www.whichfranchise.co.za

Legal Implications of Franchising in South Africa

South Africa does not have legislation in place that regulates franchise relationships. This does not mean that franchises operate in a legal vacuum – far from it.

Legal ImplicationsMain pieces of legislation that impact on franchising are:

  • Laws governing intellectual property; in this context, the Trademarks Act, No. 194 of 1993, is of particular importance.
  • The Competition Act, No. 89 of 1989 and the Rules for Conduct of Proceedings in Terms of the Act. It is an unfortunate reality that on the face of it, franchising infringes against several clauses of the act although this was never the intention of its drafters. To address this, the Competition Commission published a paper entitled The application of certain provisions of the Competition Act 89 of 1998, as amended, to franchise agreements, which aims to clarify the Commission’s stance on franchising. It can be accessed on the web site of the Franchise Association of Southern Africa – www.fasa.co.za.
  • The Consumer Protection Act and its regulations bestows certain consumer rights and afford protection to potential franchisees. Chief among these:
    • is the right to obtain a disclosure document when assessing a franchise opportunity 14 days before signing the franchise agreement
    • the right to cancel the agreement with no penalty within 10 business days of signing it (cooling off period)
    • Protection against unfair discrimination by suppliers

Protection against a franchisor receiving a direct or indirect benefit or compensation from suppliers to its franchisees or its franchise system unless the fact thereof is disclosed in writing with an explanation of how it will be applied.

We mention these acts in the interest of providing comprehensive information to franchise practitioners and students of franchising. Should you plan to invest in a franchise, examining these pieces of legislation would be overkill. All you need to know is that to enter into a franchise arrangement has legal implications. There is no need to worry unduly about this but you need to be prepared. As you take the evaluation process forward, you can expect to come across most if not all of the following documents:

  • Secrecy undertaking
  • Disclosure document
  • Franchise agreement
  • Operations manual
  • Lease agreement over premises
  • Funding agreements

The links provided above take you to pages that explain the purpose of each document and its implications in some detail. This notwithstanding, we strongly recommend that before you enter into any binding agreement and/or hand over any money, you should consult professional advisors with proven expertise in these matters. Bearing in mind that a franchise arrangement entails a long-term commitment linked to a substantial investment, the money you spend on professional advice will be a sound investment. For a list of accredited professionals in the fields of law, accountancy and consulting, visit FASA’s website – www.fasa.co.za.

Secrecy undertaking

Once you and your prospective franchisor have checked each other out and you are ready to enter into serious negotiations, the franchisor will expect you to sign a secrecy undertaking. This is only fair – the franchisor is entitled to ensure that confidential information you are about to receive does not fall, for example, into the hands of the competition.

However, signing such a document should not bind you in any way beyond obligating you to respect the confidentiality of the information that will be made available to you. More specifically, you need to watch out that putting your signature to the secrecy undertaking does not limit your right to walk away from the deal, should you so choose.

Disclosure Document

As early as 1994, members of the Franchise Association of Southern Africa (FASA) recognised that for prospective franchisees to make an informed decision, they need comprehensive information provided in a standardised format. This led to the introduction of the disclosure document. This document is intended to provide prospective franchisees with comprehensive information about all aspects of the franchise offer and covers the:

  • Full and traceable information about the franchisor company, its owners and its geographic location.
  • Details of the background, qualifications and business experience of the franchisor’s officers.
  • Full details of criminal and/or civil proceedings taken against the franchisor or its officers, either in the recent past or still pending.
  • A full explanation of the way the business works and what the franchisee’s role is expected to be.
  • The franchisor’s rights and obligations under the franchise agreement.
  • The franchisee’s rights and obligations under the franchise agreement.
  • An explanation of the main clauses contained in the franchise agreement, especially those that place restrictions on the franchisee or are onerous in some other way. Alternatively, a copy of the franchise agreement may be attached to the disclosure document.
  • Full financial details, including a schedule of initial and ongoing payments the franchisee will be obliged to make, how these will be calculated and by when they fall due. It also needs to be stated, firstly, what the franchisee can expect to receive in return for these payments, secondly, when the franchisee can expect to have to invest additional sums.
  • Financial projections for the business to be franchised, together with an explanation of how the figures were arrived at. (For example, the franchisor could state that the figures are averages based on typical performance of company-owned units or established franchisees. Should the figures purport to reflect the actual performance of an existing unit, however, reference should be made to the business potential of this unit in comparison with the perceived business potential of the new unit.)
  • A list of existing franchisees, complete with contact details, and information on terminations, if any, that took place over the past three years.
  • An auditor’s certificate stating that the franchisor company is a going concern, considered to be financially sound and likely to be able to meet its financial obligations within the normal course of business.

In terms of the FASA Code of Ethics and Business Practices, which is binding on FASA members, this information must be updated at least annually, more often should material changes take place within the franchisor company. Moreover, the franchise agreement should refer to the disclosure document and acknowledge that the franchisee joined the network based on the information it contains.

See also: Evaluating a franchise offer

Franchise Agreement

This is a complex issue and the best we can hope to achieve within the framework of this brief article is to provide you with a basic understanding of the issues involved. In a separate contribution, attorney Eugene Honey provides detailed information on franchise agreements (see below). We need to reiterate, however, that before you enter into any binding commitment, you should seek competent professional assistance.

