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The Franchise Sector And The Competition Act

The recent finding of the Competition Commission that car firms are employing anti-competitive practices, including price fixing, has again highlighted the fact that contravention of the Competition Act No. 89 of 1998 (“the Competition Act”) will not be taken lightly. It is imperative that Franchisors ensure that their agreements comply with the Competition Act.

Maria D’Amico of D’Amico Incorporated, a legal firm that specialises in the franchise sector, explains the recently released Franchising Notice in the Competition Act and how it applies to the Franchising sector. The main focus of this notice is the four areas of contention in Franchise Agreements namely price fixing, minimum resale prices, territories and exclusive supply agreements.

The rule of thumb for Franchisors should be to adhere to the FASA Code of Ethics. This boils down to being transparent in all dealings with Franchisees and all other parties, such as suppliers and consultants. Franchising should be a win-win situation and the franchise agreement must reflect this. Conflict usually ensues when the relationship between Franchisees and the Franchisor is a “them and us” scenario. The relationship between the parties should be mature enough to enable transparency and open dialogue between both the Franchisor and Franchisee.

Q: How does South Africa’s franchise sector differ from other franchise sectors around the world?
A: In most countries there is no specific legislation regarding franchising - this means that franchising and franchise agreements are governed by competition law and policy, like any other industry sector. It seems that some countries do recognize that franchising should be treated somewhat differently and have amended their Competition Act to also govern the franchising sector.

Q: Do you think it is necessary to create this notice?
A: Yes. Although the Competition Act came into effect on 1 September 1999, there is still confusion or ignorance around the provisions of the Competition Act. By way of example there has been differing opinions between legal practitioners as to whether section 4(1)(b)(ii) of the Competition Act prevents a Franchisor from excluding territories as this section deals with a restrictive horizontal practice; In its Franchising Notice the Competition Commission stated that a Franchisor is prohibited from dividing a market by allocating territories to its Franchisees. In doing so, it did not rely on Section 4(1)(b)(ii) but rather on sections 5(1), 8(c) and 8(d) of the Competition Act. This means that, should a Franchisor not wish to contravene the Competition Act, it could, prior to entering into Franchise Agreements with Franchisees, apply to the Competition Commission for an exemption. If granted, the Franchisor could make provision for exclusive territories in its Franchise Agreements and be protected from the provisions of this Competition Act in so far as it might inhibit the creations of such exclusive territories.

Q: In your opinion, does this notice disadvantage Franchisors?
A: This notice will assist Franchisors. The Franchising Notice would alert any Franchisor, whose Franchise Agreement may be in contravention of one or more of the provisions of the Competition Act, to amend their agreements, and ensure that the Franchise Agreement is in keeping with the existing laws of South Africa.

Q: In some industries, for example the diamond trade, prices are set and only selected traders are used. This is against the Competition Act. Do you think that in some instances, for economic reasons, the Competition Act should be disregarded?
A: I would not recommend that any sector disregard the Competition Act. To do so may cause it to incur substantial fines which will be disastrous from an economic point of view. Rather, such sector could apply to the Competition Commission for an exemption relating to their industry. Section 10 of the Competition Act makes provision for an exemption under certain circumstances.

Q: The Competition Act states that the Franchisor may not allocate exclusive territories unless it is for pro-competitive goals such as effective distribution. This is fine when franchises are in fixed locations, but what happens in mobile or real estate Franchises, for instance, where the territories granted act to prevent conflict between Franchisees?
A: As mentioned previously, the Competition Commission is of the view that exclusive territories could infringe section 5(1) of the Competition Act, but a Franchisor could raise a defence, to the exclusive territories arrangement. However, if a Franchisor is unable to raise a defence, then it could apply to the Competition Commission for an exemption. We would presume that the Competition Commission, when assessing an application for exemption, would take into account the individual factors of the business of a Franchisor, which in our example, is the mobile Franchisees and therefore mobile territories. It is our opinion that in such a case it is unlikely that the Competition Commission would grant an exemption to the Franchisor.

Q: Do you think there should be different rules governing franchising? For instance, franchising agreements are made to protect the brand and the entire network of Franchisees. If a Franchisee decides to stock a different product or offer different prices, this hurts the brand and undermines the network?
A: In each instance the Competition Commission will investigate the facts relevant to the case to determine whether a particular Franchise Agreement offends the principles of the Competition Act or not. As is apparent from the Franchise Notice, most jurisdictions do not specially provide for Franchise Agreements and there seems to be no reason to do so. It can be dealt with within the framework of the Competition Act.

Q: In South Africa, where the average consumer is quite price sensitive, do you think that the popularity of franchises means that the consumer either does not perceive them as being expensive, or the consumer is prepared to pay more for the perceived value or convenience?
A: Whilst the average consumer may be price sensitive, I do not believe that s/he will purchase from a particular franchise based solely on the price of a product or service. I believe that such a consumer will also take into account other factors, namely the brand name, quality of the product/service and levels of efficiency received in the store.

Q: Will Franchise Agreements have to change in future to meet these requirements?
A: As the Competition Act came into effect on 1 September 1999, existing Franchise Agreements at the time, if they contained clauses in contravention of the Competition Act, would have had to be amended. All Franchise Agreements prepared after the commencement date would not need to be amended, as the attorney preparing the Franchise Agreement should have omitted the offending clauses in the Franchise Agreement.

Q: When drawing up a Franchise Agreement, what measure do you take to ensure that the agreement is fair to both Franchisors and Franchisees?
A: Our Franchise Agreements are geared to protect the Franchisor as far as possible, bearing in the mind that the Franchisor has made a substantial investment in terms of the franchised business which includes its intellectual property. On the part of the Franchisee, we avoid inserting obligations by the Franchisee that are either ridiculous or impossible to perform.

Q: What does the legal phrase “rule of reason” mean?
A: Certain provisions in the Competition Act are prohibited per se, such as minimum resale price maintenance. About this there is no debate. On the other hand, certain prohibitions in the Competition Act will not be implemente where the tests prescribed in the relevant sections are met such as, for instance, that mentioned in section 4(1)(a). Such conduct is ultimately subject to reasonableness, or stated otherwise, the rule of reason.

Q: How would a Franchisor go about applying for an exemption from some of the provisions of the Competition Act?
A: Clause 10 of the Competition Act makes provision for an application to the Competition Commission for an exemption and the procedure is set out therein. The Commission may grant an exemption only if (a) any restriction imposed on the firms concerned by the agreement or practice in question is required to attain an objective mentioned in paragraph (b); and (b) the agreement or practice concerned, contributes to any of the following objections, namely the maintenance or promotion of exports; promotion of the ability of small businesses or firms, controlled or owned by historically disadvantaged persons, to become competitive; change in productive capacity necessary to stop decline in an industry; or the economic stability of any industry designated by the Minister.

For information on developing Franchisor Agreements and the implications of the Competition Act, you can go to www.damico.co.za