The “Required Payment” Element
The last of the three definitional elements of a franchise covered by the amended Rule is that purchasers of the business arrangement must be required to pay to the franchisor (or to an affiliate), as a condition of obtaining a franchise or starting operations, a sum of at least $500 at-5 – any time prior to or within the first six months of the commencement of operations of the franchised business.
What Types of Payments Constitute “Required Payments”?
“Payment” is intended to be read broadly, capturing 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, and begin operation of the business. Often, required payments go beyond a simple franchisee fee, entailing other payments that the franchisee must pay to the franchisor or an affiliate by contract – including the franchise agreement or any companion contract. Required payments may include:
- initial franchise fee;
- advertising assistance;
- equipment and supplies (including such purchases from third parties if the
- franchisor or its affiliate receives payment as a result of the purchase);
- security deposits;
- escrow deposits;
- non-refundable bookkeeping charges;
- promotional literature;
- equipment rental; and
- continuing royalties on sales.
Payments which, by practical necessity, a franchisee must make to the franchisor or affiliate also count toward the required payment. A common example of a payment made by practical necessity is a charge for equipment that can only be obtained from the franchisor or its affiliate and no other source.
What Types of Payments Do Not Constitute “Required Payments”?
The “payment” element of the franchise definition does not include “payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease.” “Reasonable amounts” means amounts not in excess of those that a reasonable businessperson normally would purchase for a starting inventory or supply, or to maintain an ongoing inventory or supply. This “inventory exemption” also includes goods intended to be furnished to the public through lease. Thus, franchisees – such as those in the auto or furniture rental business – can take advantage of this inventory exemption. The inventory exemption, however, does not include goods that a franchisee must purchase for its own use in the operation of the business, such as equipment or ordinary business supplies.
This post is part of a series of posts discussing the legal aspects of franchising.
CREDIT: The content of this post has been copied or adopted from the Federal Trade Commission’s Franchise Rule Compliance Guide.