Protectable Interests for Franchisors - The case of the not so Perfect 10

 

Today I was asked by my colleague Lita Miti-Qamata to present on a case in her monthly discussions that had a number of handy lessons for stakeholders in the franchise industry, including lawyers.

 

It is a Pretoria High Court decision involving the cancellation of the Perfect 10 franchise in a prominent shopping centre in Menlyn, Pretoria and the scope of the protectable interest of the franchisor after termination. In lay speak, whether a franchisor can prevent an ex franchisee from competing at the same location under a different name and operating system?

 

 

ENJOY BEAUTY (PTY) LTD V PETROVIA AND SMIT BEAUTY SALON AND ORS Case No: 67970-1/2016

 

Background

 

The applicant/franchisor provides health and beauty services operated through a franchise network. One of the brands is symbolised by the trade mark PERFECT 10 and its associated look and feel. The franchise operation sold the SKINDERM range of products and developed the “HeadStart salon management system”. The franchised IP is owned by The Imbalie Group, who owns the applicant.

 

 

Perfect 10 Branding & SkinDerm Product:

 

 

The respondent is a franchisee who cancelled the franchise contract on 15 August 2016. The primary reasons for its dissatisfaction were the applicant’s insistence on its use of the HeadStart salon system and sale of SkinDerm products only. It claimed that the former was inferior to its current system and the latter would be commercial suicide (as it sold other products).

 

Applicant’s claim for trade mark infringement

 

This was rejected by the courts as being premature. The basis, simply put, is that when the application was launched the applicant claimed both for the store to be “handed over” signage intact, and in the alternative, for the signage to be removed etc. It was only upon election of one of the alternatives (or judgment) that the respondent would know where it stood. Hence the position that the respondent found itself in, was of the applicant’s own making and the claim for infringement premature, according to the judge.

 

 

The judge unfortunately incorrectly applies the law here (para 17-18). He states that because the respondent had no intention of infringing the trade marks (because of the franchisor's confusing requests), there is no trade mark infringement. The correct reasoning that the judge should have used in coming to that conclusion, is that the franchisee's continued use of the trade marks was authorised (because of the franchisor's confusing requests) i.e. the use was not unauthorised as required by the Act. "Intention" has no part to play when considering trade mark infringement. It is questionable though whether the "confusion prayers" of the applicant, amount to "consent" but that was not canvassed..

 

The Restraint of Trade

 

There are two legs to this enquiry:

 

• Whether the letter of suretyship bound the third respondent (the application against the second respondent having been withdrawn) to the restraint of trade; and
• The scope of the restraint of trade.

 

Concerning the suretyship, the court gave short shrift to the issue stating that it had been signed prior to the relevant franchise agreement and not simultaneously with it, as the wording required. In addition, that the intention of the suretyship was to provide ongoing indemnification relating to monetary obligations and not to hold the franchisee to the restraint.

 

The judge is correct here and the lesson is to pay particular attention when drafting and agreeing documents. The word "simultaneously" means exactly that, and much like the formalities required for a confirmatory affidavit, it makes no sense to sign a separate suretyship document before the main agreement is signed. The scope of the suretyship should also spell out the obligations they apply to.

 

The analysis of the second leg was more complex. Under RSA law the position on restraints is set out in the well known Magna Alloys case which is summarised in para 27.

 

The judge establishes that that the restraint was reasonable both in time frame (1 year) and geographical extent (5kms).  The question was therefore, what exactly could be restrained. What was the protectable interest?

 

Applied to this matter, the judge held that it was the “operations manual and operating system, their own specific product, branding and logos and everything that constituted the applicant’s trade marks.” (para 34) Absent of this, in this case, the applicant had no protectable interest. The effect of this is that respondents could set up a competing business within one year, within 5kms without falling foul of the restraint.

 

The applicant’s request for interim relief was dismissed in its entirety, with costs.

 

The case will have been a blow for Perfect 10 in that it is foreseeable that the ex franchisee could simply remove the signage, stop using the product, branding and logos and continue to operate from the same store. It would mean too that it could take advantage of the goodwill in the location - the so-called "habit effect" of consumers knowing where to get their "nails done" simply by location of the store. 

 

Yet, the judge is correct, the agreement did not include "location" as part of the goodwill, the ex franchisee did not only sell franchised products and use franchised systems (it had its own) and the franchisee, it appears, was also the lessee of the space. In these circumstances, without additional evidence that showed the location to be part of the protectable interest or at least any interest beyond those noted by the judge, that goodwill belonged to the franchisee.  

 

This does not mean that goodwill in a location and restraints cannot be enforced in agreements. The lessons are to pay attention to them in the drafting and to secure as much clarity in the wording as possible, when entering into the agreement in the first place. This would also apply to non disclosure agreements, co-existence agreements and ordinary licenses. In addition, from a franchisor's perspective, control the lease.