The Consumer Protection Act (“the Act”) applies to franchise agreements and poses significant challenges to weaker franchisors, including those which do not abide by best franchise practices or provide reasonable value to their franchisees.
In terms of the Act, a “franchise agreement” means an agreement:
- where a franchisor, for consideration, grants to the franchisee a right to carry on business under a system or marketing plan, substantially determined or controlled by the franchisor or its associate;
- the business will be substantially or materially associated with advertising schemes or programmes, or a trade mark or any combination thereof used or licensed by the franchisee or its associate; 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 the franchisor, or by its associate.
This definition is fairly broad and may well extend to, not only full business concept franchise agreements, but also license, agency and distribution agreements.
In terms of the Act, the franchise agreement must be in writing and signed by or on behalf of the franchisee. It must also be stated in plain and understandable language. The disclosure requirements are set out in the regulations. Regulations may also set out additional information which will be necessary in relation to certain categories of information or industries.
There is a 10 (ten) day cooling off period during which a franchisee may cancel a franchise agreement, without cost or penalty, by simply giving notice to the franchisor.
In terms of the transitional provisions, the Act will not apply to pre-existing franchise agreements, as at 1 April 2011. It appears to apply to franchise agreements renewed thereafter. It also appears that from that date, if a pre-existing fixed term franchise agreement is due to lapse after 1 April 2013, the Act applies to at least certain transactions which are entered into between the franchisor and franchisee, in accordance with the transitional provisions.
The Consumer Protection Act is in the nature of a consumer bill of rights and includes many key concepts such as the right to equality; privacy; choice; disclosure and information; fair and responsible marketing; honest dealing and fair agreements; fair value, good quality and safety and suppliers accountability, certain of which will be briefly covered below.
With regard to the right of choice, Section 13 of the Act provides, that a supplier (franchisor) must not require as a condition of offering to supply or supplying any goods or services or as a condition of entering into an agreement, that the consumer must: -
- purchase any other goods or services from that supplier;
- enter into any additional agreement with the same or another supplier; or
- agree to purchase any goods or services from a designated third party;
unless the supplier can show that the convenience to the consumer in bundling the goods and services outweighs the consumer’s limitation of choice; or the bundling of these goods or services appears to result in economic benefit to consumers. It is a defense to any contravention of this section, if the goods or services are reasonably related to the franchisor’s branded products or services. This phrase is not particularly clear. Consideration may be given to, for example, providing for core and non core products and services in franchise agreements. The core products or services would be the primary, unique or the most important products or services which are related to the brand or franchise. “Reasonably related” to the brand is not defined and a brief justification or explanation of how the products are unique, important and related to the brand, might reduce any vulnerability.
With regard to the aforementioned key concepts of the Act, the following should be noted:
- A person must not use physical force, coercion, undue influence, pressure or unfair tactics in the marketing or supply of goods and services.
- A supplier must not by words or conduct express or imply a false, misleading or deceptive representation concerning a material fact or fail to correct an apparent misapprehension.
- A supplier must also not supply goods and services at manifestly unfair, unreasonable or unjust prices, or require a consumer to waive any rights including terms that are unjust, unfair or unreasonable.
- A term or condition will be unfair, unreasonable or unjust if it is excessively one sided, inequitable or the consumer relied on a false, misleading or deceptive representation, or notice of an onerous or unusual clause was not given.
- The attention of the consumer must be drawn to any limitation of liability of the supplier, assumption of risk of the consumer, any indemnity and any fact acknowledged by the consumer.
- Any provision of an unusual character or nature or the presence of which is not reasonably to be expected, must be notified to the consumer.
The Regulations of the Act provide for fairly comprehensive provisions as to what a ‘franchise agreement’ should include and these are briefly set out below.
Firstly, a franchise agreement must reflect at the top of the first page, a statement to the effect that:
“A franchisee may cancel a franchise agreement without cost or penalty within 10 business days after signing such agreement, by giving written notice to the franchisor.”
Secondly, a franchise agreement must contain provisions which prevent the following:
• Unreasonable or overvaluation of fees, prices or other amounts;
• Conduct which is unnecessary or unreasonable in relation to risks to be incurred by one party;
• Conduct that is not reasonably necessary for the protection of the legitimate business interests of the franchisor, franchisee or franchise system.
Thirdly, a franchise agreement must also contain a clause in terms of which the franchisor is not entitled to any undisclosed direct or indirect benefit or compensation, unless this is disclosed in writing, together with an explanation thereof.
