Business Law

Opinion No. 73 / 25F

State of California Department of Corporations

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

This letter is not an Interpretive Opinion for the reasons stated below.

Mr. Bruce Michael
Attorney at Law
Perkins, Coie, Stone,
Olsen & Williams 
1900 Washington Building
Seattle, WA 98101

Dear Mr. Cross:

The request for an interpretive opinion, contained in your letter dated June 30, 1972, as supplemented by your letters dated August 25, 1972, February 13, 1973, and April 16, 1973, has been considered by the Commissioner. Your letters raise the question whether the arrangements between Orange Cross Personal Emergency Information Service, Inc., a Washington corporation ( “Orange Cross”} , and individuals referred to therein and hereinbelow as “distributors”, “key distributors”, “senior distributors”, “master distributors” and “direct distributors” are franchises within the meaning, and subject to the registration requirement, of the Franchise Investment Law.

You have represented that Orange Cross operates a service which stores, retrieves, and relays emergency information. A subscriber provides medical and other vital data to Orange Cross and carries a membership certificate as identification, directing that, in an emergency, a collect call be made to Orange Cross to obtain that information. To sell these services, Orange Cross enters into arrangements with individuals who market the services to subscribers.

“The Orange Cross Marketing Plan”, included with your letter dated April 16, 1973, states that the individuals are required to make an initial investment of $67.17 for the Service, Kit, and Sales Materials which may only be purchased from so-called “sponsors” who are Orange Cross distributors at any of the aforementioned levels. This amount is refundable for a period of 10 days after the kit has been received. We assume that the $67.17 fee includes the $6.00 dues for membership in the Orange Cross Agent Association referred to in your letter dated June 30, 1972. Each Orange Cross distributor purchases the Orange Cross prepaid certificates at a basic discount of 27% from the suggested retail price of $29.00 per certificate. In addition, the aforementioned marketing plan provides for a “quantity discount factor”, ranging from 3% to 15%, based upon the previous month’s purchases or sales which is received in the form of a refund check from sponsors on the 25th of the month following any month in which such refund is earned. He understand that the quantity discount factor is not only based upon the personal sales of each distributor, but is also based upon the sales of individuals sponsored by each Orange Cross distributor at the various aforementioned levels.

We further understand that sponsors are responsible for training, motivating, giving direction to and supplying individuals sponsored by him. An individual moves through the various levels from “distributor” to “direct distributor” by meeting certain requirements with regard to personal. retail value of sales in a calendar month, obtaining specified percentages of refund, and sponsoring specified numbers of new distributors. He must meet certain requirements to remain in a particular level and to continue to be classified as a “sponsor”. A “master distributor” must attend a special seminar in order to become a “direct distributor”, which is the only distributorship which buys directly from Orange Cross. The direct distributors receive a 3% training bonus, based on total purchase volume, from Orange Cross for each sponsored distributor who becomes a direct distributor and for each sponsored distributor who qualifies for a maximum refund.

A sponsor is responsible for the purchase back of prepaid certificates, sales aids and any other marketable materials from distributors at any level he has personally sponsored if he is so requested. If the sponsor fails to honor his “buy-back” commitment, Orange Cross is obligated to do so.

Section 31005 of the Franchise Investment Law defines “franchise” 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 franchisee’s business pursuant to such plan or system is substantially associated with the franchisor’s commercial symbol, such as, its trade name or trademark, and the franchisee is required to pay a franchise fee. Section 31011 defines “franchise fee” 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 not 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 “franchise fee” 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.

In our opinion, the arrangements between Orange Cross and the distributors and direct distributors contain all the essential elements of a “franchise” within the definition of Section 31005 and are subject to the provisions of the Franchise Investment Law.

We do not concur in your opinion that a marketing plan or system is not prescribed in substantial part by Orange Cross. A marketing plan or system may be “prescribed” within the meaning of Section 31005, although there is no obligation on the part of the franchisee to observe it, where a specific sales program is outlined, suggested, recommended, or otherwise originated by the franchisor. Thus a sales program may be “prescribed” by the franchisor where he supplies the franchisee with sales aids or props, such as demonstration kits, films, or detailed instructions for personal introduction and presentation of the product, possibly including edited text of a sales pitch, especially where such program is supported by elaborate. training material, courses, or seminars. By such means, a nonmandatory program may attain the force of a “prescribed” one (Dept. of Corps. r Release No. 3-F, p. 3).

