How COVID-19 impacted the legal side of franchising

COVID-19 and the ensuing lockdown measures imposed by the South African government in March 2020 have had a devastating impact on the South African economy. No sector in South Africa, including the franchise sector, has been immune to the pandemic as they have all experienced in some shape or form, a sharp decline in income, rising unemployment and business closures. Consequently, COVID-19 has impacted the legal side of franchising as it has necessitated franchisors to reconsider their business systems, review their franchise agreements and make necessary amendments thereto to cater for future disruptions, be it in the form of second waves, new pandemics and/or other unforeseen events. In this article, we explore some of the clauses and contractual obligations that franchisors should consider reviewing in their franchise agreements and business models in order to prepare for the next normal.

Force Majeure Clause

Does your franchise agreement contain a force majeure clause? If not, franchisors should obtain legal advice whether to insert one as a force majeure clause provides temporary reprieve to a party from performing its obligations under a contract upon the occurrence of an unforeseen event (e.g.acts of God). A force majeure clause is therefore not only for the benefit of the franchisee but may also benefit a franchisor, should it be unable to timeously perform its obligations in accordance with its franchise agreement. In the event the franchise agreement contains a force majeure clause, a franchisor should consider whether the terms thereof restrict its ability to enforce the franchisee to comply with its contractual obligations under the franchise agreement and whether the trigger events include extraordinary events not previously catered for, such as pandemics, epidemics, national states of disaster and lockdowns in order for a party to try rely on same.

Right to Fair, Just and Reasonable Terms and Conditions

In terms of section 48 of the Consumer Protection Act, 2008 (“the CPA”), “a franchisor must not offer to supply, supply, or enter into an agreement to supply, any goods or services, on terms that are unfair, unreasonable or unjust”. As a result, when considering enforcing the terms of its franchise agreement, particularly during COVID-19 or a future disruption, a franchisor should consider its duty to act fairly, reasonably and just towards its franchisee, as the reason for the franchisee’s non-compliance may be due to factors beyond its control e.g. non-payment of royalties due to being forced to cease trading during level 5 lockdown.

Update Disclosure Document

Franchisors are reminded of their statutory obligation in terms of Regulation 3 of the Consumer Protection Act Regulations to continuously update their Disclosure Document to ensure that all pre-sale information provided therein is true and correct on the date it is given to any prospective franchisee. Franchisors must ensure that any material changes and/or information relating to the franchisor and its financial position are accurately reflected and must also update the number of franchised outlets in the event that any may have closed due to COVID-19 or any other disruption.

Update Operations Manual and Other Policy Documents

In addition to updating their Disclosure Documents, Franchisors must also remember to update their operations manual and any other policy documents (e.g. Health and Safety, Sick Leave and COVID-19 Protocols) where changes have been implemented and/or introduced by the franchisor due to COVID-19.

Review Franchise System

One of the hardest hit sectors in South Africa has been the restaurant and hospitality industry due to the trading restrictions imposed during the various lockdown levels caused by COVID-19. As a result, restaurants have learnt to quickly adapt their service offerings and many franchisors in the food and beverage industry have successfully remodelled their franchise system to cater for similar disruptions in the future. The recent rise in popularity of dark kitchen or virtual kitchen offerings is a prime example of this transformation. Dark kitchens are kitchens that sell meals exclusively through delivery. The benefit of a dark kitchen is two fold in that on the one hand, a restaurant no longer requires seating space or to hire waiters and is therefore able to decrease its overheads, and on the other hand, customers are provided with a quick and convenient food offering online.

Review Payment Obligations

Franchisors need to be sensitive to the financial abilities of their franchisees during unforeseen disruptions. Enforcing payment obligations may negatively impact an already struggling franchisee. Therefore, to further ease the burden on an already struggling franchisee, franchisors should consider waiving or implementing payment holidays in respect of royalty and marketing fees, and at the same time remembering to review any concessions granted as the industry and the economy recovers.

Extension of Deadlines

Franchisors and franchisees need to discuss whether they require an extension to perform their obligations due to any delays caused by circumstances beyond its control, and if needs be, to extend the term of their franchise agreement.

Supply Chain Issues

Franchisors should also review their supply chains and implement risk management steps by reviewing their business models to ‘safe proof’ the business from similar situations in the future; including a review of proper capitalisation, cash flow, stock inventories, marketing campaigns and customer interface.

Master Franchisee Obligations

In the event a master franchisee is obliged to comply with development obligations in a particular territory (e.g. to open a requisite number of outlets within a prescribed period), the master franchisee may need to renegotiate the terms thereof and/or extend any deadlines, if a force majeure event has delayed the rollout thereof.

Review Lease Agreement

As rent constitutes a substantial portion of a franchisee’s operating expenses, and franchisees are either tenants themselves or sub-tenants of their franchisors, franchisors are encouraged to actively assist their franchisees with negotiating with their landlords in order help franchisees trade during turbulent times.

Non-waiver Clauses

Franchisors should ascertain whether their franchise agreements contain a non-waiver clause to ensure that they are adequately protected in instances where they do not strictly enforce the provisions of a franchise agreement where a franchisee breaches same due to an unforeseen disruption. If the franchise agreement does not contain the necessary nonwaiver language, franchisors should consider including same in any addendums and/or communications to franchisees which clearly document the concession/s or relief provided to the franchisee.

From the above it is evident that COVID-19 has accelerated much needed change in the franchise sector as it allowed for franchisors to consider and cater for future disruptions and/or events that it would never have anticipated. Furthermore, and more importantly, it has brought franchisors and franchisees closer together in finding reasonable solutions to disputes for the benefit of both parties and the franchise system as a whole.

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