The Definition of “Franchise Fee” Is Extremely Broad Under the FTC Franchise Rule

Written by Raymond McKenzie on August 24th, 2011

In addition to the trademark and system/significant control prongs of the FTC Franchise Rule, the FTC Rule requires as a third prong that the franchisee make a required payment or commit to make a required payment to the franchisor or the franchisor’s affiliate in order for a relationship to be deemed a franchise. 

The term “required payment” is defined broadly by the FTC to mean:  “all consideration that the franchisee must pay to the franchisor or an affiliate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the franchise.”  16 C.F.R. §436.1(s).

The definition of a required payment captures all sources of revenue that a franchisee must pay to a franchisor or its affiliate for the right to associate with the franchisor, market its goods or services, or begin operation of the business.

The FTC Franchise Rule Compliance Guide states that “required payments go beyond payment of a traditional initial franchise fee.  Thus, even though a franchisee does not pay the franchisor or its affiliates an initial franchise fee, the fee element may still be satisfied. Specifically, payments of practical necessity also count toward the required payment element. A common example of a payment made by practical necessity is a charge for equipment or inventory that can only be obtained from the franchisor or its affiliate and no other source. Other required payments that will satisfy the third definitional element of a franchise include: (i) rent, (ii) advertising assistance, (iii) training, (iv) security deposits, (v) escrow deposits, (vi) non-refundable bookkeeping charges, (vii) promotional literature, (viii) equipment rental, and (ix) continuing royalties on sales.”

Courts throughout the country, both in interpreting the FTC Franchise Rule as well as various state franchise laws, have held that almost any payment made by a franchisee to the franchisor will satisfy the franchise fee element.   

For example, a boat dealer’s extensive advertising and its required purchases of promotional materials from the franchisor satisfied the franchise fee requirement under the California Franchise Investment Act.  Boat & Motor Mart v. Sea Ray Boats, Inc., Bus. Franchise Guide (CCH) ¶8846 (9th Cir. 1987).

Similarly, a forklift dealer’s payments to a manufacturer for additional copies of a Parts and Repair Manual constituted a franchise fee under the Illinois Franchise Disclosure Act.  To-Am Equip. Co., Inc. v. Mitsubishi Caterpillar Forklift Am., Inc., 953 F. Supp. 987 (N.D. Ill. 1997).

 Finally, required payments for training or services made to the franchisor or its affiliate may satisfy the payment of a fee element.  Metro All Snax v. All Snax, Inc. Bus. Franchise Guide (CCH) ¶ 10,885 (D. Minn. 1996).

For further investigation of this issue, see also two separate FTC Opinions, FTC Informal Staff Advisory Opinion #00-2 dated January, 2000, as well as FTC Informal Staff Advisory Opinion #03-2 dated April, 2003, found on the FTC website.  In both instances, the FTC did not focus on whether payments made by the licensee were up front initial fees or royalty payments, but whether any payment whatsoever was made by the licensee to the licensor.

 

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