Informal Staff Advisory Opinion 99-4

This staff advisory opinion is issued in response to your request for our views concerning the definition of the term "continuing commercial relationship."

I. INTRODUCTION

In your letter, you state that Challenger Center For Space Science Education ("Challenger Center"), a tax-exempt organization located in Alexandria, Virginia, establishes centers ("Learning Centers") nationwide to promote space science education. Before addressing your specific concerns, we note that your company, The Memphis Space Center, Inc., a tax-exempt organization incorporated in Tennessee, is now in litigation with Challenger Center. The questions that you pose apparently arise out of the facts underlying the law suit.

While Commission staff routinely respond to requests to clarify the Franchise Rule and its application, we cannot take sides in private legal matters, especially since Challenger Center has not had any opportunity to present us with its own view of the facts. Moreover, 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. Nonetheless, we believe that there is a public interest in clarifying what constitutes a "commercial relationship" under the Rule. Accordingly, we will provide general guidance on the subject that you may wish to consider in addressing your concerns, but take no position on the merits of your claims or on the accuracy of the facts you present.

II. THE CHALLENGER CENTER'S ACTIVITIES

In your letter, you state that Challenger Center has been establishing Learning Centers since 1988 and claims to have "30 active sites" in its promotional literature and on its web site. According to your letter, each of these 30 sites purchases expensive customized equipment from Challenger Center that is used to establish a Learning Center. Further, Challenger Center sells various merchandise with the Challenger Center logo to the Learning Centers, at wholesale prices, for resale to the public in gift shops and other retail outlets. Many, but not all, of the Learning Centers sell the Challenger Learning Center merchandise.

You state that in 1994 Challenger Center solicited an application from you to establish a Learning Center in Memphis. At that time, you were required to make a non-refundable payment of $1,000. Approximately 18 months after approval was granted, you sent Challenger Center a required check for an additional $50,000. You assert that at no time from the beginning of the application process through the time the check cleared your bank did Challenger Center provide you with a written disclosure document.

You now ask a series of questions concerning your experience with Challenger Center. All but two of these questions concern the applicability of the Franchise Rule to the arrangement between your company and Challenger Center. The remaining questions concern the return of deposits. The key question to be addressed is whether the relationship between you and Challenger Center constitutes a "continuing commercial relationship."

III. DEFINITION OF THE TERM "COMMERCIAL"

The term "franchise" refers to certain "continuing commercial relationships." 16 C.F.R. § 436.2(a). In the Statement of Basis and Purpose accompanying the Rule, the Commission elaborated on the "continuing commercial relationship" requirement as follows:

There is general agreement that central to the definition of the term "franchise" is the concept that the relationship must be both "continuing" and "commercial." . . . The rule does not apply to relationships which are not entered into with the expectation of profit, or to commercial relationships which do not involve a course of dealing over a period of time.

43 Fed. Reg. 59613, 59700 (December 21, 1979)(emphasis added).

The Rule's "commercial relationship" limitation is consistent with Section 4 of the FTC Act, which limits the Act's applicability to "any company . . . which is organized to carry on business for its own profit or that of its members. . . ." 15 U.S.C. § 44 (emphasis added). In determining whether a corporation carries "on business for its own profit or that of its members," the Commission will look beyond the technical form of a corporation's charter. Rather, the Commission will examine the corporation's actual activities on a case-by-case basis. It will assert jurisdiction where a corporation carries on its business for "its own profit or that of its members" notwithstanding any attempt to hide for-profit activities under the cloak of a nonprofit entity.(1) In determining whether the Commission has jurisdiction over a purported nonprofit corporation, the Commission may consider a number of factors including whether the corporation: (1) is organized as a nonprofit; (2) has been granted tax-exempt status by the IRS; (3) distributes funds to its members or shareholders; and (4) devotes realized profits exclusively to charitable purposes.(2) In franchise matters, the Commission may also consider whether franchisees are required to purchase goods or services from for-profit entities owned or controlled by directors or officers of the nonprofit franchisor.

IV. APPLICABILITY OF THE FRANCHISE RULE TO CHALLENGER CENTER

We begin our analysis by noting that the relationship between Challenger Center and at least some of the Learning Centers may be continuing. You state that Challenger Center supplies goods at wholesale prices to some of the Learning Centers for resale. You also allege that Challenger Center collects an annual fee from each Learning Center. Under these facts, it would appear that the relationship between Challenger Center and the Learning Centers is continuing.

Whether the relationship between Challenger Center and the Learning Centers is commercial, however, is a more difficult question. That the Challenger Center has been granted tax-exempt status creates a presumption that it has been organized for nonprofit purposes. However, you present several facts you believe support the proposition that Challenger Center engages in commercial activities with the Learning Centers. Specifically, you contend that:

  • Challenger Center claims in its promotional materials, videos, and web site to have a continuing financial and contractual relationship with 30 local service providers;
  • Challenger Center requires a one-time investment of $700,000 and an annual fee of $10,000; and
  • Challenger Center sells trademarked goods at wholesale prices to the Learning Centers for resale.

