INFORMAL STAFF ADVISORY OPINION 01-2
This staff advisory opinion addresses whether the sale of interests in your client's proposed chain of restaurants triggers the Franchise Rule's disclosure obligations.
In your letter, you state that an unidentified individual ("Owner") will own a majority interest in a chain of six restaurants, each of which will be incorporated separately. Family members and friends of the Owner, as well as other private investors, will own minority interests in several of the corporations. You further state that the Owner also owns a corporation that holds the registered trademark under which all of the restaurants will operate. The trademark holder will license use of the trademark, on a non-exclusive basis, to each of the restaurant outlets, as well as license the use of other intellectual property including "trade dress, recipes, etc."
You now seek advice on several questions concerning the ownership of interests in a franchise. Assuming that each of the proposed business arrangements satisfies the three definitional elements of a franchise, you ask whether the Franchise Rule applies where:
1. The franchisor and each franchisee are owned by identical investors;
2. The controlling interests (more than 50%) in the franchisor and the franchisee are owned by the same investors, with certain franchisees having additional minority investors;
3. The group that owns the franchisor owns less than 50% of a franchise, but still more than any other single investor in such franchisee; and
4. The group that owns the franchisor also has exclusive control over the operation of the franchisees by written contract.
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. In this instance, we will assume that the Franchise Rule applies to the underlying business arrangement, but will focus on ownership issues, as requested.
II. SALES TO FRANCHISOR "INSIDERS" ARE NOT EXEMPT
The four questions you pose raise essentially two issues:(1) whether a franchisor's ownership interest in a franchise bears upon the application of the Franchise Rule; and(2) assuming it does, whether the Rule's application differs depending upon the level of ownership interest in the franchise outlet by either the franchisor or the franchisee. We conclude that the level of interest in the franchised outlet owned by either the franchisor or franchisee is irrelevant in determining the Rule's application to a franchise sale.
Under the Rule, there is no exemption or exclusion for franchise sales to "insiders;" namely, sales to the same individuals or entities that either own the franchisor, are employed by the franchisor, or are otherwise associated with the franchisor. That said, we note that the Commission in its ongoing Rule amendment proceeding is considering an exemption for franchise sales to the franchisor's officers and owners. On this issue, the Commission stated in its Notice of Proposed Rulemaking:
There does not appear to be any need for disclosures in such circumstances because we can reasonably assume that the prospective franchisee already is familiar with the associated risks. Further, in some instances, a company may wish to offer units to its owners or directors only. If not exempt, these companies would have to got through the burden and expense of creating a disclosure document for isolated sales to company insiders.
64 FR 57294, 57322 (October 22, 1999).
Although the Rule could change in the future to exempt insiders, that is currently not the state of the law, and Commission staff cannot create Rule exemptions through staff advisory opinions. Accordingly, we would encourage you to participate in the ongoing rulemaking effort, if you believe that an exemption should be created by the Commission, as proposed above.
A prospective franchisee therefore must receive the pre-sale disclosures required by the Rule, regardless of his or her level of interest in the franchise. The term "franchisee" is defined as "as person who participates in a franchise relationship as a franchisee, . . . or (2) to whom an interest in a franchise is sold." 16 C.F.R. § 436.2(d)(emphasis added). Unless otherwise specifically excluded or exempted from Rule coverage, all franchisees who participate in the relationship as a franchisee or who obtain an interest in a franchisee should receive disclosures. Any percentage of interest in a franchise will qualify the purchaser as a franchisee. Accordingly, in determining the Rule's application to a franchise sale, the extent of the individual franchisee's ownership interest - be it more or less than 50% - is irrelevant.
Finally, you ask whether the franchisor's control over a franchisee makes a difference. Control, unlike ownership interest, is a relevant factor in determining application of the Rule. One of the three elements of the Rule's definition of a franchise is significant control or assistance. If a franchisor's exercise of control over the franchisee is "significant," which can only be determined on a case-by-case basis, then that element of the definition will be satisfied. As noted above, you already concede for purposes of this advisory that the "control" element is satisfied.
It appears to us, however, that you may be using the word "control" in this instance as a proxy for ownership and are asking whether a franchisor that controls a franchisee (even if the franchisor does not actually own the franchisee) must still provide disclosures under the Rule. As noted above, the fact that a franchisor might have some interest in the franchised outlet - be it complete ownership or a controlling interest - is simply irrelevant under the Rule.
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 10, 2001