Offer and sale of franchises

Legal definition

What is the legal definition of a franchise?

There is no specific legal definition of a franchise under South Africa law.

However, the Consumer Protection Act No. 68 of 2008 (CPA) defines a franchise agreement as follows:

[A]n agreement between two parties, being the franchisor and franchisee, respectively -

(a) in which, for consideration paid, by the franchisee to the franchisor, the franchisor grants the franchisee the right to carry on business within all or a specific part of the Republic under a system or marketing plan substantially determined or controlled by the franchisor or an associate of the franchisor;

(b) under 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 or an associate of the franchisor; and

(c) that governs the business relationship between the franchisor and the franchisee, including the relationship between them with respect to the goods and services to be supplied to the franchisee by or at the direction of the franchisor or an associate of the franchisor[.]

 

The Franchising Association of South Africa (FASA) loosely defines franchising as the granting of a right to operate a business or licence under certain specific conditions.

Laws and agencies

What laws and government agencies regulate the offer and sale of franchises?

The CPA and the Regulations published thereunder, together with the common law, regulates the offer and sale of franchises in South Africa.

The National Consumer Commission is the government agency tasked with the regulation of relationships between consumers and businesses in South Africa. Franchisees are, in certain respects, considered consumers pursuant to the definition of a consumer set out in the CPA.

Principal requirements

What are the principal requirements governing the offer and sale of franchises under the relevant laws?

Section 7(1) of the CPA sets out certain requirements for franchise agreements, which must:

  • be in writing and signed by or on behalf of the franchisee;
  • include any prescribed information, or address any prescribed categories of information; and
  • be in plain and understandable language.

 

Regulation 2 of the Regulations to the CPA contains further information that must be contained in a franchise agreement as prescribed by the responsible cabinet minister, including information such as the name and description of the relevant goods and services, the consideration payable by the franchisee under the agreement, and renewal terms.

Franchisor eligibility

Must franchisors satisfy any eligibility requirements in order to offer franchises? Are there any related practical issues or guidelines that franchisors should consider before offering franchises?

No, there are no such eligibility laws.

Franchisee and supplier selection

Are there any legal restrictions or requirements relating to the manner in which a franchisor recruits franchisees or selects its or its franchisees’ suppliers? What practical considerations are relevant when selecting franchisees and suppliers?

No, there are no such laws.

Pre-contractual disclosure – procedures and formalities

What procedures and formalities for pre-contractual disclosure are required or advised in your jurisdiction? How often must the disclosures be updated?

Generally speaking, parties are not required to make any pre-contractual disclosures in South Africa, save for certain specific types of agreements such as insurance, partnership or agency agreements, wherein parties are required to act in the utmost good faith and therefore to disclose any information that may be considered material for the other party in entering into the agreement.

Specific disclosures are required for franchise agreements in the terms of Regulation 3 to the CPA, including:

  • the goods or services to which the franchise applies;
  • any territorial restrictions that apply;
  • the renewal terms for the agreement;
  • the specific obligations of, and restraints on, each party; and
  • the details of all the financial contributions that will be required of the franchisee.

 

There is no requirement that this disclosure document should be updated at any point.

Pre-sale disclosure to sub-franchisees

In the case of a sub-franchising structure, who must make pre-sale disclosures to sub-franchisees? If the sub-franchisor must provide disclosure, what must be disclosed concerning the franchisor and the contractual or other relationship between the franchisor and the sub-franchisor?

The CPA does not directly address this issue. The sub-franchisor would have the direct contractual nexus with the sub-franchisees and, therefore, it is reasonable to argue that the obligation would fall on the sub-franchisor. It is recommended that the master franchisor include a provision in the master agreement obliging the sub-franchisor to fulfil the disclosure obligations and to indemnify the master franchisee if it fails to meet the disclosure obligations.

Due diligence

What due diligence should both the franchisor and the franchisee undertake before entering a franchise relationship?

A franchisor should conduct at least basic due diligence into the party or parties wishing to become a franchisee. In the case of individuals, a credit check and criminal check are relatively easy and inexpensive to do. The individual directors of potential franchisee companies could be similarly investigated.

Potential franchisee companies should be asked about details of directors and shareholders, and to share company documents including financial statements. A major potential drawback is that franchisee companies are likely to be new companies set up for the particular purpose of operating the franchisee business. It is, therefore, important to look at the individuals involved and any other businesses or companies with which they may be involved.

Franchisees could verify and evaluate the intellectual property rights that form the subject of the licence granted in the franchise arrangement. Franchisees can also, more generally:

  • contact existing franchisees, suppliers, employees and customers;
  • study the disclosure documents and financial statements carefully in conjunction with professional advisers to check on financial health and forecasted profitability;
  • check whether the franchisor is a member of any industry bodies with enforceable codes of conduct;
  • check for any court judgments or poor credit records against the franchise;
  • visit franchised stores with a view to experiencing the goods or services from the perspective of a consumer;
  • consider the broader market and how competitive it is; and
  • consider the regulations and potentially forthcoming regulations that may affect the industry.

 

Failure to disclose – enforcement and remedies

What actions may franchisees or any relevant government agencies take in response to a franchisor’s failure to make required disclosures? What legal remedies are available? What penalties may apply?

The prospective franchisee can report a failure to issue such notice or particular violations of disclosure requirements to the National Consumer Commission. A person failing to comply would first be issued a compliance notice. It is not clear whether a franchise arrangement would be void or voidable as a result of a failure to supply a disclosure notice. 

If the franchisor is a member of FASA, their failure to disclose can be reported to FASA. Although not a government agency, FASA’s Code of Ethics and Business Practices provides for the payment of a fine of up to 10,000 rand or termination of membership of the association if members contravene the CPA.

Where a franchisor has omitted certain information or provided incorrect or false information, the franchisee could pursue delictual remedies. To this end, the franchisee would need to prove the damage it suffered as a result of the franchisor’s failure to supply the required or correct information.

General legal principles and codes of conduct

In addition to any laws or government agencies that specifically regulate offering and selling franchises, what general principles of law affect the offer and sale of franchises? What industry codes of conduct may affect the offer and sale of franchises?

The offer of a franchise is regulated by the CPA and its Regulations. Regulation 3 sets out all the information that must be contained in the franchisor’s pre-sale disclosure and the documentation that must accompany such a disclosure, including:

  • the goods or services to which the franchise applies;
  • any territorial restrictions that apply;
  • the renewal terms for the agreement;
  • the specific obligations of, and restraints on, each party; and
  • the details of all the financial contributions that will be required of the franchisee.

 

South African law does not specifically recognise the doctrine of culpa in contrahendo. Furthermore, there is no legally recognised general duty of good faith in contracts.

FASA has a Code of Ethics and Business Practices that sets out the manner in which it expects members to establish, structure and implement franchise relationships.  

Fraudulent sale

What actions may franchisees take if a franchisor engages in fraudulent or deceptive practices in connection with the offer and sale of franchises?

In this instance, franchisees would be entitled to sue in delict for fraudulent misrepresentation.