Business Law

Opinion No. 73 / 20F

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State of California Department of Corporations

Brian R. Van Camp, Commissioner 
In reply refer to: File No. _____

This interpretive opinion is issued by the Commissioner of Corporations pursuant to section 31510 of the franchise investment law. It is applicable only to the transaction identified in the request therefor, and may not be relied upon in connection with any other transaction.

Mr. George H. Waite
Attorney at Law
134 E. Leatrice Ln. 
Anaheim, CA 92802

Dear Mr. Waite:

The request for an interpretive opinion, contained in your letter dated August 22, 1972, has been considered by the Commissioner. Your letter raises the question whether the Master Distributorship Agreement. (ā€œagreementā€) to be entered into between Electronic Beer Control (ā€œElectronicā€) and persons referred to therein and hereinbelow as ā€œdistributorsā€ are ā€œfranchisesā€ within the definition of Section 31005 and/or ā€œarea franchisesā€ within the definition of Section 31008 and subject to the provisions, including the registration requirement of Section 31110, of the Franchise Investment Law.

We understand that Electronic is engaged in the business of manufacturing and producing ā€œKEGtrolā€ Electronic Beverage Metering Control Equipment (ā€œproductā€). It manufactures its own facets and heads and assembles the electronic console.

In consideration of the purchase of an initial order of product, the agreement will grant to the distributor an exclusive ā€œMaster Distributorshipā€ in a specified territory in which he agrees to use his best efforts to promote the sale, lease, or rental of products, and to provide service in connection therewith. Electronics will give to the distributor ā€œInstallation Instructions, Service Instructions, and Guides for Serviceā€. And will also make available to distributor any and all promotional aides, of which distributor will retain the exclusive right of reproduction for his use. In addition, the distributor agrees to share any promotional ideas and developments with other distributors: not to, directly or indirectly, sell, advertise, promote or distribute products of a similar nature; and not to operate in any way outside of his exclusive territory.

Section 31005 of the Franchise Investment Law defines ā€œfranchiseā€, to include an agreement, either oral or written, between two or more persons by which a franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor, the operation of the franchiseeā€™s business pursuant to such plan or system is substantially associated with the franchisorā€™s commercial symbol such as its trademark, or trade name, and the franchisee is required to pay a franchise fee. Section 31011 defines ā€œfranchise feeā€ to mean any fee or charge that a franchisee or subfranchisor is required to pay or agrees to pay for the right to enter into a business under a franchise agreement, including, but no limited to, any such payment for goods and services. The purchase or agreement to purchase goods at a bona fide wholesale price is not considered the payment of a ā€œfranchise feeā€ pursuant to Section 31011(a), and Rule 011 of the Commissioner exempts from the registration requirement of Section 31110 of the Law. any offer or sale of a franchise which would be subject to registration solely because the franchisee is required to pay, directly or indirectly, a franchise fee which, on an annual basis, does not exceed $100.

We do not concur in your opinion that Electronic does not prescribe a marketing plan or system in substantial part. In reaching this conclusion, we have taken into consideration the aforementioned provisions regarding the exclusive territory, the limitations on activities outside the territory or on selling similar products, the furnishing of sales aides, and the sharing of activities. The. Commissioner has stated in his Release No. 3-F that a marketing plan or system may be ā€œprescribedā€, although there is no obligation on the part of the franchisee to observe it, where a apecific [sic] sales program is outlined, suggested, recommended, or otherwise originated by the franchisor. In making the determination whether there is a prescribed marketing plan or system, it is necessary to keep in mind the objective of the Law to deal with a multiplicity of business establishments created by the franchisor for all of which he ostensibly assumes responsibility by causing them to be operated with the appearance of some centralized management with regard to the standards of goods sold, services rendered and other material incidents of the operation.

We also do not concur in the opinion, which we understand you to express in your letter, that the distributorā€™s business is not substantially associated with Electronicā€™s commercial symbol. In this connection, the agreement provides that Electronic grants distributor the right to use the trademark ā€œKEGtrolā€ on printed material other than direct advertising of the product. You have represented that distributor may use it on his letterhead, business cards, etc., but that you do not require him to do so. For the operation of a franchiseeā€™s business to be substantially associated with the commercial symbol of the franchisor,.it must be communicated to the customers of the franchisee (Dept. of Corps. Release No. 3-F, p. 6). It is not necessary that the franchisee be required to use the franchisorā€™s commercial symbol rather, in our opinion, the granting of the right to use the franchisorā€™s commercial symbol on material in such a way as to communicate it to its customers is sufficient to conclude that the operation of the franchiseeā€™s business is substantially associated with the franchisorā€™s commercial symbol.

