South Africa: The Application of the Competition Act to Franchise Agreements

The Competition Commission recently published a notice designed to inform franchisors and franchisees about the impact of the Competition Act on their franchising arrangements (available at http://www.compcom.co.za).

The Commission makes it clear that despite the unique nature of franchising, the Act applies to franchise agreements, as it does to any other economic activity in the Republic.

While recognising that franchising can be an efficient way to distribute goods or services, a balance must be drawn between the protection of the franchise system (including intellectual property rights and the need to maintain quality and consistency) and the interest of franchisees and the public in ensuring adequate competition.

As all franchising agreements involve a degree of co-operation, if not out-right restraints, there is an inherent potential for anti-competitive conduct.

The following provisions may have competition implications:

• Resale Price Maintenance – Franchisors may not dictate minimum resale prices or determine the maximum discount that may be passed on. While merely recommending a price is acceptable, it should be clear that the retailer is not bound thereto and there should be no penalties or disincentives meted out to franchisees that deviate from the recommendation.
• Territorial Restrictions – Arrangements that seek to partition the market through the allocation of exclusive territories or customer groups are problematic. Where the relationship is strictly vertical, where the franchisor does not itself offer products or services in potential competition with a franchisee, an efficiency defence may be raised, such as the improvement in distribution or information flow.
• Exclusive Dealing – An obligation on a franchisee to procure only from the franchisor or a franchisor-nominated supplier can limit competition. Although exclusive dealing provisions may be justifiable if they are indispensable for protecting the franchisor's know-how and goodwill (which, if unprotected, may inhibit franchisors from launching the franchise) a franchisee should not, without good reason, be prevented from procuring supply from a third party if it is of like quality and would not harm the trademark or reputation of the franchisor.
• Tying – Tying occurs when a franchisee is made to buy products that are not really needed (tied products) in order to obtain the few products that are (tying products). A franchisor should not force franchisees to buy products that are not critical to the franchise unless there are valid efficiency, technological or other pro-competitive justifications.
• Intellectual Property – The Commission has recognised that protection of intellectual property rights may be integral to encouraging innovation and creativity. Section 10(4) of the Competition Act specifically contemplates the exemption of acts relating to the exercise of intellectual property rights. Nevertheless, where a monopolistic franchisor refuses to grant a licence or charges excessive prices, competition concerns remain.

Although franchising often gives rise to efficiencies in mitigation of anti-competitive effects, these may not always be a sufficient defence. Participants may consider applying for exemption on the basis that many franchise arrangements allow historically disadvantaged individuals and SME's to participate in the mainstream economy.

The publication of the franchising notice is an indication that the Commission has identified franchising as an arena for future investigations. If in doubt, existing and potential franchisors and franchisees should seek advice in relation to the impact of competition law on their franchise ventures.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.