Buying a franchise? These are the laws and terms you shouldn’t ignore

Photo: Cytonn Photography on Unsplash

 

  • Buying a franchise operation is a reasonably safe way to run your own business.
  • This doesn’t mean you won’t face a raft of legalese before, and on your way, to signing an agreement.
  • The Consumer Protection Act now regulates the relationship between franchisees and franchisors – but there are several other legal factors to be aware of when buying a franchise store.
  • Here are the central Acts, terms, and legal issues to look out for when buying a franchise, according to two attorneys.

Running a franchise might seem like a safe and easy way to make money, but it’s not always plain sailing. You’ll likely have to abide by numerous terms and conditions in the franchise agreement, mostly to do with the intellectual property you’re effectively buying from the franchisor. And there are also always risks involved – particularly if you don’t do your due diligence or understand the legalese before signing.

After meeting with the franchisor, passing various financial hurdles, and possibly even psychometric tests and training, you’ll likely face fairly complex legal paperwork. Understanding what to expect in this paperwork – and ensuring it is all accurate and in line with South African legislation – is key to running a healthy franchise, say two South African lawyers with a special interest in the franchise world.

A franchise may be one of the more accessible and safer businesses to start. But Hugh Melamdowitz, a partner at Spoor & Fisher South Africa, says “it’s important that you have the right knowledge and ask the right questions to avoid ease and safety becoming complication and risk down the road”.

Here are some of the key legal considerations to keep in mind when buying a franchise in South Africa.

Consumer Protection Act

The Consumer Protection Act (CPA) oversees much of the relationship between the franchisor and franchisee in South Africa, and is particularly important in the early stages of the franchise agreement.

Before the CPA, the South African franchise landscape was largely unregulated. But since the introduction of the CPA, franchisees are seen as consumers and “thus enjoy the majority of the rights and protections afforded to other ordinary Consumers under the Act”, says Khotso Mmatli, practising attorney and director at SKM Attorneys.

“The influence of the CPA can be found in every facet of the franchise agreement,” says Mmatli.

One of the critical factors Mmatli says to look out for in a franchise agreement is the franchisor’s obligation to provide a ‘Disclosure Document’ at least 14 days before the parties enter into the agreement and before accepting any monies from the prospective franchisee.

“The purpose of the disclosure document is to provide the franchisee with information pertaining to the franchisor’s business practices, usually in the form of a franchisor’s Operations Manual, and financial position (such as annual turnover and future sales projections) so as to allow the franchisee to conduct a thorough due diligence before entering into the agreement,” Mmatli says.

Mmatli also says it’s “important to note that the parties to the franchise agreement cannot agree to waive any of the rights or obligations created under the CPA”.

The CPA also allows for some escape from the franchise within a reasonable period – and it’s essential to look for mention of this “cooling off period” in the franchise documents, says Melamdowitz.

Intellectual property

The franchisor also has a right to protect its intellectual property.

“In light of the compulsory disclosures mandated by the CPA, it becomes crucial for the franchisor to protect its intellectual property (IP),” says Mmatli. “This is especially true considering that disclosed documents such as the franchisor’s operations manual would contain sensitive information about the franchisor’s know-how, processes and techniques.”

As such, Mmatli says you should expect the franchisor to request you sign a confidentiality agreement “to protect not only its own legitimate commercial interests, but also those of other franchisees within its enterprise”.

In many ways, this exchange of intellectual property is central to the franchise model – and it typically includes three elements in the form of copyrights, trade marks, and “know-how” says Melamdowitz.

Copyright

A franchise agreement should make clear that the copyright, which typically lives in the operations manual, remains with the franchisor and that any copying of it, other than that specified as permitted for running the business, would be an infringement of copyright, Melamdowitz says.

Know-how

The know-how includes what Melamdowitz calls “a business’ trade secrets”. It’s in the know-how section that you’ll learn precisely how to run the business you’re buying.

“In my opinion, this development of know-how should be encouraged, to drive job creation and business evolution,” says Melamdowitz.

An individual employee is typically not, however, entitled “to remove any documentation containing know-how, confidential information, or trade secrets, including customer lists and supplier lists”.

With these secrets, it may in theory be possible for franchisees to replicate the franchisor’s business. For this reason, it’s also possible that clauses in this section may prohibit franchisees from contacting suppliers directly. Contravening these clauses, even innocently, may cause legal issues between you and the franchise owner.

Franchisors usually control this know-how through a confidentiality agreement, which will likely stipulate all confidential information, including finances, commercial, and technical details that enable the business to run.

Trade marks

Trade marks are a central element of any franchise. Trade marks usually include the trade name, logo, symbols, slogans and other marketing elements that a franchisor uses to identify the business. The franchisor will usually include all protected trade marks in the franchise agreement, or stipulate them in a separate attachment.

“It is the trade mark that underpins all franchise businesses, because it is the trade mark that the public is aware of and that attracts customers,” says Melamdowitz.

Franchisors must have detailed knowledge of their trade marks – and franchisees will need to ensure that they respect them and abide by the legal requirements laid out in the agreement. For example, a franchise agreement may mention where, when, and how franchisees can use trade marks like logos and slogans, and if they can be altered in any way. Departure from clauses to this effect may result in action from the franchisor.

According to both Melamdowitz and Mmatli, these are the most critical legal components of any franchise agreement – and although buying a franchise from a reputable franchisor might generally be a safe business bet, it’s essential to carefully read any franchise agreement before you sign.

Melamdowitz also urges prospective franchisees to check for any court judgments against the company, evaluate credit records, and “carefully study the disclosure documents and financial statements to check on financial health and forecasted profitability”.

Franchises aren’t cheap, however, nor are they necessarily failsafe. When in doubt, both lawyers say it’s wise to consult with a legal professional who can evaluate an agreement, advise you of your rights as a franchisee, and ensure everything is above board before signing up and handing over franchise fees.

Source: Business Insider South Africa – www.businessinsider.co.za

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