Checklist for prospective franchisees before concluding a franchise contract
Franchising in South Africa has contributed to many successful entrepreneurs and according to FASA (the Franchise Association of South Africa), the franchising industry still continues to make a healthy contribution to the South African GDP.
Many prospective franchisees would focus on the financial reward as a new business owner, but it is very important to obtain legal advice before concluding a Franchise Contract in order to understand the legal implications thereof and to ensure that the contract terms are fair, and reflects a relationship governed by sound legal and business principles.
Whilst various articles are available on franchising and sections of the relevant legislation is quoted therein, this article intends to serve as a practical, non-exhaustive, checklist for prospective franchisees, when being presented with a Franchise Contract.
South African Laws That Apply To Franchising
- South African Law of Contract and common law;
- The Companies Act No 89 of 1998 (“the Companies Act”);
- The Consumer Protection Act No 68 of 2008, together with Regulations (“the CPA”);
- The Competition Act of 1998 (“Competition Act”); and
- The South African Trade Marks Act, No 194 of 1993 (protection for registered Trade Marks) and common law (unregistered Trade Marks).
Legal Structure Of A Franchised Business
Different legal entity options are available to conduct business within South Africa. A South African registered company, regulated in terms of the Companies Act (either private or public company) is generally the most acceptable legal form. Nothing however precludes a prospective franchisee from trading in a Trust, sole proprietor, or as a partnership in a franchise relationship.
Important Clauses Contained In A Franchise Contract
1. Disclosure Document
In terms of the Consumer Protection Act, a franchisor is obliged to provide any prospective franchisee at least 14 days prior to the conclusion of Franchise Contract a disclosure document. In the disclosure document, certain minimum information pertaining to the Franchisors business must be contained. The below list is a non-exhaustive, summary of what is prescribed in terms of the CPA:
- The number of individual outlets franchised by the franchisor;
- A statement regarding the franchisor’s financial position, i.e. its turnover, net profit for the financial year prior to the date on which the prospective franchisee receives the disclosure document;
- A certificate on an official letterhead from an accounting officer or its registered auditor, certifying the financial position of the franchisor and that it is able to meet its current and contingent liabilities;
- The support systems offered by the franchisor for the franchisees business; and
- Projections (potential sales, income and gross profit) in respect of a franchisees business.
As a franchisee will also invest in the franchising relationship with a franchisor, it would be advisable to negotiate a fixed minimum initial term for the Franchise Contract, with the option to renew the Franchise Contract for a further period by written notice to the franchisor. Unless the Franchise Contract is terminated for reasons of breach, both parties should commit to at least a minimum initial contract period during which period the Franchise Contract cannot be terminated for convenience by a party.
In terms of the CPA, a prospective franchisee is entitled to cancel a Franchise Contract concluded, without any costs or penalty, within 10 days from date of signature.
The Competition Act aims to prevent anti- competitive practices which may apply to the franchise industry and the following provisions are typically regulated in a Franchise Contract:
- Geographical areas and restrictions;
- Obligations and limitations in a Franchise Contract to only procure products and services from approved suppliers; and
- Pricing maintenance and minimum discounts.
A prospective franchisee should carefully consider the provisions regarding exclusivity contained in the Franchise Contract in order to protect itself against potential anticompetitive behaviour by the franchisor. Note that a franchisor may raise a defence based on efficiency, technology or other pro-competitive gains justifying an exclusive arrangement.
4. Business relationship, support
Besides the obligations imposed on both parties contained in the Franchise Contract it would be good practise to receive an operations manual from the franchisor, setting out the general management procedures, administration manual and procedures applicable to the business. The operations manual would contain know how, business secrets and confidential information pertaining to the franchisor and would be protected under South African common law.
5. Trade Marks
A franchisee would be granted the right/ licence to make use of the franchisor’s registered trade marks. The use of the franchisor’s trade mark would be strictly regulated in terms of the Franchise Contract, the Trade Marks Act as well as the common law. It would be advisable for the franchisee to obtain a copy of the franchisor's marketing guideline (if not contained in the Operations Manual) to ensure that it complies with the rules around the use of the trademarks.
It is common practice for the franchisor to contribute towards the marketing of the franchisees business, which usually forms part of the franchise fees payable to a franchisor.
Where the franchise business will operate from a retail premises, a franchisee would be required to conclude a lease agreement directly with the landlord, which location would be subject to the franchisor's approval. It is important to understand the consequences should the Franchise Contract terminate prior to the lease expiration as the financial implications could be significant.
7. Financial obligations on franchisee
Generally, a franchisee may be required to invest money in the initial start-up of the business and pay an ongoing franchise fee to the franchisor. A franchisee must ensure to obtain advice from a financially qualified person to understand the implications of the investment funding requirements and also the financial impact and calculation of franchise fees payable to the franchisor.
8. Effects of termination
Franchisees should understand what the effect is of termination of the Franchise Contract and whether it could expect compensation in respect of the business built up over the duration of the Franchise Contract. Prospective franchisees should keep in mind that over the duration of the franchise relationship goodwill, assets and a substantial client base could be accumulated for which it may want to be rewarded for upon termination of the Franchise Contract or selling of the business.
9. Any restrictions, restraints
The prospective franchisee should carefully consider any restraint of trades applicable to it and its shareholders, directors and/ or employees during and after termination of the Franchise Contract.
10. Security documents
It would be standard practise to be required to sign personal surety for the performance of the business and a cession of its debtor’s book, or in case of a company being the franchisee, the shareholders being required to pledge their shares held in the company as security.
As a majority of prospective franchisees rely upon funding from a financial institution or investor, it should understand the implications of the security provided to a financial institution and/or a franchisor in respect of any liability arising from the Franchise Contract.
Article written by: Danelle Strydom, Admitted Attorney and business owner of Creatio Legal Services. The author has more than 10 years’ experience in the commercial field, providing legal advise in regards to inter alia franchising, reselling and distribution relationships, and aims to provide professional legal services to the SME market.
For more information, contact Danelel
Tel: 012 940 9375
Disclaimer: The article above serves as a guideline and does not constitute legal advice. Creatio Legal Services 2018©