Erasibo

This is the fourth article in our series on franchising (especially restaurant franchising). Best to familiarise yourself with our other articles which sets our tone.

Continuing on our series of articles on the franchise industry in South Africa, we want to look at the Consumer Protection act and what it’s impact is on the franchise industry?

The Consumer Protection Act is the second major development in favour of consumer protection in recent years. The first being the National credit Act which is designed to improve transparency; prohibit unfair contract terms and practices; and prohibit anti-competitive practices. The Consumer Protection Act is designed to protect consumers from exploitation and unfair practices by unscrupulous businesses, and to empower consumers to make wise purchasing decisions. Together these Acts entrench the protection of consumers as prescribed under the Constitution of the Republic of South Africa.

Rights of Consumers

Under the act, franchisees are regarded as “consumers” and franchisors as “suppliers.” Franchisees are given a number of consumer rights, including the right to equality, privacy, choice, information, disclosure, fair and responsible marketing, honest dealing, fair agreements, fair value, good quality, safety, and supplier accountability. Franchisees are also protected against undue influence or pressure; unfair tactics; and false, misleading, or deceptive representations concerning material facts. This would also apply to the contracting arrangements between franchisor and franchisee.

Franchise Agreements

Under the Act a franchise agreement is defined as an agreement where a franchisor grants to a franchisee for consideration a right to carry on business under a system or marketing plan substantially determined or controlled by the franchisor. In addition, the franchisee’s business is substantially or materially associated with advertising schemes or programs or with the trademarks of the franchisor, or any combination of these that are licensed to the franchises. The agreement must be in writing and signed by at least the franchisee. The Act allows for a cooling of period of 10 business days, wherein a franchisee may cancel a franchise agreement they have signed without incurring any cost

The right to full disclosure is entrenched in the Act. This is in recognition of the number of cases where franchisees had been devastated financially after investing their life savings into franchises that were sold to them on the premise that the franchises would be far more profitable than they ever actually would be. Under the act, franchisors will be required to disclose certain information to prospective franchisees, as provided in regulations to be promulgated by the Department of Trade and Industry.

Monopoly on the Supply of Goods

Currently, franchisees in South Africa have limited protection against unfair practices by franchisors under that country’s Competition Act, particularly in relation to the tying or bundling of unrelated products by a dominant franchisor or when it comes to exclusive dealing. Complaints stemming from these activities are, however, difficult to prove, and the franchisor in question has to be dominant or have market share.

The Act has taken the foregoing prohibitions in South Africa’s Competition Act and applied them regardless of whether the franchisor is dominant. The new law prohibits bundling or tying of products by a franchisor, unless the franchisor can show either (i) that the bundling results in economic benefits for consumers or (ii) that the convenience of bundling outweighs any restriction on consumer choice. Alternatively, the bundled goods or services must be offered separately and at individual prices.

The Act guards the right to consumer choice by generally providing that franchisors must not require, as a supply condition or as a condition of entering into an agreement, that the franchisee purchase goods or services from the franchisor or from any other designated supplier. It is a valid defense to show that products or services that the franchisee was required to purchase are reasonably related to the branded products or services that are the subject of the franchise agreement. It remains to be seen how closely linked to the brand “reasonably related” will need to be to excuse such a requirement by a franchisor. As a result, many franchisors will no longer be able to be the sole supplier of goods and services to a franchisee, unless it can be shown that the products and services are “reasonably related” to the brand.

Franchisors should take care to ensure that products and services essential to the protection of their brand are explicitly listed in their franchise agreements, to reduce any later issues regarding interpretation. In other words, the Act suggests that franchise agreements provide for core and non-core products. Core products or services would be the primary, unique products related to the brand.

With regard to transitional provisions, it appears that the Act will not apply to pre-existing franchise agreements (or transactions) entered into before the general effective date, expected to be October 2010. However it will apply to renewals of contracts. The Act highlights a number of factors relating to fair and honest dealings and unfair unreasonable and unjust contract terms. The Act allows for the cancellation of contracts, whole or part should it be deemed to have contravened these principles as detailed in the Act.

Closing

The Act will have huge implications for the franchise industry. For while it has boomed has also become a place for corrupt, fly by night operations.  The Franchise Association of South Africa has expressed concern with regard to the implication of the Act and the burden it will place on its members. This is a concerning position as the Act can only create credibility for the franchise industry by ensuring that it closes the gap for illegitimate franchisors to operate.

Surely this would be a benefit to FASA, to cleanse the industry of undesirable operators. Franchisors who lack the capacity for adequate, transparent contracting and operations shouldn’t be selling off franchises. Organisations like FASA shouldn’t be accepting these franchisors as members or providing a potential front for their operations.