Substantial agreement

Newcomers to the world of franchising frequently go into a state of shock when they first come across a franchise agreement. It is almost inevitable that a franchise agreement runs into 60 pages or more, but there is good reason for this. Unlike most other commercial agreements, the franchise agreement has to deal with a host of issues including intellectual and commercial property issues, operational details, financial arrangements and the initial and ongoing rights and obligations of franchisor and franchisee respectively. For good measure, it also needs to set out what is to happen once the arrangement ends, be it because its term has expired or a breach of contract has occurred.

To prevent the franchise agreement from becoming even bulkier than most of them already are, operational issues are normally dealt with in principle only, with details contained in the operations and procedures manual which then becomes a part of the franchise agreement. This enables the franchisor to change operational guidelines, for example in response to changes in the market, without having to renegotiate the franchise agreement.

But while a franchise agreement will, of necessity, be bulky, it should nevertheless be written in a language ordinary human beings without legal background can understand. Legal jargon has no place in a franchise agreement!

Balanced agreement

To be workable, franchise agreements must reflect a balanced approach by taking the legitimate interests of the franchisor and the franchisee into account. This is quite a difference to other commercial agreements where one party often tries to secure the best possible deal, regardless of how this impacts on the other.

This balanced approach notwithstanding, however, it may appear at first glance that the typical franchise agreement is slanted towards the franchisor’s interests, and indeed it is. The franchisor is responsible for maintaining the integrity of the brand and the system. This means that he needs to have the power to enforce adherence to agreed standards. It is also in the interest of all franchisees within the network who, after all, are heavily invested in the brand and rely on the franchisor to protect their investment.

Term of the franchise agreement

Franchise agreements are normally entered into for a fixed period ranging from five to ten years in duration. It is customary to grant the franchisee an option to renew the arrangement for a similar period once the initial term has expired but this may be subject to certain conditions. Examples of such conditions are adherence to the network’s operating procedures, satisfactory financial conduct, achievement of performance targets, willingness to upgrade the unit to conform to the then current corporate identity etc.

See also The essentials of a franchise agreement and Termination of the franchise relationship. You can access these articles by clicking on their respective title. Another document of interest is the Code of Ethics and Business Practices published by the Franchise Association of Southern Africa – www.fasa.co.za.

Operations Manual

The operations manual, more accurately described as operations and procedures manual, is often described as the bible of a franchise, with good reason. It contains information on the workings of the franchise and detailed guidelines for the profitable operation of the franchisee’s business.

A good operations manual will aim to address all eventualities ranging from corporate identity issues to operating instructions and maintenance guidelines for production equipment used in the business. More recently, in response to the tightening of labour legislation, particular emphasis is placed on providing franchisees with detailed guidelines for dealing with staff.

Simply put, the operations manual should offer workable answers to all questions that are likely to arise during routine operations at franchise level. This obviates the need to call Head Office at every turn. To ensure that this actually happens in practice, franchisors need to keep the operations manual up to date at all times.

In most networks, the operations manual doubles up as a training manual during initial franchisee training. This has the added advantage that the franchisee becomes familiar with the manual and will know precisely where to locate specific information.

It is easy to see why access to the operations manual is jealously guarded by the franchisor. In most networks, operations manuals carry serial numbers and are issued on a loan basis only. Franchisees are held responsible for their return should the franchise agreement come to an end.

Lease agreement over premises

Should a franchise operate from commercial premises, these will usually be rented. An example would be a store located in a shopping centre. While it is customary for the franchisor to assist with site selection and lease negotiations, the lease agreement will usually be between the owner of the premises and the franchisee. Some franchisors will, however, insist that a clause affirming their right to take over the lease over the premises should the franchise agreement terminate.

Other options are that the franchisor takes out the lease and sublets the premises to the franchisee, or the franchisor may be the owner of the premises and let them to the franchisee.

Whatever the circumstances, lease arrangements involve substantial payments and need to be entered into with care. By way of example, the duration of the lease agreement should be in sync with the initial duration of the franchise agreement. Should this not be the case, you could find yourself in the unenviable position of having a franchise but no place to operate it from, or vice versa.

These considerations must be balanced against the risk of signing a long-term lease for premises that may turn out to be less than ideal for the purposes of the business you operate. Keep in mind that it is generally almost impossible to obtain early release from a property lease, certainly not without significant penalties. Moreover, the issue of nominal rental versus all-inclusive rental must be clarified. Some landlords quote basic rentals but subsequently add fees, for example for the cleaning of communal areas, security, operation and maintenance of lifts, etc. You need to know what you commit yourself to.

Our recommendation is that before you sign the lease, you have it examined by a competent attorney.

Funding agreements

Franchisees who require funding (and most of them do) will need to enter into one or more funding agreements, most often with a commercial bank. On occasion, private funding in several forms can be accessed or partnership arrangements may come into play. You will read more about this topic in the section dealing with finance. Whatever you do, be sure that everything you agree on is written down in a formal written agreement that has been drafted by an experienced attorney. And before you sign such an agreement, be sure that you understand the fine print. Should something puzzle you, don’t hope that it will go away and simply ignore it. This is the worst thing you could do. Rather, insist on an explanation there and then and see whether you can live with the consequences.