That the Challenger Center may claim to have a financial relationship with the Learning Centers in its promotional materials does not establish that its relationship with the Learning Centers was entered into with an "expectation of profit." Similarly, the fact that the Challenger Center charges the Learning Centers an initial $700,000 fee for equipment and a recurring $10,000 annual fee alone does not support a finding that the Challenger Center profits from these charges. Without more information, it is impossible for us to conclude that these charges generate any income for the Challenger Center. These charges may be imposed to reimburse, at cost, the Challenger Center for goods or services provided to the Learning Centers. More important, even if these charges generate income for the Challenger Center, it does not follow that the Challenger Center actually conducts business "for its own profit or that of its members." No evidence has been presented that suggested that Challenger Center uses the income from equipment sales or annual fees for anything other than ordinary charitable purposes. For example, there is no allegation that Challenger Center distributes the income to its directors or to shareholders. See Advisory 95-3, Bus. Franchise Guide (CCH), ¶ 6468.(3)

A more significant factor, however, is the Challenger Center's apparent sale, at wholesale prices, of its trademarked goods to the Learning Centers for resale. By charging wholesale prices, instead of providing goods at-cost, it would appear that the Challenger Center intends to generate income from the sale of its trademarked goods. Nonetheless, for the reasons outlined above, it is not clear to us that the Challenger Center actually "has an expectation of profit" from the income generated through the sale of such items. A nonprofit organization such as the Challenger Center that earns income from its activities will not be deemed to engage in commercial, for-profit activities unless the evidence demonstrates that the income is used for non-charitable purposes or inures directly to those associated with the organization, such as directors, officers, or shareholders. Under the circumstances, the facts presented do not rebut the presumption created by the Challenger Center's tax-exempt status that the Challenger Center is organized primarily for non-profit purposes. Accordingly, it would appear that the establishment of Learning Centers does not constitute the offer of a franchise under the Commission's Franchise Rule.(4)

V. REFUND ISSUES

Finally, you ask two questions about refunds, both of which assume that Challenger Center is covered by the Commission's Franchise Rule. First, you inquire whether a franchisor can legally keep a "non-refundable" franchise application fee after it cancels the franchise agreement against the wishes of the franchisee. Second, you ask whether a franchisor may legally hold or permanently keep a $50,000 deposit on the purchase of start-up equipment after the franchisor canceled the contract against the wishes of the franchisee?

Section 436.1(h) of the Franchise Rule provides that it is an unfair and deceptive practice under Section 5 of the FTC Act for any franchisor to "fail to return any funds or deposits in accordance with any conditions disclosed" in the franchisor's disclosure document. 16 C.F.R. § 436.1(h). The Franchise Rule, however, does not dictate the substantive terms or conditions of any franchisor's refund policy, requiring only that the franchisor disclose any such terms and conditions prior to the franchise sale. However, if the Challenger Center is not a "franchisor" covered by the Franchise Rule, it is not bound by the Rule's refund requirements. Rather, it would appear under the circumstances that any rights you may have to obtain a refund are governed by the terms of your contract with Challenger Center, as interpreted under applicable state contract law..

Please be advised that our opinion is based on all the information furnished in the request. This opinion applies only to the parties noted herein and only 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: May 13, 1999 Franchise Rule Staff

1. E.g., FTC v. National Commission on Egg Nutrition, 517 F.2d 485, 488 (7th Cir. 1975), cert. denied, 426 U.S. 919 (1976); Community Blood Bank of Kansas City Area v. FTC, 405 F.2d 1011, 1018 (8th Cir. 1969).

2. E.g., Community Blood Bank, 405 F.2d at 1019; Ohio Christian College, 80 F.T.C. 815, 849 (1972); College Football Ass'n, 117 F.T.C. 971, 989 (1994). See also Advisory 95-3, Bus. Franchise Guide (CCH) ¶ 6468 (1995). Cf. The Association of Logos Bookstores, Bus. Franchise Guide (CCH) ¶ 6419 (1980)(nonprofit cooperative association provides services to members at cost).

3. In Advisory 95-3, we concluded that HIPPY USA, a nonprofit educational corporation, fell outside of the Franchise Rule because it did not receive any profits from the sale of its services, directly or through its licensees. At the same time, we recognized that it is possible that the directors and other officials of a nonprofit organization may earn income from the sale of its materials and/or receipt of royalty payments from its licensees. No such allegation has been made here.

4. If the Challenger Center engages in commercial for-profit activities and meets the three definitional elements of a franchise as set out at 16 C.F.R. § 436.2(a), then it would be required to provide prospective franchisees with a disclosure document at the first personal meeting or at least 10 days before the prospective franchisees signs any binding legal agreement or pays any fee in connection with the franchise sale. 16 C.F.R. §§ 436.1(a); 436.2(g) and 436.2(o). No franchisor may charge a prospective franchisee any fee before furnishing a copy of its disclosure document.