Fourthly a franchise agreement should contain numerous other provisions and we would like to highlight the following:
• A description of the goods or services which the franchisee is entitled to sell or render;
• Obligations of the franchisor;
• Obligations of the franchisee;
• A description of the business system;
• Direct or indirect consideration payable to the franchisor;
• Details of territorial rights, if granted;
• A description of the proposed site, premises or location;
• Details of the intellectual property licensed;
• Details of the master franchisee, if relevant;
• Details of initial training and ongoing training and assistance;
• Terms and conditions relating to the duration, renewal, goodwill and assignment;
• Full details of any marketing fund including that the funds are deposited into a separate account, that any such funds are used for marketing and advertising purposes of the goods and services of the franchise system and that full financial statements of all receipts and expenses will need to be provided;
• Any restrictions imposed on the franchisee;
• Full particulars of the financial obligations of the franchisee including the initial fee, working capital, royalties, total investment required and other amounts payable;
• The effect of termination or expiration of the franchise;
• If requested in writing, an explanation of terms or sections not understood.
Although certain of the points are traditionally found in the average competently drafted franchise agreement, franchisors will now need to check and audit their franchise agreements so as to ensure that they are compliant. The regulations may of course be updated from time to time and franchisors will therefore need to remain abreast with any such new or updated regulations. Further, if any written explanation of a term or section is given, this must be legally correct, failing which the franchisor risks being bound to an incorrect explanation.
Although international best practice has for many years dictated that competent disclosure should be given to franchisees, this has previously not been law in South Africa. The Franchise Association of South Africa (FASA) has however for many years required for membership that franchisors should furnish franchisees with a competent agreement, a compliant disclosure document, as well as an operations manual. The CPA regulations also set out requirements in relation to disclosure documents which are required to be furnished to franchisees at least fourteen days prior to the signing of a franchise agreement.
As a minimum a disclosure document must contain:
• The number of individual franchised outlets
• The growth of the franchisors turnover, net profit and the number of individual new franchised outlets for the immediately preceding year;
• A statement of confirmation that the franchisor is able to pay its debts as and when they fall due;
• Written financial projections of the franchised business or of franchises of a similar nature, together with particulars of the assumptions upon which these representations are made.
The disclosure document must be accompanied by an accounting officer or auditor’s statement confirming inter alia that the business of the franchisor is a going concern, that it is able to meet its current and contingent liabilities, as well as its financial commitments and that the franchisors annual financial statements have been prepared in accordance with generally accepted accounting practice.
In addition the disclosure document must also be accompanied by a list of current franchisees, their contact details, and a clear statement that the prospective franchisee is entitled to contact any of the franchisees listed, or alternatively to visit any outlets operated by those franchisees. In addition, an organogram depicting the support system in place for franchisees should also be attached.
Further, powers of a court or tribunal to ensure fair and just conduct, terms and conditions are substantial. If such a court or tribunal determines that a transaction or an agreement is in whole or in part unconscionable, unreasonable or unjust, the court may:
- Make a declaration to this effect;
- Make an order it considers fair and reasonable in the circumstances including the restoration of money or property to the consumer and compensate the consumer for losses or expenses to the transaction; and/or
- Order the supplier to cease any such practice.
In addition a court may also make an order severing any part of an agreement, provision or notice, or if it is reasonable to do so, alter it to render it lawful. It may also declare the entire agreement, provision or notice void, as from the date it took effect and may make any order that is just or reasonable in the circumstances.
As a result franchisors should keep a full document trail and record of all communications with franchisees. They should also ensure that all communications and dealings with the franchisees are true, accurate, fair and reasonable. Franchisors should require a franchisee to do a proper assessment on the location and the franchisor should do the same. Franchisors should also choose franchisees very carefully and complete and sign the franchise agreement properly. The franchisors should also point out any unusual or onerous clauses and should wait for the 10 (ten) day cooling off period to lapse before doing anything further.
The franchisor should also honour obligations in terms of the franchise agreement, as well as all representations made by its employees, as well as those set out in the disclosure document. It will be in the best interests of the franchisor to support and encourage the franchisee to perform as soon as possible, so as to avoid difficulties. Franchisors should also provide good quality products and services promptly at reasonable prices. Every statement, representation, non disclosure, action or inaction may be relevant to legal proceedings at a later stage.
As a result the legal franchise landscape has certainly changed and steps should be taken as soon as possible to ensure that the franchise agreement and disclosure document, as well as all related requirements are complied with.
CONCLUSION
In conclusion, it is essential that the Franchisor ensures that the Franchise Agreement, the disclosure document and all initial and ongoing dealings with the Franchisee, are compliant with the terms of the Act.
Written by: Eugene Honey (partner Adams & Adams)