John Doe, 03 September 2014 in Corporate Law
The effect of application of the Competition Act to franchising agreements is crucial, as it may in future have a penalising outcome for those businesses which are found to be substantially preventing or reducing competition in a given market. Section 5 (1) of the Competition Act states that “An agreement between parties in a vertical relationship is prohibited if it has the effect of substantially preventing or lessening competition in a pro-competitive gain resulting from that agreement outweighs that effect.”
- There must be an existing agreement between the parties;
- The parties must be in a vertical relationship with one another;
- The agreement between them must substantially prevent or lessen competition in the relevant market; and
- The agreement can be excused if any technological or efficiency gains arise from the agreement, gains which outweigh any anti-competitive effect.
When does the agreement substantially prevent or lessen competition in the relevant markets?
An agreement will be “condemned by reason of the effects that it has. No prohibition attaches to an agreement simply by reason of its contents.” The relevant market has been described as “the narrowest market at a given stage of the supply chain in which a hypothetical monopolist operating at that level could exert a significant degree of market power”. In practical terms a “relevant market” is established when a defined category of products is marketed in a defined territory. In order to determine whether or not a franchise agreement has the effect of preventing or lessening competition in the relevant market are we need to ask:
- What are the effects of the exclusivity clauses (territory / products)?
- Does the agreement have a “locking in” effect?
- Does the agreement have repercussions on consumers? and
- What is the duration of the agreement? The standard franchise agreement lasts for a period of five to ten years which is long enough to have a serious impact the issues which have been discussed above. Voluntary compliance
The Act requires all businesses in the Republic, and outside the Republic where applicable, to comply with all its provisions, which includes ensuring that the conduct of businesses does not negatively affect the competition in a particular market. Failure to comply with the Act will result in the imposition of the relevant penalty provisions, which may include a fine of up to 10% of the firm’s annual turnover.
There are escalating pronouncements from the Competition Commission against exclusivity in franchises, including the imminent promulgation of the “Franchise Act”. There is no South African case law nor are there guidelines or regulations which could assist in the interpretation of Section 5 (1) of the Competition Act. Accordingly, even if there were merely a suspicion of a contravention of the Competition Act and even if there were no legislative or other developments, which could adversely affect the validity of the existing franchise agreements – it is not only prudent but in fact an economic necessity for franchisees to ensure compliance with the Competition Act. Amendments to franchise agreements (Table) In order to ensure compliance with the Competition Act we recommend the following changes can be made to franchise agreements:
- Whilst franchisees may retain their exclusivity with respect to other existing franchisees, their territories will be opened up for new franchises and the existing franchisees will be encouraged and rewarded for their recruitment of new franchisees in their territory as well as the territory of other franchisees;
- Franchisees will be encouraged to open more outlets and to trade more actively in their territory;
- No minimum prices or maximum discounts will be set;
- Franchisees may purchase products from alternative suppliers as long as these are of similar quality as the franchise products
Footnotes  Competition Tribunal’s decision in the Seven Eleven case  Unterhalter Restrictive Vertical Practices at 166 South African Raisins case (Case No. 04/IR/Oct99)