Royalty and relief in the midst of Covid-19

The Covid-19 pandemic has hit the pockets of many South African businesses and the situation has been no different in the franchise industry as the majority of franchisees are Small and Medium-sized Enterprises. Most franchisees are classified as non-essential services and as a result, have been forced to close their businesses for the duration of the Covid 19 enforced lockdown. Even with the gradual phasing in of return to business, fast food franchisees remain closed for on-site consumption. Personal care franchisees such a beauty salons and hairdressers remain closed all together.

Leading up to the lockdown, franchisees would have already observed a sharp decline in sales during the month of March and some may have even struggled to reach their breakeven point during this time. Adding to the mix of royalty and marketing fees, franchisees would have been burdened with additional payment obligations in respect of loans, rentals, salaries and to suppliers.

The obligation to pay Royalty Fees

Royalty fees are fees payable by franchisees to franchisors as determined by the franchise agreements between the parties for the continued use of the franchisor’s goodwill by the franchisee. As these fees are regulated by contract, there are no set industry fees and the amount and percentages payable vary with each agreement.It is important to note that as the payment of royalty fees is a contractual obligation, the harsh consequences of the Covid-19 pandemic in itself is not enough to escape payment thereof.Without the required consent, failure to pay these fees would constitute a breach of contract which could have serious legal consequences including cancellation of the contract.

Generally royalty fees are either a set fixed fee or a percentage of the turnover made by the franchisee. Where a percentage of the turnover is used to determine royalty fees payable to the franchisor, the effects of the Covid-19 pandemic would also decrease the value of the royalty fee payable. It is however in the case of a set fixed fee being payable where there could be harsher consequences as the income of the franchisee diminishes while the liabilities pertaining to the royalty fees remain the same.

Many franchisors have suspended royalty payments due and payable by franchisees until further notice. These include franchisors from the fast food, automotive, DIY and business-to-business sectors. This will go a long way into the recovery of the industry which has taken a huge financial knock.

Relief Schemes by Government

The South African Government has been working towards financial relief measures for persons and businesses who have suffered as a result of Covid-19. Examples of these include the Temporary Employers Relief Scheme known as TERS, established to assist employers in paying staff salaries and the Covid-19 loan guarantee scheme established to assist employers with paying operational costs.

The Covid-19 loan guarantee scheme was established by the National Treasury, the South African Reserve Bank, and the Banking Association of South Africa in order to help Small and Medium Enterprises cope with the harsh consequences of Covid-19 and the subsequent lockdown periods.

The loan is available to businesses with an annual turnover of less than R300 million, who are in good standing and has a relationship with any of the participating banks and are registered with SARS. These qualifying businesses must show that they are financially distressed as a result of the Covid-19 disaster and the lockdowns which resulted from it. The loans may only be used to pay for operational expenses such as salaries, rent and costs paid in the ordinary course of business. It may not be used for any other purpose.

The loan amount will be advanced to successful applicants in up to three monthly instalments. Successful applicants will have a period of five years to repay the loan at a fixed interest rate of repo rate plus 3.5%. Repayments are due to commence after the expiry 3 months after the full advancement of the loan amount.

Participating banks include Absa, First National Bank, Investec, Mercantile Bank, Nedbank and Standard Bank. Applicants must apply to the participating banks directly. In total, R100 billion has been set aside for the scheme with an option to increase this amount to R200 billion.

Conclusion

As set out above, the impact of the regulations in the context of franchises relate to the prohibition on trading by non-essential businesses. This consequently has the effect of leading to a downturn in the financial position of various businesses with the result that some businesses may have to close their doors and others may not be able to comply with their rental obligations.

It is important that the businesses within the industry make use of any relief measures possible to weather this ongoing storm. Franchising is a relationship between the franchisor and franchisor and therefore each party needs the other in order for the relationship to grow. It is therefore encouraging that franchisors have assisted where possible including the suspension of royalty fees in certain instances.

For more information contact Garth Kallis, Associate at Fairbridges Wertheim Bekker Attorneys