Business vs franchise transfer: What happens to employee contracts?

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In the context of a franchised business, this section raises some interesting questions. The cornerstone of a franchised business is an agreement between the business owner (the franchisee) and a franchisor.

In terms of the Consumer Protection Act, 68 of 2008 (CPA), the essential features of a franchise agreement are -

• “for consideration paid, or to be paid, by the franchisee to the franchisor, the franchisor grants the franchisee the right to carry on business …under a system or marketing plan substantially determined or controlled by the franchisor...”
• “the operation of the business of the franchisee will be substantially or materially associated with advertising schemes or programmes or one or more trade marks, commercial symbols or logos or any similar marketing, branding, labelling or devices, or any combination of such schemes, programmes or devices, that are conducted, owned, used or licensed by the franchisor or an associate of the franchisor”; and
• the agreement “governs the business relationship between the franchisor and the franchisee, including the relationship between them with respect to the goods or services to be supplied to the franchisee by or at the direction of the franchisor or an associate of the franchisor”.

Franchise IP

As defined by the CPA, and as understood in business, a franchised business is based on intellectual property (IP - “advertising schemes or programmes or one or more trade marks, commercial symbols or logos or any similar marketing, branding, labelling or devices, or any combination of such schemes, programmes or devices”) which the franchisor permits the franchisee to use.

The IP is essential to the identity of the business and how it is operated, and much of the value of the business is based on it. For that reason, franchisors, while allowing their franchisees to use the IP, and in fact insisting they do so, are also at pains to stress that they, and not the franchisees, are the proprietors of the intellectual property, that the franchisee cannot use it in any way not approved by the franchisor and, in particular, that the franchisee cannot sell or sub-licence the intellectual property.

Franchise agreement terms

This is invariably emphatically recorded in the franchise agreement. If the franchisee wishes to sell its business, the agreement makes it clear that the franchisee can only dispose of its fixed assets; the purchaser must enter into a new franchise agreement with the franchisor in its own right to be able to use the intellectual property.

To be allowed to use the IP, the purchaser must pay the franchisor a fee or royalty, as did the seller when it commenced its business.

Given those circumstances, it may be argued that, when a new franchisee starts operating a business, having acquired the equipment and taken over the premises of a former franchisee, it did not acquire the business of the former franchisee, but only the fixed assets of the business.

That being the case, it may be argued, the new franchisee will not be substituted for the former franchisee in terms of section 197 of the LRA, and therefore does not have to honour the employment contracts of the former franchisee’s employees.

Labour Court case

This was argued before the Labour Court in Motor Industry Staff Association and another v Eastvaal Motors (Pty) Ltd [2024], a case in which a company (MM), which had been carrying on a franchised business as a dealer in motor vehicles, had sold its assets and stock to the respondent, Eastvaal Motors (EVM).

The IP and goodwill of MM’s business had not been transferred to EVM as it was not MM’s to sell; it was up to the franchisors, Ford and Honda, to grant franchises to EVM to enable it to carry on the business.

MM and EVM argued further that it was not their intention to transfer the business of MM to EVM, so section 197 did not apply and therefore, the employment of the second applicant, an employee of MM, did not automatically transfer to EVM.

The court held that, for a transaction to fall within section 197 of the LRA, three elements were necessary –

• a transfer from one employer to another;
• the transfer of whole or part of a business; and
• transfer as a going concern.

Transaction analysis

In analysing the transaction, the court held that the intention of the parties was not the determining factor as to whether a transfer of a business has occurred; the facts and circumstances of each case must be considered. The court pointed out that several components of the original business were transferred, including –

• assets and infrastructure;
• stock;
• tools and equipment;
• lease agreement;
• customers and existing job orders.

The fact that the franchise agreements with the franchisors, Honda and Ford, could not be, and were not, transferred, and that EVM had to enter into new franchise agreements in its own right, was found by the court to be irrelevant.

Having regard to all the components of MM’s business that were transferred to EVM, there had been a transfer of the business for the purpose of section 197.

Job preservation prevails

What has become apparent over the years in the manner in which the Labour Court interprets disputes relating to Section 197, is that in true Labour Court style, substance prevails over form and uppermost for the court is job preservation.

The issue of job preservation has also found favour in the Constitutional Court in the manner it has pronounced on second generation outsourcing (as a form of a Section 197 transfer).

In every case where a franchisor awards a franchise to a franchisee, the franchisee will be required to enter into a franchise agreement with the franchisor. As a condition of the agreement, it will be required to acquire the necessary assets to carry on the business.

The Eastvaal judgment makes it clear that the fact that the franchisee has entered into an agreement in its own right with the franchisor does not automatically make it a “new” business; if the incoming franchisee has acquired the assets, and taken over the premises, from a former franchisee, it will in all probability have to take over the former franchisee’s employees as well.