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Not a Franchise? Do Business Opportunity Statutes Apply?

March 2002
By James A. Ullman, Greenberg Traurig, Phoenix Office

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What is a Business Opportunity?

James A. Ullman
"The function of these statutes is to extend certain disclosure protections afforded to purchasers of franchises to those that purchase business opportunities."

Twenty-four states, including Florida, have enacted business opportunity statutes. The function of these statutes is to extend certain disclosure protections afforded to purchasers of franchises to those that purchase business opportunities. The statutory definitions of a business opportunity vary significantly, although each statute has the following common elements:

  1. An oral or written contract for a seller to provide products, services, equipment or supplies to enable the buyer to commence a previously nonexistent business; and
  2. Certain representations made by the seller, e.g. a guarantee of income exceeding the price paid for the business opportunity, a right to a refund or re-purchase, or provision of a sales or marketing program enabling the purchaser to derive income from the business opportunity. The representations by the seller to the buyer are generally in the form of some sort of guarantee or buy back provision and a promise that the buyer will not lose the cost of the investment.1

Normally, a sales or marketing program claiming that the purchaser will derive income from the venture that is NOT tied to a license of a federally registered trade or service mark will be considered a business opportunity. Certain states expand upon the definition, indicating that if a seller will find outlets or accounts for the purchaser, that is considered a business opportunity, even if no guarantee of success is associated.2 The jurisdictional threshold of these statutes is extremely low - ranging from an initial investment of $200.00 to substantial investments with no dollar limit.3 Therefore, the reach of these statutes can be broad and, as such, a trap for unwary sellers.

What Are Typical Business Opportunity Ventures?

There are a myriad of commercial endeavors that can and will trigger these statutes. Sellers promoting “guaranteed income” from the sale of a service or product that is associated with the seller’s marketing plan or scheme to accomplish those guaranteed results would meet the definition. Advertising such as “earn $50,000 per year in a new business” or “new product line sells itself - guaranteed profits in excess of $100,000 on your investment” will trigger the eye of most state examiners.

Historically, the sales of vending machines or displayed racks are the most typical kinds of business opportunities. However, reported decisions have shown that there is a panoply of commercial endeavors that have been held to be business opportunities. Examples include, loan brokerage businesses, merchandise discount programs, rabbit breeding kits, personnel services, frozen pizza distributorships, home health care services, billing services for physicians, and Internet web site building companies.

How Does One Comply with Business Opportunities Statutes?

Each state that has promulgated a business opportunity statute has a requirement to prepare and present a disclosure document to a prospective purchaser. Several states require filing of these documents prior to disclosure.4 Many other states mandate a merit review of the disclosure document before it will be accepted for filing and a registration issued.5

Disclosures will vary, but the intent of such disclosures is generally to provide the purchaser with information about the business opportunity sufficient to make an informed investment decision. The following items are routinely required:

  1. Background information on the principals of the seller, (including work history, litigation, bankruptcies and arbitration);
  2. The length of time the seller has sold business opportunities;
  3. A full and detailed description of the services the seller will perform;
  4. Current financial statements;
  5. Complete description of the training provided by the seller including duration, description of any major expense to be incurred, an earnings claim which illustrates the number of purchasers who have actually achieved sales or received earnings in the year prior to the disclosure date; and,
  6. The total number of purchasers of business opportunities within a three year period.

Under the Florida statute, the disclosure statement must be filed annually prior to placing an advertisement designed to sell a business opportunity, with any material updates required within thirty days thereafter. The regulatory authority, the Florida Department of Agriculture and Consumer Services, can impose a bond, trust, or guaranteed letter of credit for the protection of purchasers. Upon filing and registration, a certificate issues in Florida that permits the sales of business opportunities. There is a three business day cooling off period prior to receipt of any funds or execution of any contract. The other states all have had administrative agencies charged with certain regulatory authority including imposition of bonds, escrows of purchasers’ fees, and jurisdiction over unfair trade practices including injunctive relief and penalties.

Remedies to Purchaser

Commercial relationships that are subject to these statutes have draconian penalties to the seller for failure to comply. Juxtaposed to franchising or other licensing agreements, it is safe to assume that state regulators do not favor these relationships. There are a series of specific remedies for either the failure to comply with the business opportunity statutes or a willful misrepresentation either verbally or in the disclosure document that lead to a sale.6 The most common remedy for these violations is rescission. Many statutes permit the purchaser within a period of time (normally for one to three years after discovery), to receive all sums paid upon return of the product, equipment or supplies received by the purchaser. Further, cease and desist injunctive relief is available by most regulators in the event that the seller has either defrauded the public, made a false statement in his offering circular, or refused to provide information to the regulatory agency, or violated any rules promulgated by the agency involved in regulation.

There is a private cause of action in all states and attorney’s fees are recoverable in most states, including Florida. Monetary penalties imposed by the state agency are part of each state’s regulatory scheme. Criminal sanctions are available for willful violations in all states, except Nebraska, North Carolina, South Carolina, Texas and Utah.

