The Perils Of The Franchise Agreement

The Perils Of The Franchise Agreement

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Many entrepreneurs choose a franchise as an alternative to starting their own business due to the attraction of foregoing ‘school-fees’. The franchise business model promises established product or service, brand-name recognition, pre-sold customer base, ongoing support and training, increasing your chances of business success.

However, the allure of tried-and-tested business models and the promise of financial success are often inadequately executed in legal agreements, leaving the franchisee with little or no recourse in the event of failure of delivery by the franchisor.

Here’s what you should know before signing on the dotted line.

Three must-dos

1. Do your due diligence

Before entering into any agreement with a franchisor, conduct a due diligence to better position yourself to make an informed decision about the franchise opportunity. Focus on the franchisor’s system size and growth, ongoing support, training, and competitive edge.

Furthermore, analyse the franchisor’s financial information to ascertain break-even. In this regard, it’s critical to closely examine the disclosure document, which the franchisor is obliged to provide, containing, for example, written projections in respect of levels of potential sales, income, gross or net profits or other financial projections for the franchised business.

Related: Passing a Due Dilligence Test


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2. Know the law

There are many pieces of legislation that impact franchising.

  • The Consumer Protection Act 68 of 2008 (CPA): The CPA and its regulations entitle consumers, including franchisees, to certain rights such as the right to obtain a disclosure document from the franchisor 14 days prior to signing the franchise agreement, and the right to cancel the agreement with no penalty within ten business days of signing it (cooling-off period).
  • Laws governing intellectual property: The Trademarks Act 94 of 1993 is of particular importance as the licensing of intellectual property to the franchisee is the core of the franchise agreement. The franchisee operates under a common trademark, format or procedure, and the franchisor offers or is obliged to maintain a continuing interest in relation to know-how and training. Therefore, trademarks, copyright and know-how are the three most important areas of intellectual property in most franchise systems.
  • The Competition Act 89 of 1989: This act states that there must be a balance between the protection of the franchise system and the interest of the franchisees and the public in ensuring adequate competition. When reviewing the franchise agreement, franchisees must look out for clauses relating to resale price maintenance, territorial restrictions, exclusivity, tying and intellectual property.

3. Obtain legal advice

Franchise agreements often contain comprehensive legal provisions that may intimidate franchisees. It’s good practice in business to have all important contracts reviewed by an attorney in order to have a clear understanding of all the terms and associated risks.

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Three don’ts

1. Don’t act too hastily

Do not read the contract hurriedly and be tempted to sign without close consideration. It’s important to read and understand the franchise agreement thoroughly. Failure to do so presents risks of future conflict or breakdown in relationships — questions or concerns for clarification are to be raised in writing with the franchisor.

Related: The Danger Of Being Franchisee No. 1

2. Don’t assume the franchisor will not amend the agreement

Occasionally franchisors utilise bully tactics, presenting the franchise agreement ‘as is’. The franchisee certainly has the option to negotiate less biased and mutually favourable terms. It’s however noteworthy to consider the intention of the franchisor who presents an unalterable franchise agreement.

The franchisor may use a uniform franchise agreement to protect the entire franchise system, including the brand, operating system and franchised business as a whole.

If a franchisor is not willing to negotiate on important issues, it could be an indication of potential problems within that franchise system as the franchisor lacks confidence and certainty concerning the validity of its brand and operating system.

3. Don’t sign if uncertainties persist

Bias provisions, unresolved risks identified or general reservations may result in discomfort when executing the franchise agreement. Persevere in negotiations or consider an alternate franchisor if discussion results in deadlock. Do not enter into an agreement with uncertainties still looming or terms that are difficult to abide by.

Monisha Prem and Lesya Pansegrouw
MONISHA PREM and LESYA PANSEGROUW are attorneys at M. Prem Inc, which is a law firm specialising in business law and business development. The firm focuses on contract negotiation and preparation, mergers and acquisitions structuring and facilitation, regulatory and corporate governance compliance, enterprise and supplier development intervention. www.mprem.co.za

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