paid by a franchisee to a franchisor, the Commission has not considered contributions of labor alone as constituting a "payment."

We are more concerned, however, about potential losses. By entering into the business relationship, a strategic partner assumes a current obligation to share in losses as a condition of entering into the business relationship. Any sharing of losses would directly benefit GHG. Indeed, a required assumption of a franchisor's debt by a franchisee would constitute a required payment, no less than a direct payment to the franchisor. However, under the terms of your client's proposed agreement, a strategic partner's obligation to pay any losses would not occur until more than six months after the start of business operations. More important, if GHG were to seek to enforce the contribution of loss provision in its agreement, the strategic partners apparently would retain the right to raise defenses of fraud or breach, thereby minimizing any potential injury to the strategic partner. See Automobile Importers of America, Inc., Bus. Franchise Guide (CCH), ¶ 6382 (1979). For these reasons, absent any other payments by the strategic partners to GHG and its affiliates, it does not appear that the minimum payment requirement would be satisfied.

III. CONCLUSION

For the reasons noted above, your client's proposed business arrangement appears to satisfy the Franchise Rule's trademark and significant assistance elements. However, it does not appear to satisfy the required payment requirement.

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: March 5, 2001

Franchise Rule Staff

Endnote:

1. Of course, any payment by a strategic partner to your client for training, equipment, leases, etc. would be considered a required payment.