In connection with the requirement of a franchise fee, you have represented that distributor makes no payments to Electronic except for products purchased at their wholesale price and you have invoked the exception which Par. 2(a) of Section 31011 makes from the definition of ā€œfranchise feeā€ by providing that the purchase or agreement to purchase goods at a bona fide wholesale price shall not be considered the payment of a franchise fee.

This exception is based on the rational that no substantial prejudice will come to a person buying a business and paying only the bona fide wholesale price for goods which he proposes to sell in that business, since he can readily turn goods of established value into cash, should the franchisor fail, in any way, to provide the promised support. Well-known trade marked goods, of course, can be liquidated much easier that little-known products manufactured by a new franchisor not having a substantial identity. In this connection, you have represented that your product is to be sold to a distributor at your pricing which is the wholesale price, although you are unable to supply any comparable wholesale retail prices since Electronic is distributing a specialized product and is performing, manufacturing and assembling, which no other company performs in the same integrated manner.

Whether the price which the distributor under the agreement are required to pay for the products, exceeds the bona fide wholesale price (or exceed it by an amount in excess of the tolerance allowed by Rule 011) is a question of fact which we will not resolve in an interpretive opinion, since such opinions are limited to the interpretation of, and the determination of legal questions arising, under the Law {Dept. of Corps. Release No. 2-F).

Section 31153 of the Law imposes the burden of proving an exemption exception or an exemption from a definition upon the person claiming such exception or exemption. Accordingly; the burden of establishing the fact that Electronic is selling its products at their bona fide wholesale price is upon Electronic and, in our opinion, your letter does not enable us to conclude whether this burden has or has not been met.

However, based on your representation th
at no fees are paid by the distributors to Electronic except for the purchase price of the products, which you represent to be the bona fide wholesale price for that product, it is our opinion that the agreements between Electronic and the distributors are not ā€œfranchisesā€ within the definition of Section 31005, and subject to the provisions of the Franchise Investment Law, including the registration requirement of Section 31110.

However, you should be aware that to the extent that distributors under their agreement with Electronic may be required to purchase specified amounts of product, whether initially or as a prerequisite to a continued exclusive territory, the exceptional provision of Par. 2(a) of Section 31011, in our opinion, is not available, if the amount so required to be purchased exceeds the quantity which a reasonable businessman normally would purchase by way of a starting inventory or to maintain a going inventory. Payment for such excessive purchases is made by the franchisee not because he has a present need for or wants to acquire the goods; it is understandable only as intended to secure the right of selling them under the franchise agreement, and for that reason it constitutes a franchise fee (Mattes, the Franchise Concept, California State Bar Journal, Vol. 47, p. 348).

We have also noted the provisions in the agreement granting the distributor the right and privilege to establish ā€œsubdistributorsā€ within his territory and that any contract with a subdistributor must substantially contain the same basic liabilities and restrictions, rights and privileges of the Master Distributorship Agreement.

Section 31008 defines ā€œarea franchiseā€ as an agreement between a franchisor and a subfranchisor whereby the subfranchisorā€™s granted the right, for consideration given in whole or in part for such right, to sell or negotiate the sale of franchises in the name or on behalf of a franchisor. According to Section 31009, a ā€œsubfranchisorā€ is a person to whom an area franchise is granted. Section 31010 provides that the term ā€œfranchisesā€ where used in the Law, unless specially stated otherwise, include ā€œarea franchiseā€. If Electronicā€™s arrangements with the distributors constitute franchises, its arrangements with the distributors whereby subdistributors can be established, constitute ā€œarea franchisesā€ within the definition of Section 31008 of the Law since the subdistributorsā€™ agreements require the same obligations and payment as required in the Master Distributorship Agreement.

Dated: San Francisco, California
May 21, 1973

By order of 
Commissioner of Corporations

By __________________ 
Supervising Corporations Counsel
Office of Policy

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