One of the guest speakers at the recently held Franchise Association of Southern Africa’s (FASA’s) annual conference was Professor Tanya Woker, who has a special interest in the impact of the Competition Act on franchising. Quite unlike the stereotypical law professor, Tanya has the ability to explain complex legal concepts in layman’s terms. In her presentation, she interspersed essential theory with meaningful practical examples. At the end of her session, everyone present had a reasonable understanding of the issue. We were there and took away the following information.

The Competition Act regulates activity between businesses that should be competitors. It is administrated and enforced by a three-layered structure, namely:

• The Competition Commission
• The Competition Tribunal
• The Competition Appeal Court

The legislation’s impact is wide-ranging and affects vertical and horizontal relationships. It extends into the realm of franchising, whereby the franchisor is in a vertical relationship with its franchisees, and franchisees are in a horizontal relationship with each other.

Application of the Competition Act

It is important to understand that the Competition Act makes a clear distinction between:

Per se prohibitions - these are absolute and applications for exemption are unlikely to be granted. An example of a per se prohibition is price fixing.

• Franchisors are not permitted to set fixed prices. They are permitted to set “recommended prices” but may not sanction franchisees who refuse to abide by them.
• Franchisees are not permitted to fix prices among themselves either.

Other per se prohibitions are:

• Tying arrangements - This means that franchisees are forced to purchase or stock an entire basket of products if all they really want is one specific product in the range.

Tying arrangements fall under per se prohibitions if the franchisor is a dominant firm. Even if this is not the case, they are viewed with suspicion and likely to be carefully investigated. They are, however, acceptable if the franchisor can show that there is a pro-competitive gain.

• Exclusive dealing arrangements - This could be an obligation to purchase from a prescribed source, or the franchisor prescribes the range franchisees are permitted to offer their customers.

Exclusive dealing arrangements are permissible if the franchisor can show that they are necessary to protect the trademark or prevent “free-riding”.

(For example, one franchisee maintains a well-furbished display area. Everyone goes there to view the range and obtain expert advice but prospective customers eventually deal with another franchisee of the same network who saves money by not maintaining a full display of the merchandise, and by not employing expert staff. As a result, this franchisee can therefore afford to offer discounts.)

Should the Competition Board become aware of possible transgressions, it may ask the Competition Tribunal to investigate. Should the Competition Tribunal come to the conclusion that a certain practice is against public interest, it has the power to impose substantial fines. This is no empty threat – the Competition Tribunal has imposed stiff fines, up to 10% of an offending company’s annual sales, in the past.

Parties that are unhappy with the findings of the Competition Tribunal have the option to take their case to Competition Appeal Court for a review.

Other prohibitions - On the face of it, many of the practices that are essential for the operation of franchises fall foul of the Competition Act. However, the Competition Board has said that it recognises the economic contribution franchising makes and is prepared to look at each case individually.

• Territorial restrictions - An example of a prohibited practice for which, on application, an exemption may be granted, is a clause in a franchise agreement that imposes territorial restrictions. The franchisor could argue that although such a restriction reduces competition among franchisees, it is necessary for the smooth functioning of the network. There is a good chance that an exemption will be granted, but:

  • No blanket exemption can be claimed. Each case will be investigated on its specific merits, and a ruling made that is valid for this particular franchise only.

  • Even if an exemption is granted, the franchisor cannot compel franchisees to refuse to deal with a customer who operates in another franchisee’s territory. Customers continue to enjoy an unfettered right to chose.

• Restraint of trade - To restrain someone from free trading is generally seen as infringing upon a person’s constitutional rights. However, such restraints may be upheld if the restraint:

• Is necessary to protect the franchisor’s legitimate interests, for example know-how.
• Is reasonable in extent and duration.

This notwithstanding, restraints are frequently difficult to enforce. Even more than any other clause in a franchise agreement, a restraints of trade clause needs to be carefully drafted by an experienced practitioner and tailored to the specific circumstances of the network.

Conclusion

The outcome of an investigation by the Competition Commission will always be influenced by two factors:

• Is the company a dominant firm? Dominance generally means a market share in excess of 45%. Even if a company’s market share is below this percentage, it may have to prove that it does not abuse its position of power. On request, companies who hold more than 35% market share need to prove to the Competition Commission that they are not in a position of dominance.
• What is the intention behind the practice under investigation? If the practice is intended to shut competitors out, the Competition Commission will not approve it. If, however, the franchisor can show that the practice is necessary to ensure the orderly operation of the network, and/or to protect intellectual property, approval may be granted.

As a rule, restrictions contained in franchise agreements must serve the purpose of preserving the network. In this context, it must be noted that the law allows control over standards and opportunistic behaviour is discouraged. As stated earlier, practically every franchise agreement infringes against competition legislation on one or more points. If an agreement contains per se restrictions, these must go – an exemption is unlikely to be granted. To ensure the enforceability of other provisions, franchisors are advised to ask the Competition Commission to review their franchise agreements.

Should an investigation reveal infringements against per se prohibitions, a substantial fine is likely to be imposed. In other instances, a warning to stop the practice forthwith will be issued first.