The CPA grants extensive new statutory rights to franchisees and franchisors, who are now faced with considerable additional obligations. The CPA prescribes both the form and content of franchise agreements and, among others, compels express pre-contractual disclosures and representations from franchisors, allows for cooling-off periods and even directs that franchise agreements should not be "unfair". This has resulted in would be franchisors seeking to escape the ambit of the CPA by attempting to camouflage franchise agreements as licence agreements, distribution agreements or agency agreements. However, at least in so far as the legislature is concerned – a rose by any other name would smell as sweet.
The CPA expressly defines a franchise agreement and irrespective of the title of the agreement, if it falls within the CPA's definition of a "franchise agreement", it will be deemed to be one and thus subject to the provisions of the Act. This legislative interference is not unique. In fact, in the United States, Canada, Europe and Australia very similar (in some instances almost identical) legislation applies. One might argue that this serves to discipline those who intentionally (and unsuccessfully) attempt to "downgrade" a franchise agreement into something else. However, there can be serious repercussions even when parties unintentionally turn their licence agreement into a franchise agreement, thereby triggering the provisions of the CPA.
In its most basic form, a franchise agreement is the licensing of a trademark by a franchisor to a franchisee but which includes and involves the franchisor's support, backing and provision of business assistance to the franchisee. The very essence of a franchise agreement is the franchisee's reliance on the franchisor's backing and support. In fact, the franchisee's dependence on the franchisor's help is considered a right of the franchisee, and an obligation in this regard is imposed on the franchisor. This results in the franchisor gaining a clear (albeit limited) interest in the business of the franchisee. The franchise agreement then governs this business relationship between the franchisor and the franchisee.
In general, a license agreement is markedly simpler and generally imposes fewer legal implications. Such an agreement can be as simple as granting the licensee the unrestrained right to use a proprietary asset in return for the payment of a royalty. However, licencing a trademark is more complex. Unchecked or abandoned licensing of a trademark may lead to dilution. Thus, in order to preserve the distinctiveness of a licenced trademark, licensors insist (justifiably so) on strenuous license agreements that control almost every aspect of the use of their trademarks. This measured control affects almost all aspects of the licensee's business. This is where the licensor can sometimes inadvertently trespass into the territory of the franchisor.
The definition provided in s1 of the CPA defines a franchise agreement as:
"Franchise agreement" means an agreement between two parties, being the franchisor and franchisee, respectively –
(a) in which, for consideration paid, or to be paid, by the franchisee to the franchisor, the franchisor grants the franchisee the right to carry on business within all or a specific part of the Republic under the system or marketing plan substantially determined or controlled by the franchisor or an associate of the franchisor.
(b) under which the operation of the business of the franchisee will be substantially or materially associated with the advertising schemes or programmes or one or more trademarks. Commercial symbols or logos or any similar marketing, branding, labelling or devices, or any combination of such schemes, programmes or devices, that are conducted, owned, used or licensed by the franchisor or an associate of the franchisor, and
(c) that governs the business relationship between the franchisor and the franchisee, including the relationship between them with respect to the goods or services to be supplied to the franchisee by or at the direction of the franchisor or an associate of the franchisor."
If one compares the CPA's definition of a franchise agreement with the terms of most substantial and formidable licence agreements then, in some cases, the formulation of the latter may well satisfy the definition of franchise agreements and the licensee, who now becomes a franchisee, will be handed a number of trump cards when a dispute becomes litigious. There are, in this respect, a myriad prejudicial consequence, not least of which is that the license agreement (which is now deemed a franchise agreement) will fall short of the various statutory provisions pertaining to fairness and equity and other prescribed requirements as to form and content.
The difference between a franchise agreement and a license agreement is best stated in an article by Paul D. Supnik on the INTA Bulletin:
"Simply stated, a franchise may be perceived as a licensing arrangement with 'something more'. That 'something more' generally involves a business plan associated with the trademark license and the provision of business help from the franchisor to the franchisee. From a legal perspective, it is that 'something more' that may in advertently convert a license to a franchise. While a trademark owner might think in terms of simply licensing trademark rights to a licensee for a royalty (provided there is quality control), an agreement that imposes 'excessive quality control' such that it directs the licensor's manner of doing business may convert the license to an inadvertent franchise."
There is little current case law in this regard in South Africa. In the United States case of Wright-Moore Corp v Ricoh Corp (Indiana, US) a distribution agreement for copiers was deemed a franchise agreement simply because it was determined that the agreement provided for a marketing plan, the association of the business with a trademark and the payment of a fee for this.
Ricoh argued that Wright-Moore was not a franchisee and, as a result, Indiana franchise law did not apply. The term "franchise" is defined in the Indiana Franchise Act and is a contract in terms of which:"
(1) a franchisee is granted the right to engage in the business of dispensing goods or services, under a marketing plan or system prescribed insubstantial part by a franchisor;
(2) the operation of the franchisee's business pursuant to such a plan is substantially associated with the franchisor's trademark, service mark, logotype, advertising, or other commercial symbol designating the franchisor or its affiliate; and
(3) the person granted the right to engage in this business is required to pay a franchise fee."
The court held that the plaintiff had provided sufficient evidence to defeat the defendant's claim that the plaintiff was not a franchisee. The similarities between the definition of a franchise as provided for in the Indiana Franchise Act and the CPA are striking. Similarly, the definition provided by the United States Federal Trade Commission (the FTC) of a franchise is as follows:
"Franchise" means any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contracts pecify, or the franchise seller promises or represents, orally or in writing, that:
(1) The franchisee will obtain the right to operate a business that is identified or associated with the franchisor's trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark;
(2) The franchisor will exert or has authority to exert a significant degree of control over the franchisee's method of operation, or provide significant assistance in the franchisee's method of operation; and
(3) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate."
The conclusion is that it is this element of control which seems to be the determining factor in deciding whether a licence agreement is a franchise agreement.
According to Michael W. Rafter of Kilpatrick Townsend & Stockton LLP, Georgia, USA, the FTC has articulated that it will not deem as "significant” any controls solely designed to protect the trademark owner's good will in the mark. Thus, for the licensor to be involved in aspects pertaining to the design, packaging and advertising of products to ensure that the mark is used properly and conforms to the licensor's guidelines should not alter the essence of a licence agreement to that of a franchise agreement.
Typical control requirements of a franchise agreement include obligations of a franchisee to follow a specific methodology inherent to a franchisor's business system, such as site selection and to adopt specific hours of operation, production techniques, operating methods, training techniques, marketing and advertising methods, administrative and financial controls, information technology, trade connections and business associations, content of operations manuals, rights in intellectual property, trade dress, technical information and equipment, supply requirements and the like.
The conclusion seems to be that it is this measured control by the franchisor, or influence on and in the business of the franchisee, that alters the nature of a licence and turns it into a franchise. It is clear that the most significant difference between a trademark license agreement and a franchise agreement is the degree of control a licens or seeks to exercise over the licensee's use of the trademark and other methods of business operations. The risk of a licensor being deemed a franchisor arises when a licens or holds too much control over the aspects of the licensee's business operations. This is what needs to be diminished, not accentuated.
The drafter must be alert to the fact that this assessment or evaluation applies not only to license agreements but also to distribution agreements, agencies and possibly even reseller agreements.
