Why a franchisor should conduct anti-bribery & corruption due diligence on franchisees

When supplying an independent owner with the right to use an established business, a trade name, trademark, proprietary business knowledge and business system, it is essential for a franchisor to conduct a comprehensive background due diligence on that proposed owner.

South Africa has over the last few years seen a substantial increase in matters relating to ethics, bribery and corruption (ABC).  While ABC considerations may not have previously paid a substantial role in background due diligence, it is becoming increasingly important that franchisors seek comfort that an independent owners (including their companies entering into the franchising agreement) have not been suspected of, or have been found to engage in, unlawful conduct.

While the question of liability by a franchisor for a franchisee’s ABC-related misconduct has not been tested in South African courts, franchisors should not, in the current regulatory climate, sidestep conducting the appropriate searches in the hope that criminal and civil liability will not be extended to it.

Other than a focus on criminal and civil liability, reputational harm has long been a risk identified by franchisors when it comes to the conduct of the franchisee.  A reporter reporting on ABC-related misconduct by a franchisee (whether or not that misconduct relates to the franchise) will likely refer to the name of a well-established franchise in an article.

A suitable ABC due diligence should be conducted before entering into a franchising agreement and then periodically, and should include the following:

  • Engaging with the franchisee to complete a comprehensive questionnaire dealing with ABC aspects.
  • Politically exposed persons or other political relationships of the shareholders and directors of the franchisee.
  • Background investigations of the franchisee, its directors and shareholders consisting of reviews of adverse media and reputational issues through public records, news and media reports and other open source intelligence-gathering methods.
  • An understanding of potential third parties, intermediaries and subcontractors to be engaged by the franchisee.
  • Commitment by the franchisee to comply with appropriate anti-bribery and corruption and anti-money laundering laws (including where relevant, with the US Foreign Corrupt Practices Act and UK Bribery Act).

On conclusion of an ABC Due Diligence, a franchisor should also ensure that controls are put in place to mitigate ABC risks.  Appropriate steps should include:

  • Enforcing participation with a compliance program which takes into consideration the requirements of anti-bribery and corruption and anti-money laundering laws. This may include, for example, reference to influencing government officials, other fraudulent misconduct and the appointment of third parties.
  • Providing the appropriate ABC training to the franchisee, including to management of the franchise.
  • Implementing controls to raise red flags and ensuring that resources are allocated to regularly monitor, report on and document compliance by the franchisee.
  • Implementation of a system to enable confidential reporting without fear of retaliation.
  • Ensuring that the franchisee has a comprehensive internal accounting and record-keeping systems in place, with the appropriate mechanisms put in place.