The Consumer Protection Act (No. 68 of 2008) (“CPA”) governs franchise agreements, with the purpose of protecting the franchisees. The understanding is that this protection is required because:
- the franchisor may have extensive control over the operations of a franchisee’s business;
- the franchisor may have exaggerated the potential returns that the franchisee can earn, may not market the brand effectively;
- the initial franchisee fee, the ongoing royalty rates, purchases from the franchisee and other costs incurred by the franchisee may render the franchise unprofitable;
- studies have shown that new franchises have a stronger tendency to fail than independent businesses, and franchisees often lose large amounts of money; and
- evaluating the risks of investing in a franchise can be highly technical and complex, and the potential franchisee will often be reliant on information to be supplied to it by the franchisor. [1]
The entire franchise agreement is void if it does not comply with the CPA, which is a serious penalty to franchisors who ignore it.
This protection for franchisees may well be warranted, but the requirements for compliance with the CPA are strict and make it complex and expensive for new franchisors to set up a franchise model and begin licensing franchisees.
The definition of a Franchise Agreement in the CPA:
The CPA defines a ‘franchise agreement’[2] as being (in summary) an agreement between two parties which has all of these components:
- some kind of consideration is paid or will be paid for the rights granted by the franchisor to the franchisee to carry on business in South Africa under a system or marketing plan substantially determined or controlled by the franchisor; AND
- under which the operation of the business of the franchisee will be substantially or materially associated with advertising schemes or programmes or one or more trade marks, commercial symbols or logos or any similar marketing, branding, labelling or devices, or any combination of such schemes, programmes or devices, that are conducted, owned, used or licensed by the franchisor; AND
- that governs the business relationship between the franchisor and the franchisee, including the relationship between them with respect to the goods or services to be supplied to the franchisee by or at the direction of the franchisor.
All of the elements listed in the definition of a franchise agreement in the CPA need to be present.
No exemption from CPA for juristic person franchisees, irrespective of their asset value or annual turnover.
In most instances the CPA will not apply to the provision of goods or services to a juristic person with an asset value or annual turnover equal to or above R2,000,000. However, this exemption does not apply to a franchise agreement even if the franchisee is such a juristic person[3], and nor will the exemption apply to a solicitation to enter a franchise agreement, an offer by a franchisor to conclude a franchise agreement with a potential franchisee, or the supply of goods or services to a franchisee under a franchise agreement.
What is so onerous about a franchisor complying with the CPA?
Under the CPA, the conclusion of a franchise agreement must entail, and be accompanied by, a number of prescribed actions and avoid any prohibited conduct.
REQUIRED CONTENT OF THE FRANCHISE AGREEMENT: The CPA contains very strict requirements as to what is contained in a franchise agreement (which are listed in Regulations 2 of the CPA), examples of which are:
- it must contain the EXACT wording from section 7(2), and this must be recorded at the top of the first page of the franchise agreement, and it must include a reference to section 7 of the CPA[4];
- it must contain provisions which prevent the franchisor charging the franchisee ‘excessive prices’[5];
- it must contain a clause informing a franchisor that he, she or it is not entitled to any undisclosed direct or indirect benefit or compensation from suppliers to its franchisees or the franchise system, unless the fact thereof is disclosed in writing with an explanation of how it will be applied[6];
- it must, as a minimum, contain the following specific information (the list contains 25 items) such as the following:
- the name, identity number, town of residence, job titles and qualifications of the franchisor’s directors or equivalent officers;
- details of any proprietor, member or shareholder of the franchisor if they are different from the persons who are directors of the franchisor;
- written explanation of any terms or sections not fully understood by the prospective franchisee upon the prospective franchisee’s written request;
- the amount of funding that is available from the franchisor, if any, and the applicable conditions;
- if the franchise agreement provides that a franchisee must directly or indirectly contribute to an advertising, marketing or other similar fund, the franchise agreement must contain clauses informing the franchisee:
- of the amount, or if expressed as a percentage, the method of calculation of such contribution;
- that within six months after the end of the last financial year, the franchisor will provide a franchisee with a copy of a financial statement, prepared in accordance with applicable legislation, which fairly reflects the fund’s receipts and expenses for the last financial year, including amounts spent, and the method of spending on advertising and/or marketing of franchisees and the franchise system’s goods and services;
- the franchisor must for every three months period make financial management accounts relating to the funds available to franchisees;
- that moneys in the fund may not be spent on advertising and marketing of the franchisor’s franchises for sale;
- any contribution to such a fund will be deposited in a separate bank account and used only for purposes of the fund;
- of the franchisor’s contribution to such fund, if any; and
- of the fact that the franchisor and or franchisor associated franchised businesses do not enjoy any direct or indirect benefit not afforded to independent franchisees;
DISCLOSURE DOCUMENT REQUIRED: The CPA also requires a franchisor to provide a prospective franchisee with a disclosure document, dated and signed by the franchisor, and delivered to the prospective franchisee at least 14 days prior to the signing of the franchise agreement (as per Regulations 3 of the CPA).