Exemptions/Exclusions

Although the business opportunity disclosure document is not overly burdensome to prepare, most entrepreneurs would prefer to avoid the characterization of their venture as a business opportunity. In that regard, legal advice with respect to exemptions or exclusions that may be available becomes paramount. The essential exclusions are as follows:

  1. Licensing of a Federally Registered Trademark - The license of a federally registered trademark or service mark to the purchaser exempts an offering from business opportunity statutes in several states.7 The license must be granted to the specific purchaser and the trademark must have already been registered with The United States Patent and Trademark Office. Applications for registrations of a trademark that have not ripened to an actual registration will not permit this exemption to be utilized.
  2. Franchising - Since the definition of a franchise encompasses, among other provisions, the license of a federally registered trademark or service mark, virtually every state that has enacted a business opportunity law grants an exemption from it if the seller is undertaking legitimate franchising activities, i.e. preparation of disclosure documents mandated by the Federal Trade Commission at 16 C.F.R. 436.1 et seq. Certain states with business opportunity statute also have franchise regulations requiring registrations and merit review prior to sale. In those states, an exemption cannot be claimed unless the franchise can lawfully be sold within the state.8
  3. Limiting Sales to Established Businesses - Essentially, business opportunity statutes target new enterprises. If the purchaser is already engaged in the business and acquires additional marketing plans, inventory, equipment or services for an identical business, then arguably the statute will not apply.
  4. Negotiating a Waiver of the Business Opportunity Laws - Approximately half of the states specify that the parties cannot waive business opportunity laws. Waiver is not permitted in California, Connecticut, Illinois, Iowa, Kentucky, Minnesota, Nebraska, Ohio, South Dakota, Tennessee and Texas. A recent Florida case that implies that waiver is permissible. See S.J. Business Enterprises, Inc. v. Colorall Technologies, Inc., 755 So. 2nd 769 Business Franchise Guide (CCH) ¶ 11,828 (Fla. Dist. Ct. App. 2000).

There are other strategies that may work to avoid these statutes:

  1. Limiting Sales to States without Business Opportunity Laws - One half of the states do not have any business opportunity laws. The Federal Business Opportunity laws that exist are narrower in scope.9
  2. Sale of an Ongoing Business - If the majority of the assets or stock of a business is sold, the transaction is exempt from business opportunity registration in several states.10
  3. Purchases with High Net Worth11 - A sophisticated buyer exemption is available in some instances. See Lang, Lang & Suhor Investors, L.L.C., et al. v. The American Bagel Co., et al., Business Franchise Guide (CCH) ¶11,447 (U.S. Dist. Ct. MD. 1998), discussing Ohio Law.
  4. Disclaimer of any guarantee of earnings or profits. This is a thin reed to assert as courts often construe this condition for the benefit of the purchaser.

Conclusion

Business opportunity regulations at the state level are a patchwork quilt of similar definitional statutes with widely varying prohibitions, enforcement activity, and exemptions. State enforcement has been sporadic; however, registrations or exemptions filed create a significant amount of activity within these states. If possible, business opportunities sales should be avoided, as compliance state-by-state is time consuming and expensive.

 

Footnotes

1 The guarantee that the buyer typically will earn income in excess of the initial investment is required in California, Indiana, Iowa, Kentucky, Michigan, Nebraska, Oklahoma and Texas. Fourteen other states do require some kind of representation relating to profit or income in order to trigger the statutory coverage: Kentucky, Florida, Illinois, Louisiana, Maine, Maryland, Minnesota, North Carolina, South Carolina, Oklahoma, South Dakota, Utah, Virginia and Washington. The guarantee requirement can be satisfied by a representation of potential profits and has been loosely construed by several courts.

2 Iowa, Illinois, Maryland, Oklahoma and South Dakota

3 Three states, California, Indiana and Ohio, have maximum investment limits of $50,000.

4 California, Florida, Indiana, Michigan, Nebraska, North Carolina and Utah.

5 Connecticut, Illinois, Iowa, Kentucky, Minnesota, New Hampshire, Oklahoma, South Dakota, Texas, South Carolina, Washington, Maryland and Maine.

6 Many state permit enforcement of business opportunities via consumer fraud statutes. However, the specifics of consumer fraud remedies are not addressed herein.

7 Connecticut, Georgia, Louisiana, Maine, North Carolina, South Carolina.

8 California, Illinois, Virginia and Washington.

9 The definition contained within the federal regulations is limited to “retail outlets or counters for the goods, commodities for services, locations or sites for vending machines, rack displays or other product sales displays.” However, enforcement has been heightened at the federal level under the United States Department of Justice's cooperation with the FTC on "Project BIZ-ILLION$" commenced in 2000 as a "multi-prong on traditional business opportunity scams..."

10 Maine and Florida.

11 Illinois Business Opportunity Law Section 5-10(c).

 

© 2002 Greenberg Traurig


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