Informal Staff Advisory Opinion 98-3

This staff advisory opinion is issued in response to your recent request for advice concerning the Commission's Franchise Rule. 16 C.F.R Part 436. Specifically, we will address whether a secured, non-negotiable, promissory note due six months after the franchisee actually opens for business qualifies for the Rule's minimum payment exemption. 16 C.F.R. Section 436.2(a)(3)(iii).


In your letter, you state that your client, identified only as "BR," intends to create a database of local businesses for over eighty market areas in the United States. Akin to an on-line yellow pages,(1) this database will include items such as personnel and real estate listings and will be available without charge to those who have access to the Internet.

To build the database, your client will enter each targeted market by creating an "Authorized Sales Agency" ("Agency") for that market. Each Agency will recruit its own personnel, find a local advertising agency, sell listings on BR's web site, and submit to BR the information necessary to create the individual web-site listings. In return, BR will provide training and marketing support, create and maintain the directories on BR's web site, provide full web page design and publishing for the Agency's clients, and provide the Agency with accounting services.

For purposes of this advisory request, you have asked us to assume that your client's business arrangement satisfies the Rule's definition of the term "franchise." The only issue we need to address is whether the required payment falls within the Rule's minimum payment exemption. Before addressing the specific payment arrangement, some additional background on the Rule's minimum payment exemption is warranted.


As noted above, the Rule exempts franchise relationships "where the total of the payment[s] . . . made during a period from any time before to within 6 months after commencing operation of the franchisee's business, is less than $500." 16 C.F.R. § 436.2(a)(3)(iii). In the Statement of Basis and Purpose accompanying the Rule, the Commission explained the rationale underlying this exemption as follows:

The record supports the proposition that the rule should focus upon those franchisees who have made a personally significant monetary investment and who cannot extricate themselves from the unsatisfactory relationship without suffering a financial setback. Implicit in the concept of franchising, as viewed by the Commission, is the assumption of a financial risk by a franchisee in entering into a franchise relationship.

44 FR 59614, 59704 (December 21, 1978)

Since the Rule was promulgated, Commission staff has issued several advisory opinions interpreting further when franchisees should get disclosures because they face a "significant financial risk." In an early opinion, staff distinguished between franchisees who sign negotiable and non-negotiable promissory notes. We advised that a franchisee who signs a non-negotiable promissory note can assert defenses of non-performance and set-off in collection actions brought by the franchisor. Accordingly, a franchisee who signs a non-negotiable note for a payment due more than six months after starting business may not be covered by the Rule's protections. On the other hand, a franchisee who signs a negotiable promissory note may not be able to extricate himself from an unsatisfactory relationship without suffering significant economic harm because his defenses would be extinguished if the note were sold to a good faith purchaser. In short, we stated:

[P]roposed payment devices which would have the potential of frustrating or circumventing the protections afforded by the rule, or imposing substantial financial risks on the prospective franchisee, will not be considered by the Commission's staff as suitable for an exemption under Section 436.2(a)(3)(iii).

Automobile Importers of America, Inc., Bus. Franchise Guide (CCH) ¶ 6382 (August 9, 1979).

Most recently, we elaborated further on the use of non-negotiable promissory notes. While non-negotiable promissory notes ordinarily do not subject the franchisee-signer to a significant financial risk, the same cannot be said of non-negotiable promissory notes that contain an acceleration clause. We advised that franchisees who sign notes containing an acceleration clause make a present commitment to pay the entire balance due. Such arrangement, if more than $500, cannot qualify for the minimum payment exemption. Advisory 95-10, Bus. Franchise Guide (CCH) ¶ 6480 (1996).


Your letter sets forth one of the most complex payment arrangements we have ever been asked to review. You state that each Agency will be obligated to pay BR a fee of $75,000. However, this payment will be due no earlier than six months after the business begins operation. In addition, each Agency will pay BR a fluctuating royalty, beginning at the 27% level. No Agency will be liable to pay BR any portion of that royalty which exceeds $500 until its business has been in operation for at least six months. You further state that BR will require each Agency to execute a non-negotiable promissory note which does not contain an acceleration clause. You ask, however, whether BR can secure the non-negotiable promissory note with some form of collateral. You add that the secured promissory note contemplated by BR would enable the Agency to assert defenses in a judicial forum -- before a court or arbitration panel -- before any foreclosure takes place.

We begin our analysis by noting that the main purpose underlying the Commission's Franchise Rule is to prevent significant economic losses through fraudulent or deceptive franchise sales. Where a franchisee makes no required payment in connection with the purchase of a franchise, Rule coverage is not an issue because the franchisee, even if deceived, suffers no economic loss. Similarly, a franchisee who signs a non-negotiable promissory note has a reduced risk of financial loss because, if deceived, the franchisee can raise any defenses it may have, such as breach of contract, misrepresentation, and fraud. A franchisee who signs a non-negotiable note is no less able to assert its defenses if the note is secured by collateral. As described in your letter, the franchisee does not waive any right to assert defenses simply by signing the secured note. Rather, the existence of collateral means only that, if successful in an enforcement action, the franchisor is assured of a post-judgment remedy. We conclude, therefore, that a secured, non-negotiable promissory note (without an acceleration clause) probably qualifies for the Rule's minimum payment exemption

Nonetheless, one concern remains. In your letter, you state that BR may use arbitration to enforce its non-negotiable promissory note. Where an action to enforce a note is heard in a court, it is reasonable to assume that ordinary rules of procedure under federal or state law will ensure that the franchisee receives due process and can assert its defenses. While we certainly support alternative means to resolve consumer disputes, we are uncertain whether the same due process protections apply to all arbitration proceedings. Indeed, the rules by which an arbitration may be conducted can vary depending upon the sponsor of the arbitration. Thus, the burden is on the franchisor to prove that the forum selected to enforce any non-negotiable promissory note guarantees the franchisee's ability to raise all defenses.


Finally, we note that you state in your request for a staff opinion: "If your analysis of the facts set forth in this letter would not permit you to give us a favorable advisory opinion, I would greatly appreciate it if you would call me prior to issuing a negative advisory opinion so that we might discuss further the pertinent issues." We consider requests such as these to be improper.

Commission staff issues informal advisory opinions in the public interest to resolve a novel issue of law or question of Rule interpretation. We do not negotiate responses to advisory requests. Further, we cannot act as private counsel to any member of the public, nor can we pre-screen or endorse any particular business proposal. Moreover, we will look with disfavor upon attempts by private counsel to seek our advice, and may deny an advisory request, where the requester posits numerous hypothetical scenarios in an obvious attempt to hit upon "the one" which will garner a favorable staff response. Multiple requests for advise such as these seldom serve the public interest and often impede staff's ability to provide timely advice to other requestors.

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: May 4, 1998
Franchise Rule Staff

1. Your client apparently seeks to compile a database of information from businesses who voluntarily participate in its program. The Commission, however, has concerns about "individual reference" or "look-up" services -- companies that collect and disseminate private information about consumers. Before disseminating private information about consumers, companies should notify the consumer and permit the consumer to opt out of the distribution of non-public information to the general public. See FTC, Individual Reference Services: A Report To Congress (1977).