The franchise agreement governs the relationship between the franchisor and franchisee and includes critical provisions relating to obligations of parties and prevention of conflict, dispute and financial loss. It is essential for a franchisee to understand his rights, obligation, general provisions and risks in terms of the agreement.
Seven critical clauses in the franchise agreement:
1. Consumer Protection Act acknowledgment
In terms of the Consumer Protection Act 68 of 2008 the following provisions are to be acknowledged or included in the franchise agreement:
A franchisee is entitled to cancel a franchise agreement without cost or penalty within 10 business days after signing the agreement, by giving written notice to the franchisor.
The franchisor is not entitled to direct or indirect compensation from suppliers, its franchisees or franchise systems, unless this is disclosed in writing with an explanation of how it will be applied. The franchisor must supply the franchisee with a disclosure document, pre-agreement certificate and current list of franchisees.
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2. Grant clause
An important clause relates to granting the franchisee a licence to operate the franchised business and use the franchisor’s intellectual property rights such as brand names, confidential information and copyright.
This clause will designate the territory in which the franchisee may operate and whether or not the franchisee has exclusivity rights. Where a franchisee is given exclusive rights to use the franchisor’s intellectual property in a certain area, for example, the franchisee will be entitled to exclude all others, including other franchisees and the franchisor, from operating in that area.
A franchisee can alternatively be granted the sole but non-exclusive right to operate the franchised business in a certain area. This means that the franchisor will not grant a licence to other franchisees in the area, however, it does not exclude the franchisor from opening one or more outlets and competing with the franchisee in that area.
A franchisee may be granted a non-exclusive licence, giving it the right to use the franchisor’s intellectual property without any exclusive or sole rights.
3. Payment clause
The franchisee is usually required to pay an initial lump sum, which is paid to obtain the licence to operate the franchised business. The breakdown of this amount may include the costs of setting up the franchise, equipment, advice, assistance and training by the franchisor, and an amount for goodwill.
Once the franchised business is operational, the franchisee is required to pay royalties to the franchisor monthly, quarterly or annually. These royalties may be fixed or calculated as a percentage of turnover, and are payment for ongoing use of the franchisor’s intellectual property.
In most instances, the franchisee will also be required to contribute a regular amount towards the marketing of the franchise. Such contributions are paid into an independently managed fund and the franchisor and its associated businesses may not enjoy any direct or indirect benefit from such contributions not afforded to independent franchisees.
4. Obligations of parties
The franchisor’s initial obligations include assisting the franchisee with setting up the franchise, furnishing the franchisee with the operating manual, disclosing the franchise system and training the franchisee. Ongoing obligations include additional training, assisting with resolving problems, assisting with management and providing guidance.
The obligations of the franchisee are fairly wide-ranging and include paying all sums due to the franchisor timeously, operating the franchised business in accordance with the franchise system as set out in the operating manual to protect the intellectual property, goodwill and reputation of the franchisor, keeping records and books of account, and marketing the franchise.
The termination clause should deal with timeous payment and provide the franchisor the right to terminate should the franchisee fail to comply with the operating manual, or challenge the intellectual property rights of the franchisor, or commit an act or omission that will damage the brand of the franchise system.
6. Resale rights
Franchisees are usually only permitted to sell their franchise with prior consent of the franchisor, and provided that the purchaser enters into a new franchise agreement with the franchisor on acceptable terms.
Many franchisors include a right of first refusal, which allows the franchisor to buy back the franchise at a rate determined by them, or to match any potential purchaser’s offer.
7. Restraint of trade
It is advisable to include a restraint of trade provision to protect the franchise system, which should be reasonable with regard to the area, nature of activity and period in order for it to be enforceable.