This is the third article in our series on franchising (especially restaurant franchising). Best to familiarise yourself with our other articles which sets our tone.

Commercial banks are part of legitimate business. We trust them with our savings, we store our incomes in them, and we borrow money from them, all the time assuming that the transactions are legitimate and reasonable and regulated to some extent. We rely on them for every aspect of functioning of civilised life-homes, cars, business, school fees and personal events.  We also expect that they will exercise reason in their interactions with us because their survival depends on the patronage of their clients. So their responses to us are based on good credit lending praFFrctices and when banks make errors in planning, governments are hard pressed not to finance their recovery with taxpayer’s money, as in the case of the US recently. Banks are essential to the stability of our economy; citizens and the banks share a common investment in our economic future.

But have banks gotten too big for us. Do they represent something untouchable? So when they repossess homes and cars in a panic about the money that is being lost like a waterfall without following the specified due processes outlined in those contracts is this acceptable under the circumstances or is this just a case of bullying. And what really is their responsibility as the credit provider?

In responding to this question I will share with you our own insightful experience with the banking environment recently, which has been the cause of much debate within our own inner circle.

We took out a loan to finance a franchised restaurant. After the bank evaluated our application they informed us that we were not disadvantaged enough to qualify for any form of BEE preferences (the words used were “not black enough”). This opinion of the banks was nether policy nor constitutionally justifiable. However, we were in love with the business idea, so we didn’t make a scene. We put up 40% of the financing required for the franchised restaurant we wished to buy. The bank confirmed that it had done a due diligence on the restaurant and the franchisor and was extremely happy with the results and would finance the deal.

In fact the franchisor was so highly credible to the bank, that the bank offered them great deals on banking and transacting facilities for their franchisees and they offered the group an approved financing facility for all new franchise restaurant setups. Since we knew what the obligations placed on the bank were by law to thoroughly assess any new deal we felt extremely confident in all the new “benefits” the bank was offering the franchisor.

So when the figures provided to us and the bank by the franchisor turned out to be deliberately exaggerated and show that a fraud was committed by the franchisor so as to ensnare us in the business deal the issue of what exactly is the responsibility of banks in this circumstances was raised by us. The answer apparently is that the banks have no obligation. The bank completed a FICA assessment of the franchisor; their results didn’t cry out any kind of foul – it should have. There was evidence of their foul practice’s aplenty, which at the time was outside of our sphere of access.

Now that the bank is aware that there was a fraud committed by the franchisor does it discontinue giving out loans to new franchisees wishing to purchase restaurants in the same group or does it blacklist the group? No of course it does not.

Granted our matter hasn’t been to trial yet, but we can supply details (irrefutable forensic evidence) to the banks legal department and they can make a judgment about the caliber of clients they want to maintain or their obligation to new investors. If the bank continues to give out loans to unsuspecting buyers wishing to take up opportunities within the same group, would the new franchisees be able to sue the bank for facilitating a fraud since the bank has knowledge that the franchisor is suspected of fraudulent behaviour?

At the very least the bank should consider suspending any new deals pending our case going to trial and being decided on, because should we win our case the franchisor may not be able to operate anymore and new franchisees would be placed at risk of defaulting on their loans, which is a risk to the banks bottom line.

At the very minimum this franchisor has committed FICA fraud? Should the bank not have called in SARS immediately? The bank leverages their risk on personal sureties signed by borrowers – the franchisees, so whatever happens with the business, the bank will get its money one way or the other. But should they? The National Credit Act outlaws irresponsible lending and by this it means that the banks assessment of whether a borrower is suitable for credit has to do with an assessment of the borrower’s ability to pay. If the borrowers ability to pay has everything to do with the business’s capacity to generate a certain profit, and the business was in fact never able to do that as the figures provided were a fake. Is the bank not responsible for irresponsible credit provision?

I’m not suggesting that the banks share responsibility for your business decisions or mine. You go to the bank for financing not buying into your idea. But they do have a role to play in not perpetuating a fraud when they know about it and they do have a job to ensure that there facilitation is not being used for money laundering or other such activities. The new Consumer protection Act certainly talks to the issue of facilitating fraud and specifies the right to have contracts cancelled in this case. What does that mean for a bank that knowingly provides financing to fraudulent franchisors. Can those loans be cancelled and they held responsible for the transaction?

On the cross side asking the banks to take more responsibility will be ensuring that loan facilities become even harder to access and you will pay for this risk in the repayments.

If you are hoping to see your banker as a partner in your business, best check out the development bankers, such as the Industrial Development Corporation or National Empowerment Fund. Since they accept a high percentage of risk they are better at evaluating the risk with you. If the business collapses they lose their cash too. So if you have to go after a franchisor that has defrauded you have a big partner on your side and you are out a considerably less amount of cash.