Franchise Agreements: Clauses, Enforceability & Legal Sanctity in India
A franchise agreement is a contractual relationship, just like another contract. Similar to any other contract, a franchise agreement has two parties, namely, the franchisor and the franchisee. The franchisor leads his Intellectual Property Rights and the business system to the franchisee, who pays a royalty and a fee for conducting the business with the brand name of the franchisor. Once the franchisee commences the business, the franchisor aids the franchisee in conducting the business. Franchise agreements serve two purposes –
a) Promotes a product.
b) Promote a business system/format.
It is interesting to note that there is no specific legislation that governs franchise agreements in India. Its legal position can be traced through various legislations which gives it the legal effect and makes the contract binding.
Fundamentally, every franchise agreement is a contractual relationship between the two parties and therefore the essential elements of a contract such as lawful consideration, competent parties, free consent, offer and acceptance, and lawful object must be present to be legally enforceable.
Legal issues surrounding Franchising –
Sometimes in franchise agreements, the relation between franchisor and franchisee could be deemed an agency, as defined under Section 182 of the Indian Contract Act, 1872. If the franchisee is authorized to enter into contracts with third parties in place of the franchisor, the relationship could be deemed an agency. The reason it becomes crucial to determine the relationship between the franchisor and the franchisee, the former could become liable for the acts of the latter irrespective of the fact if such an act was carried out in the ordinary course of business or not. Further, in Union of India v. Moti Lal, (1962) A.P. 384, it was held that a third party would not be liable if the authority of the franchisee is limited unless he is aware of such limitation.
The franchisors have to be careful in setting up their royalties and other fees, which they must discuss with their advisors. Proper set-up of royalty payments permits both the franchisors and the franchisee to succeed in the long run, including financial success.
Transfer of Intellectual Property Rights (IPR) lies at the core of Franchise agreements. Due diligence of the Intellectual Property Rights being licensed under the agreement is important. Further, such licensing should not violate the Intellectual Property Rights of any third party and it must indicate the exact nature and extent of the rights so granted. Such Intellectual Property Rights, which have been transferred, must also not be misused in any manner. In Getty Petroleum Corp v. Island Trans. Corp., 862 F. 2d10 (2d Cir. 1988), it was held that the franchisor has to ensure that the franchisee is in no way using the trademark of the franchisor for any purpose falling outside the agreement.
Under the Consumer Protection Act, 1986 and the Consumer Protection Act, 2019, consumers can file a complaint with respect to unfair or restrictive trade practices for any deficiencies in the goods or services before the consumer forums. The same can happen in a franchise agreement where both the parties could be held liable for defective goods supplied by the franchisee. Even, the franchisor can be sued by the franchisee or the sub-franchisee acting as the consumer(s). Thus, documenting provisions to minimize such liabilities is essential.
The Monopolies and Restrictive Trade Practices Act, 1969 prohibits monopolistic trade practices [Section 2(i)] and restrictive trade practices [Section 2(o)]. Thus, the parties to a franchise agreement must ensure that their practices must not fall in the aforementioned areas, or else an injunction can be granted to curb such practices [Section 12(a)] and award compensation for the losses and damages suffered [Section 12(b)]. Examples include selling a product below the Minimum Retail Price, false representation of products and distortion of Intellectual Property Rights. Further, the Monopolies and Restrictive Trade Practices stipulate registration of agreements relating to restrictive trade practices. In ReGarware Plastics Polyester Limited., RTP Enquiry No. 1272/1987, Order dated 5-10-1987, the MRTP Commission held that a clause in a dealership agreement that appointment of dealers can only be carried out with prior permission of the manufacturers or the suppliers would come under the definition of restrictive trade practices. However, in re United Breweries Limited and Indo Lawenbrau Breweries Limited, the commission held that where there was a restriction on the manufacturing of beer, the agreement would be void, but the commission also insisted to rephrase the clause rather than deleting the entire agreement. Further, the Competition Act of 2002 is enacted and which has replaced the Monopolies and Restrictive Trade Practices Act, 1969 and the laws with respect to competition are governed under this law.
Many franchisors also make the mistake of setting up a very high fee and they must introspect themselves as to what the franchisees would get in return for this initial fee. The franchisors must note that most successful franchisees operate on finding good prospects – such as finding a healthy promoter for the franchise, paying royalties on time and non-misuse of brand name(s) and Intellectual Property Rights. Misuse of Intellectual Property Rights and other issues surrounding the franchise agreement can lead to disputes in the long run and make the business relationship unhealthy.
The Standards of Weights and Measures Act, 1976 comes into picture when a franchising agreement relates to the sale or distribution of goods by weight, measure or number. According to this Act, all commodities, which are to be sold in packages, must adhere to certain norms and must have certain declarations, which also includes all exported and imported goods.
The provisions of the Companies Act, 2013 and other rules on companies in India become applicable if the franchisor and the franchisee is a “company.” Moreover, the income of the franchisor or the franchisee would be subject to the taxes imposed on the companies. If the franchisor intends to enter into a joint venture with the franchisees, it has to comply with the applicable regulations.
The Foreign Exchange Management Act, 1999 would become applicable if there is an International franchise agreement between a resident of India and a non-resident. As per the rules framed under the Foreign Exchange Management Act, 1999, approval of the Reserve Bank of India is needed for making remittances outside India for the use and/or purchase of a trademark or franchise in India. Further, there is no cap imposed on the lump sum payments, which can be made by Indian franchisees to the ones outside India.
Labor law issues could be very important in determining the extent of control the franchisor has over the operations of the franchisee. For example, in the US in Fugazy Continental Corp. 231 N.L.R.B. 1344 (1977), the court was of the opinion that since the franchise was for a temporary period, the franchisor had complete discretion in renewing, determining the level of insurance, fare structure of the franchisee, who in this case were limousine drivers. However, a conflicting opinion in Kallmann, 245 N.L.R.B. 78 (1979), the court dealing with restauranteurs, held that franchisees were independent contractors since they chose the suppliers, determined the prices, and hiring decisions.
What are the problems faced by Franchisors and Franchisees in India?
• Franchisors often face difficulty in looking for a trustable person as the franchisee.
• Franchisors are often sceptical of losing goodwill and/or misuse of their brand.
• Franchisors are often sceptical of the franchisee acting independently and arbitrarily and violating the norms of their business relationship.
• Franchisors often suffer from non-disclosure of accurate information in calculation of franchise fees.
• Franchisee’s heavy dependence on the franchisor may affect the personal decisions, profitability and business operations of the franchisee.
• Huge capital investment and consideration for using the invention, brand name, business, and the services of the franchisors.
Key clauses for a Franchise Agreement –
• Intellectual Property
• Grant clause
• Payment clause
• Obligations of the franchisor and franchisee
• Assignment/Cession/Alienation of rights
• Termination and after termination clause
• Restraint of trade
• Confidentiality clause
• Provisional period
Post the economic liberalization of 1991, several foreign companies/global business houses have strengthened their foot hole in India. At present, the business and commercial laws govern the franchise agreements in India. A firm step was taken in 1999, by establishing the Franchising Association of India, acting as the body, which represents the interests of franchisors, franchisees, vendors, etc. Franchising has been at its peak. It has 4,000 brands from different sectors, be it small-scale business or large-scale businesses, ranging from food, health, entertainment, finance, retail, travel etc. It is estimated that franchising will reach 20% by the end of 2025.
Authored By: Adv. Anant Sharma & Mayank Barman