Informal Staff Advisory Opinion 03-2

This staff advisory opinion is issued in response to your recent request for our views concerning the applicability of the Federal Trade Commission's Franchise Rule to a license agreement.

I. INTRODUCTION

Wormgold Solutions, LLC ("Wormgold"), produces equipment and a mix needed to manufacturer a form of "compost tea," a soil supplement used in landscaping and agriculture. According to Wormgold, this compost tea, called "Wormgold Solution ("WGS"), improves plant health and reduces water consumption. Wormgold intends to license the manufacture of this product to third parties, using the Wormgold trademark and equipment.

According to your letter, licensed Wormgold facilities will use the WGS name. In addition, licensees will use Wormgold equipment and mix to manufacture WGS. As licensor, Wormgold will advise the licensees to follow established soil testing standards before using WGS and to follow established guidelines when applying WGS. Wormgold will also provide technical assistance upon request, but will provide no direct control of the operation of the production facilities. Finally, you add that licensees will pay no fee for the license. You ask whether the Wormgold proposed license arrangement will constitute a franchise.

II. A LICENSE ARRANGEMENT MAY BE A FRANCHISE

The Franchise Rule applies to several types of continuing commercial relationships, including "package and product franchises."(1) A package franchise adopts the business format established by the franchisor and is identified by the franchisor's trademark. A product franchise distributes goods that are produced by the franchisor and which bear the franchisor's trademark, or are manufactured by the franchisee according to the franchisor's specifications.

Whether Wormgold's proposed business relationship constitutes a "franchise" is not dependent upon what the parties call it: Wormgold will be covered by the Franchise Rule if the business relationship it creates satisfies the three 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, in the context of distributorship arrangements:

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. 49,966 (August 24, 1979).

We begin our analysis by noting that the term "franchise" refers to a continuing commercial relationship. According to your license agreement, licensees will use Wormgold equipment and mix in order to produce WGS. In addition, Wormgold will provide ongoing technical assistance. Under these facts, it appears that Wormgold and its licensees have a continuing commercial relationship.

To be covered by the Franchise Rule, a business arrangement must also satisfy the three definitional elements of a "franchise." The three required elements common to package and product franchises covered by the Franchise Rule are: (1) the distribution of goods or services associated with the franchisor's trademark or trade name; (2) significant control over, or significant assistance provided to, the franchisee; and (3) a required payment of at least $500 within six months of commencing business operations. 16 C.F.R. § 436.2(a)(1)(i).

A. Distribution of Goods or Services Associated with>the Franchisor's Trademark or Trade Name

Investors in a WGS manufacturing plant will produce a soil supplement under the Wormgold trademark. This is sufficient to satisfy the first definitional element.

B. Significant Control or Assistance

As noted above, Wormgold provides licensees with equipment and mix needed for the manufacturer of WGS. In addition, Wormgold provides licensees with technical assistance, upon request, as well as advises licensees on soil testing and product application standards. In your letter, you state that WGS manufacturing facilities will be located 120 miles apart, suggesting limited manufacturing territories. Thus, it appears that Wormgold will impose some controls and offers some assistance to the investors. The question remains, however, whether such assistance and controls are "significant."

In the Final Interpretative Guides, the Commission stated that "significance" is a "function of the degree of reliance which franchisees are reasonably likely to place upon the controls or assistance." See Final Interpretive Guides, 44 Fed. Reg. at 49,967. This is especially true of investors who are inexperienced in the particular business. Id. 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 meaning of the assistance and control to the investors. Id.

See also Statement of Basis and Purpose, 43 Fed. Reg. 59614, 59701 (December 21, 1978).

Based upon the information contained in your letter, we are unable to determine whether the assistance and controls offered to potential Wormgold licensees are "significant." Specifically, your letter is devoid of any information about the potential investors in a WGS manufacturing plant, such as their business backgrounds and knowledge of the soil supplement industry. Without such information, we cannot determine whether your offer of assistance is significant to these individual licensees. For example, the Wormgold system may use technology that is unique or technology that is sufficiently complex that it requires training even by individuals sophisticated in the agricultural or nursery industries. Where training or other assistance is necessary to ensure proper manufacture and use, such assistance may be deemed significant.

C. Minimum Payment

The final question is whether the Wormgold licenses satisfy the Rule's $500 minimum payment requirement. In your letter, you state that Wormgold will charge no license fee. Franchise Rule coverage, however, is not dependent upon a license fee or other up-front payment. Rather, any minimum required payment will suffice. Indeed, 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. at 59,703-04. Thus, when considering whether the "minimum payment" requirement is satisfied, the Commission will consider all sources of payments, direct or indirect, that licensees will make, or commit to make, to Wormgold.

In your letter, you state that licensees will use Wormgold equipment and mix to produce WGS. However, you do not state how much the equipment and mix costs. If the total cost of equipment and mix exceeds $500 during the first six months of the licensee's operation, then the third definitional element will be satisfied.

III. CONCLUSION

Based upon the information you have provided it appears that Wormgold's proposed license agreements satisfies the Rule's trademark requirement. However, in the absence of more detailed information, we cannot determine whether the control and assistance and the minimum required payment elements are satisfied in this instance.

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.

Franchise Rule Staff

Date: April 16, 2003

Endnote:

1. Another type of continuing commercial relationship covered by the Franchise Rule is a 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.