In this connection, you have represented that Orange-Cross provides full company-wide advertising and sells individuals kits and sales materials. In addition, sponsors train new distributors and, we understand, the distributors are also supplied with a detailed sales approach, including: sample introductions to prospective purchasers of Orange Cross services, the advantages of the services, answers to frequently-asked questions and “closings”. Distributors are urged to attend all “required educational classes offered, both in the field and at the Home Office”. Moreover, Orange Cross has established a suggested retail price for its services.

Of even more significance in determining whether Orange Cross is prescribing a marketing plan or system in substantial part is the fact that every orange Cross distributor at all levels must promise to abide by the rules and policies as stated in the Orange Cross manual and other literature, including the requirements that they buy all of their Orange Cross supplies from or through their own sponsor, use only the literature and sales aids produced by Orange Cross, and not conduct their business as a corporation.

we also do not concur in your opinion that the distributors’ business is not substantially associated with the Orange Cross commercial symbol because the agents are not allowed to represent to the public that they are from the Orange Cross organization. The Commissioner has stated that for the operation of the franchisee’s business to be substantially associated with the commerci
al symbol, it must be communicated to the customers of the franchisee (Dept. of corps., Release No. 3-F, p. 6).

In this connection, the aforementioned detailed sales approach and the other material which a sponsor may use in attempting to recruit distributors contains numerous references to Orange Cross. Moreover, it would seem imperative that, in order for the purchaser to avail himself of the Orange Cross services, the forms used to give data to Orange Cross and the membership certificates must all contain references to Orange Cross.

We also do not concur in the opinion, which we understand you to express, that the payments which distributors are required to pay fall within the exemption for a ”franchise fee” set forth in Section 31011(a) or the amount tolerated by Rule 011.

In our opinion, the $67.17 initial payment constitutes a “franchise fee” within the meaning of Section 31011 of the Law. The provisions of Section 31011(a), that the purchase or agreement to purchase goods at a bona fide wholesale price is not to be construed as the payment of a franchise fee, is inapplicable not only to this initial payment, but to the payments for certificates as well. The word “goods” used in 31101 (a) must be given a meaning commensurate with this rationale and does not include payment for training, association dues, or the purchase of Orange Cross services. No exception is made in the law or in the rule with respect to payments which the franchisee is required to make under the franchise agreement in return for benefits other than goods, such as payments for real estate or for services. Here the law presumes that even though part of the franchisee’s payment may be for some other consideration, some of it is for the right to engage in the franchise business and is a franchise fee.. Moreover, under the aforementioned rationale of Section 31101, the exceptional provision with respect to “goods”, does not include an idea or program, whether or not the same is offered or distributed by word of mouth, through instructions or lectures, or in the form of written or; printed material or by combination of both. Rather the communication of such an idea or program. is in the nature of a service, to which the exception of Section 31011(a) is not applicable. In the instant case, the distributors in order to conduct their business, must continue to purchase the service, represented by the membership certificates, which, in our opinion, do not constitute “goods”, but constitute “services”, to which, as indicated above, the exceptional provision of section 31011(a) is inapplicable. The program being offered is comparable to “software” in the computer industry, which is considered the rendering of a service and not the sale of “goods”.

Since it appears that the distributors will be paying in excess of $100 annually for the “services” they will resell, Rule 011 does not exempt the “franchises” from the registration requirement of Section 31110 of the Law. Section 31153 of the Law provides that the burden of proving an exemption or an exception from a definition is upon the person claiming it. Accordingly, the burden of proving that the aforementioned payments do not exceed $100 when computed on an annual basis is upon Orange Cross.

We call your attention to Section 31008, which defines “area franchise” to mean an agreement between a franchisor and a subfranchisor whereby the subfranchisor is 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 the franchisor. Since pursuant to Section 31010, the word “franchise” in Section 31110 includes “area franchise”, area franchises granted by Orange Cross are also subject to the registration requirement of that Section. Since Orange Cross’ arrangements with any of the distributors constitute franchises, its arrangements, whereby each is given the right to sponsor other individuals, constitute an “area franchise” within the definition of Section 31008 of the Law.

Because of certain features of the proposed arrangements, your attention is called to Section 327, California Penal Code.

Inasmuch as interpretive opinions are issued for the principal purpose of providing a procedure by which members of the public can protect themselves against liability for acts done or omitted in good faith in reliance upon the administrative determination made in the opinion, and since there can be no such reliance where the Commissioner asserts jurisdiction with respect to a particular situation, advice to that effect, as contained in this letter, does not constitute an interpretive opinion.

Dated: San Francisco, California
June 26, 1973

By order of 
Commissioner of Corporations

By __________________ 
Supervising Corporations Counsel
Office of Policy

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