The Franchisor/Franchisee Relationship

1. INTRODUCTION

According to the Franchise Association of South Africa , a franchise takes place when an individual is given the right to operate a license or business under certain conditions. Moreover, it can further be described as a product of a contractual relationship between a franchisor and a franchisee in terms of which the franchisor permits the franchisee to make use or his /her commercial know-how, distribution network, trade mark, patent or distribution network in return for a royalty fee attached to a license. (1)

Furthermore, the Competition Commission recognizes franchising as contributing towards employment opportunities; and as one of the best and efficient ways of opening up markets for small and medium-sized enterprises (SME’s) and for historically disadvantaged persons.

The franchisor may insist on certain requirements amongst its franchisees in order to ensure uniformity in the presentation and selling of goods/services. (2) For example, the franchisor may require the franchisee to obtain stock from him/her or from selected suppliers, or to produce the stock according to the franchisor’s specifications. In addition to the need to protect intellectual property rights such as trademark, the franchisor may also supervise the location, décor, and may make arrangements of premises that are in accordance to the distinctive layout/format associated with the franchise.(3) Despite all of these, it is important to recognise that the franchisee’s business is still an independent business to that of the franchisor. (4)

2. CONSUMER PROTECTION ACT 68 of 2008
In South Africa, the Consumer Protection Act (the Act) regulates franchise-related matters. In terms of regulation 3 of the Consumer Protection Act regulations (5), every franchisor is required to provide disclosure documents to a potential franchisee. It is further required that the documents must be signed and dated and by an authorised officer of the franchisor and provided at least 14 days prior to the signing of the franchise agreement. At minimum, these documents must include:

a) the number of individual outlets franchised by the franchisor;
b) the growth of the franchisor’s turnover, net profit and the number of individual outlets, if any, franchised by the franchisor for the financial year prior to the date on which the prospective franchisee receives a copy of the disclosure document;
c) 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 or certificate by a similar reviewer of the company or franchisor, 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; and
d) 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.

Subsection 3 stipulates that these disclosure document must be accompanied by a certificate on an official letterhead from a person eligible in law to be registered as the accounting officer of a close corporation, or the auditor of a company certifying that:

a) the business of the franchisor is a going concern;
b) to the best of his or her knowledge, the franchisor can meet its current and contingent liabilities;
c) the franchisor can meet all its financial commitments in the ordinary course of business as they fall due; and
d) the franchisor’s audited annual financial statements for the most recently expired financial year have been drawn up:

i. According to generally accepted South African accounting standards;
ii. Based on accounting policies consistent with past years, except to the extent stated;
iii. According to the provisions of the Companies Act No. 61 of 1973 (or any legislation which replaces this Act), and all other applicable laws; and
 iv. fairly reflecting the financial position, affairs, operations and results of the franchisor as at that date and for the period to which they relate.

Moreover, the disclosure documents must be accompanied the following:
A list of current franchisees, if any, and of outlets owned by the franchisor, stating, in respect of any franchisee:

(i) the name under which it carries on business;
(ii) the name of its representative;
(iii) its physical address; and
(iv) its email and office telephone number, together with a clear statement that the prospective franchisee is entitled to contact any of the franchisees listed, or alternatively, to visit any outlets operated by a current franchisee to assess the information disclosed by the franchisor and the franchise opportunity offered by it and an organogram depicting the support system in place for franchisees.

The disclosure documents must be updated annually. Therefore, the franchisor is obligated to update on a continual basis, when a new franchised business is sold, or when any information changes. No obligation exists to make continuing disclosures to existing franchisees; only to potential franchisees.

3. Silent Pond Investments CC v Woolworths (Pty) Ltd and Engen Petroleum Limited (3487/2007)
In this case, an agreement was entered into between Silent Pond Investment CC (Silent Pond) and Engen Petroleum Limited in terms of which Silent Pond acquired the right to operate an Engen Petroleum Station on certain premises. Furthermore, Silent Pond was required in terms of the agreement to operate a convenience store on such premises to be known as “Quick Shop”. Silent Pond operated the Petroleum Station and Quick Shop for three years.

At a later stage, a Tripartite agreement was entered into between the parties and Woolworths (Pty) Limited. In terms of the Tripartite agreement, Silent Pond was authorised to use Woolworth’s trade mark in relation to the convenience store. The transfer of know-how was also regulated by the Tripartite agreement.

Moreover, the Tripartite agreement stipulated that the convenience store must be managed in accordance with Woolworths’ Code of Business Principles and operating manual. Silent Pond was further required to purchase products only from Woolworths. In addition, various payments had to be made to Woolworths in terms of the Tripartite agreement. However, it later transpired that Woolworths was in the process of establishing a food retail outlet not more than 200 metres from Silent Pond’s petroleum station and the Woolworths selling point established within the Quick Shop.

Therefore, the court in this case had to deal with the following issues:
 a) whether a breach of contract existed on the part of Woolworths and
 b) whether Silent Pond was entitled to rely on the tacit term of the Tripartite agreement to the effect that Woolworths would not take any steps which would adversely affect Silent Pond.

In dealing with the abovementioned issues, the court turned to paragraph 41.4 of the Tripartite agreement which stipulated that:
"In implementation of this Agreement, the parties hereto undertake to observe the utmost good faith and they warrant in their dealings with each other that they shall neither do anything nor refrain from doing anything which might prejudice or detract from the rights, assets or interest of the other of them".

In its decision, the court had regard to various decisions of the Supreme Court of Appeal to the effect that uberrima fides cannot be a basis for setting aside or not enforcing a contract. The court found that the parties intended to add more to their agreement than simply a provision that specific rights and obligations in terms of the agreement had to be performed in good faith. (6) In importing the specific principle of good faith, the parties intended more than a mere debtor-creditor relationship. The implies that they would not act in such a way as to "prejudice" or "detract" from the others’ rights, assets or interests. (7)

The court stated that it was clear that the parties did not intend the relationship between them to be a partnership, nor did they intend their relationship to be one of agency or mandate. The court submitted that it nevertheless considered itself bound to give the duty of good faith, in the implementation of the Tripartite agreement, some meaning.

The court’s approach in the Woolworths case is summarised well in its conclusion: (8)
"It is correct that the parties did not contract on terms, which conferred upon Silent Pond a specific restraint of trade, within a specified area for the duration of the agreement. In my judgment, I do not have to decide this case on the basis of the absence of such a clause. I must consider the conduct of Woolworths as against the duties imposed upon it in terms of clause 41.4, and if Woolworths’ conduct fails to match up to the requirements of clause 41.4, then it follows that Woolworths is in breach of that clause and Silent Pond is entitled to seek specific performance."

FOOTNOTES

1. Franchise Notice 2014
2. Brassey 2002: 20.
3. Brassey 2002: 20.
4. Brassey 2002: 21.
5. Consumer Protection Act 68/2008: Regulation 3.
6. Silent Pond Investments CC v Woolworths (Pty) Ltd and Engen Petroleum Limited (3487/2007): par 49.
7. Silent Pond Investments CC v Woolworths (Pty) Ltd and Engen Petroleum Limited (3487/2007): par 50.
8. Silent Pond Investments CC v Woolworths (Pty) Ltd and Engen Petroleum Limited (3487/2007): par 57.

BIBLIOGRAPHY

Books: BRASSEY M.
2002. Competition Law. 1st Edition. Cape Town: Juta
Legislation: Consumer Protection Act 68/2008.
Case Law: Silent Pond Investments CC v Woolworths (Pty) Ltd and Engen Petroleum Limited (3487/2007).

Article contributed by Stegmanns Inc.