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socrateaser, Attorney
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We are a manufacturer of nicotine liquid (e-liquid) for use

Resolved Question:

We are a manufacturer of nicotine liquid (e-liquid) for use in electronic cigarettes organized as a Utah LLC (treated as a partnership by the IRS). We sell our products online and through independent retailers throughout the country under various DBAs. We also manufacture private label the same product lines for other companies.

Recently, we opened a new retail store in our state (UT) that has been successful. Because the retail store was to be a partnership with an investor, we had decided that to protect our manufacturing company assets (including the registered trademark the retail stores will operate under) we created a separate LLC wherein the investor owned 49% equity and our LLC would own 51%. This seems to have worked out well with the investor for that store.

My question is:

Is this arrangement optimal; creating a new LLC when opening a new retail location with a new investor? I would suspect that if a new retail location was solely owned by our original LLC then creating a new LLC would serve no benefit.

Please let me know if you require further clarification.

Thank you,

Nick DeLand
Submitted: 1 year ago.
Category: Business Law
Expert:  socrateaser replied 1 year ago.

Under 16 Code Fed. Regs. 436.1(h): Franchise means any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:


  1. The franchisee will obtain the right to operate a business that is identified or associated with the franchisor's trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark;
  2. The franchisor will exert or has authority to exert a significant degree of control over the franchisee's method of operation, or provide significant assistance in the franchisee's method of operation; and
  3. As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.

 

The question here is whether or not your partnership agreement is in fact a franchise agreement. Because if it is, then you could be in some very hot water with both the state and federal government. A partnership is not a franchise -- but without reviewing your LLC operating agreement, it's difficult to be able to conclude that you have not created a franchise with your investor.


Other than that, I don't see a legal problem with your plan.

Please let me know if I can be of further assistance. Hope this helps.
Customer: replied 1 year ago.

Thank you for your prompt reply. We are not promoting the partnership as a franchise, merely as a single store owned by a separate LLC of which 51% is owned by my LLC and the other 49% by another individual or legal entity. Since my original LLC owns the trademark I have the authority to use it in commerce. I can't see where this would create a franchisor/franchisee relationship requiring compliance with franchise law (we do not charge a franchise fee as it is not a franchise).


 


Just wanted to make sure that the arrangement best protects my original LLC, and that there is not a better way that I am overlooking.


 


Thanks again

Expert:  socrateaser replied 1 year ago.
I really don't see a problem with your organizational structure. However, there is another issue here concerning the investor, if he/she is entirely passive.

The definition of an investment contract, under federal securities law is an agreement where, “a person (1) invests his money (2) in a common enterprise and (3) is led to expect profits (4) primarily or substantially from the efforts of others." SEC v. W.J. Howey Co., 328 U.S. 293 (1946); SEC v. Glenn W. Turner Enter., Inc., 474 F.2d 476 (9th Cir.), cert. denied, 414 U.S. 821 (1973).

If your investor is entirely passive, then your store may be subject to SEC regulation D -- which means that the investor must be accredited, or you could have even a bigger problem than with the franchise issue.

Not trying to throw roadblocks in front of you, but I want to make sure you've thought this through completely.

Hope this helps.
Customer: replied 1 year ago.

Good thoughts, and thank you for them. The first retail store is run mostly by the partner but we are not passive either. The arrangement with the second store would have his nephew (who currently is one of our employees at the first store) serve as manager of the second store. This investor has nothing to do with the first store other than his nephew being an employee. We will not be running the second store either, however we will still own 51% and will not be passive with this store either.


 


If I understand your post above, then this arrangement seems to not subject us to SEC Reg D. Obviously, the best case scenario is for my own LLC to open retail stores without a third party.

Expert:  socrateaser replied 1 year ago.
Since the federal securities law trigger is an investment which is truly passive, a material participant in a business venture is never within the scope of the law.

Hope this helps.
socrateaser, Attorney
Category: Business Law
Satisfied Customers: 34822
Experience: Retired (mostly)
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