Wednesday, April 25, 2012

Tips On How Manufactures and Distributors Can Avoid Federal And State Franchising and Business Opportunity Laws and Disclosure Requirements


Complying with business opportunity disclosure requirements and franchise disclosure requirements is arduous and expensive! 

Manufacturers and distributors of products should take all precautions they can to avoid having the sale of their product be classified as a franchise or "business opportunity" under federal or state law.

Unfortunately, there is a VERY FINE LINE between what qualifies as a "distributorship", "business opportunity", and "franchise." If this fine line is crossed and disclosure requirements are not followed correctly, the penalties can be severe. Civil fines, injunctions, and other types of penalties are only the beginning. Some states have criminal penalties to sanction those who fail to comply.

I have compiled a simple list of tips that every distributor and manufacturer of products should NOT DO and AVOID to make sure that its business can avoid pesky and burdensome regulation.    

AVOIDING FEDERAL FRANCHISE LAWS AND DISCLOSURE REQUIREMENTS

Under federal law, three elements must be present for a business to be considered a franchise: (1) the use of a common trade name or trademark; (2) the payment of a fee of at least $500 (it can be as little as a one-time payment, or "indirect" franchise fee payment, such as the profits derived from the sale of product or services to a "licensee".); (3) the rendering of "substantial" assistance (This assistance can take the form of training, an operating system, marketing, purchasing, on-going advice, a proprietary computer program or other forms of support. Helping a "licensee" or "distributor" develop a marketing plan).  

If all three elements are present, then the relationship will be a franchise. Therefore, to avoid being a "franchise" AVOID doing one of the three requirements. This can be accomplished in any of the three following ways:

1. Do Not Allow Customers or Buyers of Your Product Use Your Trademark or Company Name -  In fact, it should be spelled out in all contracts and purchase orders that the buyer is prohibited from using your trade name as their own in any way, except to the extent that they state that they are an authorized distributor of your product.  

2. Do Not A Charge Any Fees Beyond the Price of Goods Sold - This includes payments for "exclusive territory", equipment, product displays, sales kits, advertising, etc.

3. Do Not Provide Significant Assistance or Exercise Significant Control Over the Buyer - Let the buyer run its own business. This is true even if they aren't running it how you want or as effectively as you believe they could. It is best practice to add a term to any contract or purchase order that the buyer is an independent contractor/business and is not an employee, affiliate, subsidiary,  franchisee, or other type of "associated" business. 

AVOIDING FEDERAL AND STATE BUSINESS OPPORTUNITY LAWS AND DISCLOSURE REQUIREMENTS

Currently, federal law and the laws of 25 states regulate "business opportunities." To see what qualifies under federal law, read my last blog post. What qualifies and is regulated as a "business opportunity" varies from state to state. Generally, if a business sells or leases a product or service that costs more than $500 or more to enable the buyer to get into the "business", the business may be considered a business opportunity seller if the business also meets one other additional requirement. Therefore, the following additional requirements should be AVOIDED:

1. Do Not Provide "Buy Back" Arrangements - If a program or seller "buys back" what the buyer makes, grows, breeds, assembles, fabricates, etc., and it is what the seller originally sold to the buyer, business opportunity regulation likely applies. A warranty for a defective good is not a "buy back arrangement."

2. Do Not Provide a "Sales or Marketing Program" - Do not provide buyers any "written or oral procedures or plan" on how to sell or market product or services.  Do not provide buyers training materials, sales or display equipment or merchandising devices, specific sales or marketing techniques, or sales, marketing or advertising materials that are intended for use by the buyer to influence a consumer to purchase a product or service. What constitutes a sales or marketing plan is very ambiguous! Consult with an attorney to discuss.  

3. Do Not Provide Site Location Assistance - Do not even give names of independent companies that can provide assistance. Let buyers find their own location to sell and market products.

4. Do Not "Guaranty" that a Buyer Will Profit From Its Investment - Also do not guarantee that you will refund all or part of the price paid or repurchase any of the products supplied by the seller if the buyer is unsatisfied with the business opportunity. 

5. Do Not Represent that there is a Market for Your Goods or Services - Luckily only a couple of states have this tricky requirement (California and Indiana). It is good practice to have an attorney examine marketing materials before they are distributed or used in these states.

As can be seen above, product manufacturers and distributors walk a VERY fine line between what legally is considered a "franchise", "business opportunity," and distributorship arrangement. It is important to have an attorney familiar with this area of law review all of your contracts and marketing materials to make sure that you are not inadvertently crossing over the line and breach state and and federal laws. The law firm of Meyers Roman Friedberg Lewis LPA would be happy to discuss any questions that you may have regarding this area of the law.