It is common practice, during the course of discussions between a franchisor and a prospective franchisee, with a view to concluding a franchise agreement, for the franchisor to require the franchisee to make payment of a deposit. In such cases, the franchise agreement, or another document that the franchisor requires the franchisee to sign, in anticipation of the conclusion of a franchise agreement, often states that the deposit is "non‑refundable" in the event that a franchise agreement is not signed, or, having been signed, is cancelled shortly thereafter. There remains a significant amount of misunderstanding around the question as to whether, and when, money paid by a franchisee as a deposit may be retained by the franchisor.
This note summarises the law and FASA's practice in this regard, for the guidance of franchisors and franchisees.
Section 5(6), read with section 5(7) of the Consumer Protection Act ("CPA"), provides that the CPA applies to a franchise agreement, and also to:
all of which are deemed by the Act to be transactions between a supplier and consumer within the meaning of the CPA.
FASA's Code of Ethics provides for deposits paid in anticipation of the conclusion of a franchise agreement in the following terms:
"Where a Franchisor Member receives any monies from any prospective franchisee in contemplation of the conclusion of a Franchise Agreement…and, whether at the instance of the Franchisor Member or the prospective Franchisee, negotiations in connection with such contemplated agreement are terminated without an agreement being concluded: -
The CPA contains various provisions relating to payment of deposits.
None of these expressly prohibits a franchisor from retaining a deposit paid in anticipation of entering into a franchise agreement. However:
Having regard to all of these provisions, a term in an agreement that a deposit paid by a prospective franchisee is non‑refundable, would seem to fall within the purview of this regulation. It is, therefore, presumed to be unfair and, in terms of section 48(2), may not be included in a consumer agreement, unless it is at least related to some services rendered by the franchisor and represents a fair charge for the services concerned. Details of the services and the way in which the charge is calculated, should be clearly stipulated, to minimise the likelihood of disputes in this regard.
The CPA requires that a franchise agreement must be in writing and signed by or on behalf of the franchisee and must include any "prescribed information". In regard to deposits the regulations stipulate that a franchise agreement must contain. :
Section 7(2) of the CPA provides that the franchisee may cancel the agreement "without cost or penalty" at any time within a period of 10 (ten) business days after signature of the agreement (the so-called "cooling off period"). A clause in a franchise agreement that provides, without qualification, that the whole of a deposit or initial fee will be non‑refundable will be unenforceable as it would amount to a cost or penalty levied on the franchisee, unless the clause limits the franchisor to withholding so much of the deposit as equates to the value of any services that the franchisor may have rendered, or costs he reasonably incurred, in connection with the agreement and in anticipation of a long-term relationship. These services and costs might include advice on site selection, negotiations with suppliers and credit providers, etc.
In terms of section 64(1) of the CPA, if a consumer agrees or is required, in terms of any agreement, to pay any amount in respect of services to be provided at a date more than 25 business days after the payment is made, the amount paid remains the property of the consumer until the supplier makes a charge against it. By definition, a deposit or initial fee paid in terms of a franchise agreement, at the time of signature, will relate to services to be rendered after the date of signature of the agreement. If any of those services are to be rendered more than 25 (twenty five) days after the signature date, section 64(1) will prohibit the franchisor from levying any charge against the deposit until the service are in fact rendered.
A franchise agreement may be cancelled is after the ten day cooling off period has expired, if:
If a franchise agreement contravenes, or does not comply with, the requirements of the CPA or the regulations, including the stipulations of the regulations in respect of deposits and initial payments, the agreement will be invalid, either in total or to the extent of the contravention. In addition, the provisions of sections 48(1), 51(1) and 65(2), dealt with above, will apply in the same way as where no agreement is concluded, or where the agreement is cancelled during the cooling off period. In other words, a franchise agreement may not provide, without qualification, for payment of a non-refundable deposit.
FASA appreciates that neither party wants to be committed to a franchise relationship before doing its homework, and assessing the viability of the prospective business. The franchisor is entitled to require a deposit in anticipation of these expenses, both in connection with the initial investigations and in assisting the franchisee in setting up his business. On the other hand, the franchisee should not be expected to forfeit a large sum of money in anticipation of services he may never receive.
FASA recommends, in order for both parties protect themselves against these risks, that:
For further information contact Ian Jacobsberg, Partner at Hogal Lovells (South Africa) Ltd – Tel: 011 286 6900 or email firstname.lastname@example.org