Understanding Franchise Agreements and Competition Law in Cape Town

Franchising has become one of the most effective ways to expand a brand while empowering independent business owners to operate under a proven business model. A franchise agreement is a legally binding contract between a franchisor and a franchisee. The franchisor grants the franchisee the right to operate a business using its established brand, systems, intellectual property, and marketing strategies in exchange for fees or royalties. These agreements often include strict operational requirements to ensure brand consistency, from sourcing products to marketing, pricing, and store layouts.

While franchise agreements create commercial opportunities, they also limit the freedom of franchisees to operate as independent businesses. This is where competition law comes into play.

What is Competition Law?

Competition Law, also known as antitrust law in some jurisdictions, aims to maintain fair and effective competition in markets. It seeks to prevent practices that distort or limit competition, such as price-fixing, collusion, abuse of dominance, or agreements that unfairly restrict market entry. In South Africa, this is governed by the Competition Act 89 of 1998 (“Competition Act”), which applies to all economic activities within the Republic.

The purpose of competition law is to ensure that consumers benefit from lower prices, better quality products, and increased innovation by preventing businesses from manipulating markets in ways that harm competitors or consumers. In-house counsel, whether local or international, must carefully examine franchise agreements to ensure they comply with competition regulations, as these agreements often contain vertical restraints between franchisors and franchisees.

How Franchise Agreements Intersect with Competition Law

A franchise agreement involves a vertical relationship between two independent entities. Although vertical arrangements can improve efficiency and protect brand integrity, they can also reduce competition if they go too far. The Competition Commission in South Africa has highlighted several clauses in franchise agreements that could raise anti-competitive concerns:

1. Resale Price Maintenance (RPM): This occurs when the franchisor dictates the minimum price at which a franchisee must sell goods or services. Section 5(2) of the Competition Act expressly prohibits RPM. While franchisors may recommend retail prices (Section 5(3)), any attempt to enforce these prices or penalise franchisees for offering discounts is unlawful.

   
   

2. Exclusive Territories: Many franchisors grant exclusive territorial rights to franchisees to avoid internal competition. While this can incentivise investment and maintain brand reputation, it can also restrict market access for other businesses and reduce consumer choice. Under Section 5(1) of the Act, exclusive territories that substantially lessen competition could be problematic unless efficiency or consumer benefits can be proven.

   
   

3. Exclusive Dealing: A clause requiring franchisees to buy all their goods from the franchisor or approved suppliers may stifle competition, particularly if comparable quality goods are available elsewhere. These arrangements can only be justified if they are necessary to maintain brand quality and do not substantially prevent competition.

   
   

4. Tying of Products: Tying occurs when a franchisor requires a franchisee to purchase unrelated products as a condition of obtaining the main franchise goods or services. If the franchisor is dominant in the market, such tying may violate Section 8(d)(iii) of the Competition Act.

   
   

5. Intellectual Property (IP) Clauses: Franchise agreements often protect IP, such as trademarks, logos, and proprietary systems. While such protection is legitimate, abuse of IP rights, such as refusal to license or excessive pricing linked to IP, could raise competition concerns.

   
   

The Global Perspective on Franchise Agreements

Internationally, competition authorities also monitor franchise agreements closely.

• In the European Union, vertical agreements (including franchise arrangements) are assessed under Article 101 of the Treaty on the Functioning of the EU. This prohibits agreements that restrict competition unless they produce economic benefits that outweigh the harm. RPM is considered a "hardcore" restriction.

  
  

• In the United States, antitrust law applies to franchises just like any other distribution arrangement. Tying arrangements and territorial restrictions are scrutinised under the "rule of reason" to assess their overall effect on competition.

  
  

• Australia and Canada adopt similar approaches, balancing efficiency and pro-competitive benefits against the harm caused by restrictive clauses.

  
  

South Africa aligns with these principles, adopting a mix of outright prohibitions (e.g., RPM) and "rule of reason" analysis for other vertical restraints.

Why In-House Counsel Should Pay Attention

For in-house legal teams, especially those managing cross-border franchise networks, compliance with competition law is non-negotiable. A single restrictive clause could trigger regulatory action, substantial fines (up to 10% of annual turnover in South Africa), and reputational damage. Counsel must ensure that franchise agreements strike a balance between protecting the franchisor’s brand and allowing fair competition.

This includes:

• Reviewing pricing clauses to ensure they are framed as recommendations, not obligations.

• Assessing territorial restrictions to confirm they do not unfairly block market access.

• Providing franchisees with flexibility in sourcing goods, where feasible.

• Ensuring IP clauses protect brand integrity without overreaching into anti-competitive practices.

  
  

Best Practices for Franchise Agreements

Understanding the Legal Framework

Franchisors and franchisees must understand the legal framework governing their agreements. This includes being aware of the Competition Act and its implications for their operations. Knowledge of the law can help both parties navigate potential pitfalls and foster a more collaborative relationship.

Regular Legal Reviews

Conducting regular legal reviews of franchise agreements is essential. These reviews should assess compliance with current competition laws and identify any clauses that may pose risks. By proactively addressing potential issues, franchisors can protect their interests while ensuring fair competition.

Training and Education

Providing training and education for franchisees on competition law is beneficial. This can help franchisees understand their rights and responsibilities, fostering a culture of compliance. Educated franchisees are more likely to adhere to legal standards and contribute to a positive brand image.

Open Communication

Maintaining open communication between franchisors and franchisees is crucial. This can help clarify expectations and address concerns related to competition law. A transparent relationship can lead to better compliance and a stronger partnership.

Seeking Legal Advice

Franchisors should seek legal advice when drafting or amending franchise agreements. Legal professionals can provide insights into compliance with competition law and help structure agreements that protect both parties. This ensures that the agreements are not only legally sound but also beneficial for business growth.

Conclusion

Franchise agreements are not inherently anti-competitive, but they are closely regulated to prevent harmful market behaviour. By understanding the principles of competition law and carefully structuring franchise agreements, franchisors and franchisees can avoid legal risks while still maintaining a strong and consistent brand.

For up-to-date legal advice, please get in touch with us at info@spencelaw.co.za.

Disclaimer: This article is for general informational purposes and is not legal advice. For a detailed review of your franchise agreements, contact Spence Attorneys. We frequently work with international clients looking to establish ventures in South Africa.