Under California’s Franchise Investment Law (“CFIL”), a business relationship constitutes a franchise if: 1) the franchisor grants the franchisee the right to engage in a business offering, selling or distributing goods or services substantially associated with its trademark, service mark, trade name or logotype; 2) the franchisor provides significant assistance or exercises control by prescribing a system or marketing plan; and 3) the franchisee agrees to pay, directly or indirectly, a fee or charge of at least $500 for the right to enter into the business under a franchise agreement (the “Fee Element”). Payments for goods or services will satisfy the Fee Element; payments for ordinary business expenses will not. That said, California courts typically interpret the Fee Element broadly.
In Zentner v. Farmers Group, Inc., et al., Zentner claimed he was wrongfully terminated under a District Manager’s Appointment Agreement he entered into with Farmers (the “DMAA”), which he claimed was a franchise agreement under the CFIL. The California Court of Appeal disagreed, holding that Zentner failed to satisfy the Fee Element.
Under the DMAA, Zentner recruited and trained prospective insurance agents for Farmers. If Farmers signed a “career” or full-time agent that Zentner trained and recommended, Zentner was required to sign a second contract with Farmers partially guaranteeing subsidy loans Farmers provided to the agent. If the agent failed to repay the loan or quit working for Farmers within a specified period of time, Farmers could automatically deduct fees relating to the guarantee from monthly payments it made to Zentner under the DMAA. The court found that while Zentner may have guaranteed loans under those separate agreements, he had never incurred any liability. Regardless, such a “fee” would not satisfy the Fee Element because it was not required before Zentner could engage in business and was entirely contingent on the agent’s status as a “career agent,” the term of the agent’s service and whether the agent failed to repay the loan. The court viewed this as a “potential recruitment cost, rather than a franchise fee.” The court also rejected Zentner’s claim that expenses he incurred to attend Farmers conferences, establish call centers to generate leads, buy leads from Farmers and promote Farmers products were franchise fees. Although these were expenses required under the DMAA, the court found that they were merely ordinary business expenses. Click here to see the case.
We generally advise our franchisor clients that just about any payment or commitment can amount to a franchise fee IF the franchisee agrees to pay it as a condition to obtaining the right to commence operation of the franchised business. The Zentner case reminds us that contingent fees and ordinary business expenses will not satisfy the Fee Element, a fact that disgruntled licensees should carefully consider before engaging in costly litigation claiming the existence of a franchise.