This staff advisory opinion is issued in response to your request for advice on whether your client's proposed sale of free-standing sandwich shops constitutes the sale of a franchise, as contemplated by the Franchise Rule. 16 C.F.R. Part 436.
I. INTRODUCTION
In your letter, you state that your client originally incorporated to sell franchises for free-standing sandwich shops located in convenience stores. Your client, however, now believes that offering the business as a franchise is too costly. Accordingly, your client would like to restructure its business arrangement to avoid Franchise Rule coverage.
You state that the proposed business arrangement would have the following characteristics. First, your client would allow persons who wish to sell your client's products the use of your client's trademark. Second, the stores that use the trademark would be required to purchase cold cuts, cheeses, bread, napkins, bags, and similar items from an affiliate of your client. In addition, investors would be required to purchase from your client both inventory and the basic shop "unit," which you describe as similar to a kiosk with an oven and refrigerator. You state that any shop owner that elects not to sell your client's inventory would be required to discontinue the use of the trademark. Finally, you state that the only assistance that your client (or an affiliate) may provide to the shop owners would be on-site training demonstrating proper cooking procedures and sandwich design.
You now ask whether the arrangement described above would constitute a franchise, as defined in the Franchise Rule. You apparently believe that this type of arrangement would not satisfy the Rule's "significant control or assistance" requirement. 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 of 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 the proposed business 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 appears that your client intends to maintain an ongoing relationship with the purchasers of the sandwich shops. Purchasers are expected to buy food and related items (napkins, bags, etc.) from your client, or an affiliate, in exchange for the use of your client's trademark. This is sufficient to constitute a continuing commercial relationship. We now turn to whether the three definitional elements of a franchise described above are also satisfied.
A. TRADEMARK
In your letter, you state that your client will permit the sandwich shop purchasers to use your client's trademark. Since your client apparently is willing to offer the use of its trademark as part of the sale, any representations about the availability of the trademark by your client to prospective purchasers will satisfy the Rule's trademark element.
B. SIGNIFICANT CONTROL OR ASSISTANCE
In your letter, you suggest that your client will not impose significant controls or offer significant assistance to the sandwich shop purchasers. In numerous advisory opinions, Commission staff has made clear that to be "significant," the controls and assistance 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 controls and assistance are likely to have a direct and immediate affect on at least that class of sandwich shop purchaser that elects to use your client's trademark. As noted in your letter, your client will impose both product and source-of-supply restrictions, requiring purchasers to buy specific food and related items from your client or from an affiliate. Product purchase obligations and sourcing restrictions are likely to directly affect the purchasers' costs, and thus their ability to cover basic operational expenses, as well as their ability to purchase additional inventory and meet payroll obligations. In addition, product and sourcing restrictions may also have a significant economic effect to the extent that they limit the franchisees' independence and impede their profitability. We also find that your client's offer of on-site training in cooking procedures and sandwich design may be significant, especially to purchasers who are inexperienced in the food preparation. For these reasons, we conclude that your client's proposed business arrangement may satisfy the Rule's significant control and assistance requirement.
C. MINIMUM REQUIRED PAYMENT
Finally, we note that your letter does not directly address the Rule's minimum payment requirement. You do state that investors must purchase the basic shop unit from your client. Although you do not state how much the unit costs, we can reasonably conclude that the cost of the unit, which contains an oven and refrigerator, will likely exceed $500. Accordingly, it appears that investors in your client's sandwich shop will pay at least $500 within the first six months of operations.
III. CONCLUSION
For the reasons noted above, the sale of your client's sandwich shops may constitute the sale of a franchise. If your client offers purchasers a license to use your client's tradename, exerts control over the business operations through product and sourcing restrictions, offers to provide assistance in the form of on-site training, and collects at least $500 within the first six months of operation, then a franchise relationship will be created.
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 28, 1999
Franchise Rule Staff