Informal Staff Advisory Opinion 96-1

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

I. INTRODUCTION

In your letter, you state that your client, Pine Mountain Building Systems, Inc. ("Pine Mountain"), proposes to offer dealerships for log accent panelized materials and other construction items. The company will permit dealers to use the Pine Mountain name and symbol as part of the dealership package. You also state that the company will provide dealers with materials, protected territories, plans, and engineer consulting services. The dealers will also receive discounts or commissions on sales, and advertising incentives. In addition, Pine Mountain will refer sales leads generated by national advertising to local dealers.

In your letter, you ask whether Pine Mountain's dealership 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 advising your client whether the proposed business arrangement constitutes a franchise.

II. DEFINITION OF THE TERM "FRANCHISE"

Whether the dealerships contemplated by Pine Mountain are "franchises" for the purposes of the Commission's Franchise Rule is not dependant upon what the parties call the business arrangement, but whether the arrangement satisfies the 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, 49966-67 (August 24, 1979).

From the information provided to us, it appears that Pine Mountain's dealerships may constitute a product franchise. The three definitional elements of a product franchises are: (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) and 436(2)(a)(3)(iii).

III. PINE MOUNTAIN APPEARS TO OFFER A PRODUCT FRANCHISE

In the business relationship you describe, Pine Mountain dealers will distribute trademarked goods (Pine Mountain's construction systems) and will utilize Pine Mountain's trademarks in the operation of their businesses. Therefore, the first requirement for Rule coverage is met.

Further, Pine Mountain's offers of assistance appear to be significant. See 16 C.F.R. §§ 436.2(a)(1)(i)(B)(1) and (2). As you note in your letter, Pine Mountain will provide its dealers with consulting and engineering assistance, referrals, and marketing assistance. This type of assistance is sufficient to trigger coverage by the Franchise Rule. See e.g., Advisory 95-5, Bus. Franchise Guide (CCH), ¶ 6470 at 9657 (April 4, 1995).

The final prerequisite for coverage is the required minimum payment. As an initial matter, 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. 59614, 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 distributors may make to the franchisor.

The information you have provided indicates that Pine Mountain distributors are required to make at least two types of payments: (1) payments for inventory; and (2) payments for the purchase of a model home or office. Whether the purchase of inventory constitutes a "minimum payment" depends upon the particular facts.

The Commission does not consider the purchase of reasonable amounts of inventory at a bona fide wholesale price for resale to constitute a "minimum payment." See Final Interpretive Guides, 44 Fed. Reg. at 49967. From the information you have provided, it appears that the purchases of inventory by Pine Mountain dealers will be at bona fide wholesale prices and not in excess of what a reasonable businessman would normally purchase. If true, these purchases will not trigger Franchise Rule coverage. However, the contractually required purchase of a Pine Mountain log home or office, which you concede will cost in excess of $500, is enough to satisfy the required payment element for Franchise Rule coverage. Such purchases are analogous to a required purchase of equipment or supplies needed to operate the business.

For the reasons stated above, we conclude that the dealership arrangement contemplated by Pine Mountain appears to satisfy all three definitional elements of a product franchise. We will now address whether this arrangement nonetheless qualifies for the "fractional" franchise exemption.

IV. THE FRACTIONAL FRANCHISE EXEMPTION

The fractional franchise exemption is one of four exemptions provided by the Franchise Rule. See 16 C.F.R. § 436.2(d). The exemption is available to a company offering a business relationship that meets each of the elements for Rule coverage if it can prove the following two conditions are met: (1) the franchisee with whom it enters a relationship has been "in the business represented by the franchise more than 2 years;" and (2) the "sales arising from the relationship . . . represent no more than 20 percent of the sales in dollar volume of the franchisee." Id. at § 436.2(h).

It is the franchisor's obligation to establish that it qualifies for any of the Rule's exemptions. While it is possible that the Pine Mountain dealers might be in the same line of business for more than two years, you provide no evidence to support such a finding in your request letter. Similarly, you have submitted no information from which we can draw any inference about the sales levels the dealers may attain by becoming associated with Pine Mountain. For these reasons, we cannot conclude that Pine Mountain qualifies for the fractional franchise exemption.

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: April 12, 1996
Franchise Rule Staff