Mr Franchisor - IS YOUR FULL ARSENAL IN PLACE?

By Eugene Honey

Over the past few months we have dealt extensively with the Consumer Protection Act (CPA). Franchisors who have not embarked on the process of refining their business model to reduce vulnerabilities, have not yet updated their franchise agreement to be CPA complaint, ensuring that the franchisor’s rights are upgraded and protected, are advised to do so as soon as possible.  Dallying over these tasks may leave a franchisor vulnerable should they seek to enforce their rights, including against an errant franchisee. 

The primary question here is whether the franchisor is in a position to properly protect the franchise system. To help franchisors critically assess their position in this regard, we provide a few pointers below.

The franchisor’s rights at termination of the agreement fall predominantly into two areas. Firstly there are the contractual rights as set out in the franchise agreement, and secondly, the franchisor’s Intellectual Property (IP) rights, including trade marks, trade dress copyright, know-how, trade secrets and goodwill. 

Breach and other contractual provisions in favour of the franchisor, to protect both the franchisor and the franchise system, generally should include inter alia the following:
·         Any breach of the agreement and non-compliance with the operations manual.
·         Any failure to pay amounts due in terms of the franchise agreement. This includes upfront franchise fees, set-up costs, administration fees, ongoing management services fees and marketing contributions, as well as payments for products sold and services rendered to the franchisee and other amounts.
·         Termination on insolvency, sequestration, judgment against the franchisee and possibly business rescue (which may be a risk to the franchisor).
·         The franchisor’s rights to take assignment of the lease of the franchised premises at termination, should it so wish. 
·         Deficiency correction process.
·         Accountability of the shareholders to ensure that they are personally bound to the provisions and obligations set out in the agreement.
·         Security provisions, including suretyship.
·         Failure to find suitable premises or to maintain the lessee’s rights in relation to suitable premises.
·         Fines for breaches or non-compliance.
·         Penalties for loss of royalties and income in the event of termination during the period of the agreement.
·         Consequences of termination or after termination provisions should also include rights, as mentioned, entitling the franchisor to take over the lease, to purchase the franchisee’s assets and to repossess all goods not yet paid for, as well as the removal of all items, materials, signage and the like, which are similar to, embody or are associated with the franchisor.
·         Restraints of trade provisions should also be inserted which are reasonable in relation to activity, period and territory, including a right entitling the franchisor to restrict any restraint, should this prove necessary so as to protect the rights of the franchised business, the franchisor and franchise system.
·         Any change in shareholding, members’ interest or composition of the franchise without the written consent of the franchisor.
·         Failure to meet minimum performance standards. Particularly where sole or exclusive rights are granted, the provision should allow for the revocation of such rights, or alternatively a reduction in territory.

With regards to the Intellectual Property, although the franchisor should enjoy these rights separately, these should also be dealt with in the agreement so as to ensure the franchisor’s contractual rights thereto. It is essential that the Intellectual Property, including trade marks, copyright, know-how, trade secrets, trade dress and goodwill, be competently identified, defined and licensed in the agreement. In so doing, at termination, the franchisor will be in a position to contractually prevent the franchisee from making any further use thereof.

The franchisor’s Intellectual Property rights are critically important in protecting both the franchisor and the franchise system and this will be dealt with in greater detail in following articles. In the interim, it is recommended that all Intellectual Property licensed to franchisees, be properly protected. At the very least, all relevant trade marks should be registered to ensure that the franchisor owns all copyright licensed to franchisees and steps should be taken to keep licensed know-how confidential. 

Bowman Gilfillan
+27 11 669 9000

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