This disclosure document has the following additional requirements:
- it must contain certain minimum information[7], such as:
- the number of individual outlets franchised by the franchisor;
- the growth of the franchisor’s turnover and net profit;
- a statement confirming that there have been no significant or material changes in the company’s or franchisor’s financial position since the date of the last accounting officer, or auditor’s certificate;
- that the company or franchisor has reasonable grounds to believe that it will be able to pay its debts as and when they fall due;
- written projections in respect of levels of potential sales, income, gross or net profits or other financial projections for the franchised business or franchises of a similar nature with particulars of the assumptions upon which these representations are made.
- it must be accompanied by a certificate from an accounting officer or auditor, certifying that[8]:
- the business of the franchisor is a going concern;
- to the best of his or her knowledge the franchisor is able to meet its current and contingent liabilities;
- the franchisor is capable of meeting all of its financial commitments in the ordinary course of business as they fall due; and
- the franchisor’s audited annual financial statements for the most recently expired financial year have been drawn up:
- except to the extent stated therein, on the basis of accounting policies consistent with prior years; and
- fairly reflecting the financial position, affairs, operations and results of the franchisor as at that date and for the period to which they relate.
What if the franchisor owns shares in the franchisee:
Even if the franchisor owns shares in the franchisee company, the CPA’s requirements must still be fully complied with. There is no exemption from them for subsidiary companies.
What if instead of a fee being paid by the franchisee, it issues shares to the franchisor?
- Even if the shares have only a nominal value at the time they are issued, it could be argued that the future dividends the franchisor would earn from such shares down time, together with the growth in their value as a capital asset, is a form of payment. As such, it does not escape the relationship being deemed a franchise under the CPA.
- If the parties did want to take the risk that this would not be a franchise relationship, they may need to clearly separate the issuing of the shares from the licence agreement, and there must be no interconditionality between the two. It is a risk though for the franchisor, as the franchisee can raise as a defence that the CPA was not complied with and so claim that the entire agreement is void.
- In addition, it is just not commercially realistic that a licence would be granted to operate a business under the brand style and systems of another business without the payment of an upfront or ongoing fee. So it does instinctively raise questions.
How can you avoid the application of the CPA:
The ‘franchisor’ entity would need to decide if it is willing to provide so few services and/or have so little oversight on the ‘franchisee’ such that it will NOT fall within all of the different obligatory components of the definition of ‘franchise agreement’ in section 1 of the CPA. If so, the agreement would not be a franchise agreement, and can be, for example, just a supply and licensing agreement.
Sections of the CPA which do not apply to Franchise Agreements:
The following provisions of the CPA do not apply to franchise agreements:
- section 14 (expiry and renewal of fixed-term agreements);
- section 15 (pre-authorisation of repair or maintenance services);
- the consumer’s right in terms of section 17(2) to cancel an advance reservation, booking or order;
- the provisions of section 19 pertaining to the consumer’s rights regarding delivery of goods or supply of service;
- the provisions of section 33 about catalogue marketing;
- the provisions of section 34 with regard to trade coupons and similar promotions;
- the provisions of section 38 about referral selling;
- the provisions of section 47 concerned with over-selling and over-booking; and
- the provisions of sections 49(1) (limitations of risk or liability) and 50 (written consumer agreements).
Both franchisors and potential franchisees would be well advised to enlist legal advice prior to the conclusion of any franchise agreement.
[1] Authors: Evert van Eeden; Jacolien Barnard, Title: Consumer Protection Law in South Africa, Last Updated: 2017 -Second Edition, (published by My Lexis Nexis Library on its website: http://www.mylexisnexis.co.za/, Accessed on 8 April 2021)
[2] section 1 of the Consumer Protection Act, No. 68 of 2008
[3] section 5(7) of the Consumer Protection Act, No. 68 of 2008
[4] Regulation 2(a) of the Consumer Protection Act, No. 68 of 2008
[5] Regulation 2(b) of the Consumer Protection Act, No. 68 of 2008
[6] Regulation 2(c) of the Consumer Protection Act, No. 68 of 2008
[7] Regulation 3(1) of the Consumer Protection Act, No. 68 of 2008
[8] Regulation 3(3) of the Consumer Protection Act, No. 68 of 2008