Key Legal Aspects of Franchising Law

What is a license?

A license agreement is a type of contract in which the proprietor of intellectual property would grant to a user or licensee the right to use that intellectual property.  The relevant intellectual property could, for example, include patents, registered designs, trade marks, copyright, know how and the like, either individually or collectively.

What is a franchise agreement?

A “franchise agreement” is often used for the type of license where a full business concept and a bundle of intellectual property, including usually at least trade marks, copyright and know how, is licensed.  The owner of the intellectual property is often the franchisor and it licenses, as mentioned, a bundle of intellectual property, to a franchisee, for a period of time, in accordance with the terms of the franchise agreement.  A full business concept franchise is more common these days.

The term “franchising” has however been used broadly in relation to a range of agreements which, on the one hand, may be a simple trade mark license agreement, all the way to a far more sophisticated agreement in terms of which a full business concept is licensed to a franchisee.

Franchising legislation in the Consumer Protection Act

In South Africa, the Consumer Protection Act (CPA), which came into existence on or about 1 April 2011, includes legislation relating to franchising.  A “franchise agreement” is defined in the CPA, as follows:-

‘franchise agreement’ means an agreement between two parties, being the franchisor and franchisee, respectively-

  • in which, for consideration paid, or to be 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;
  • 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 or an associate of 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 or an associate of the franchisor. ”

As can be noted, the definition is fairly broad.

In terms of Regulation 2 of the CPA, there are about 50 or more points which must be dealt with in a compliant franchise agreement.  This would include aspects such as the nature of the business, authorised products and services, the intellectual property licensed, the term of the franchise, as well as any renewal provisions, the rights granted, financial obligations of the parties, obligations of the franchisor (both initial and ongoing), obligations of the franchisee (both initial and ongoing), provisions relating to marketing, training, investment, termination, renewal and numerous others.

A competent franchise agreement protects the whole franchise system

Franchise agreements are often viewed to be fairly onerous.  Firstly, in terms of franchising law, they are normally quite comprehensive.  This can, at first blush, be viewed by a prospective franchisee as somewhat too onesided.  However, a comprehensive but balanced franchise agreement in fact protects not only the franchisor, but also the franchisee and particularly the franchisee’s investment.  To the extent that a franchise agreement is not sufficiently comprehensive, so that it protects the rights of the franchisor and franchise system, an errant or non-compliant franchisee may cause damage to the brand and to the value of all franchised businesses in the franchise system.  However, if the franchisor enjoys sufficient rights, it is able to hopefully fairly promptly, protect the brand, the rights of the franchisor and franchise system, and thereby maintain the reputation and value of the franchised businesses in that system.

The CPA also provides that a prospective franchisee should be furnished with a disclosure document, at least 14 days prior to the signature of the franchise agreement by the franchisee.  In terms of the CPA, a compliant disclosure document should provide the prospective franchisee with enough information to inform the franchisee about the business proposition made to him or her.  A compliant disclosure document would include details of the franchisor’s principals, their experience, the shareholders of the franchisor, the franchisor’s financial performance, the growth of the franchise system, details of all franchisees and any litigation in the franchise system, financial projections and financial viability information, details of the costs and full investment, including working capital and other essential information, to inform the prospective franchisee about the investment and franchise business he / she is considering buying into.

Intellectual property in a franchise system

With regard to the intellectual property licensed by the franchisor to the franchisee, this should, as far as possible, be competently protected and managed.  For example, the trade marks of the franchisor should be competently registered and protected on the relevant Trade Marks Register usually, at least, in word and logo form, in all the relevant international classes of goods and services, so as to ensure the trade mark and brand is protected in relation to all the products and services of the franchised business.

It is also essential that the copyright of the franchisor be owned by it.  A key pitfall in terms of South African Copyright Law is that, to the extent that the creation or development of a copyright work is outsourced to a third party, even though the franchisor may pay for the creation or development thereof, he may not acquire ownership thereof, unless this is transferred to him by way of a written, signed copyright assignment agreement.

Copyright would include many essentials of the franchised business, including the operations manual, website, logos, corporate identity, advertising materials, training manuals and various other commercial and promotional materials.

The third important type of intellectual property licensed in most franchise systems is know how.  Know how would include valuable expertise, processes, methodologies, systems, recipes, formulae, trade secrets, confidential information and experience acquired by the franchisor over a period of time.

Know how is protected by way of confidentiality provisions in the franchise agreement or otherwise in confidentiality agreements.

The Operations Manual is an essential document in a franchise system

The operations manual is the third important document in a franchise system.  It is a dynamic annexure to the franchise agreement and is an exceptionally important document, which can be used in a franchise system to manage, protect and develop the franchise system, products, services and operations.

The advantages and disadvantages of franchising

The advantages of buying into a franchise would include the following:-

  1. Acquiring a right to use an established recognised brand and refined business system;
  2. To owning your own business but not being in business by yourself;
  3. According to statistics, there is a far greater likelihood of success of a new franchise business succeeding, than a non-franchised business;
  4. A competent franchisor, who is at hand to provide experienced assistance, support and guidance; and
  5. Usually a better return on investment.

The disadvantages of buying into a franchise would include the following:-

  1. There are usually higher set up and establishment costs, as franchisors would insist that this is attended to properly;
  2. Whilst you own your own business, as a franchisee, the franchisee is required to operate in accordance with a prescribed business system and is restricted in relation to the products which can be sold and the services which can be rendered;
  3. There is certainly a risk if one buys into a poorly managed and operated franchise system, in that not only would one be restricted to the prescribed operations, products and services, but one would be subject to poor management, systems and leadership by the franchisor. A poor franchisor could also misrepresent the likely performance and viability of the franchised business.  As a result, there would be limited room for creativity and flexibility in a poor environment;
  4. There would be ongoing royalty and other payments to the franchisor; and
  5. The success of the franchised business is often dependent upon the performance and competence of the franchisor.

Considerations when franchising internationally

In the event that that franchisor and franchisee are not in the same country, consideration will need to be given to primarily four aspects, which include the protection of the intellectual property in that territory, taxation considerations, exchange control authorisation and the compliance and enforceability of the franchise agreements, in that territory.  If the franchisee is in the foreign territory, he will usually have to apply for exchange control approval, in terms of the franchise agreement, to obtain authorisation to pay the franchisor amounts due in terms of the franchise agreement, including initial and ongoing payments.

CONCLUSION

From the aforegoing, you may have realised that a franchise agreement and a franchise arrangement is fairly complex.  It is therefore certainly advisable, as a potential franchisor, to obtain competent advice from a franchise lawyer, with regard to the protection and establishment of a franchise, including the strategic planning, assessment of objectives, establishing a structure to achieve objectives, preparation of the franchise agreement and disclosure document, as well as also the operations manual.  For a franchisee, on the other hand, they are buying into a complex franchise system and before they sign a franchise agreement, they should obtain detailed advice from an experienced franchise lawyer regarding the legal aspects, and an accountant, regarding the viability of the franchised business.

Eugene Honey
Eugene Honey
Partner | Attorney