Mater Franchising arrangements will be the flavor of the afternoon as it offers the franchisor the benefit of the franchisee's knowledge of the local environment; provides usage of local sales and marketing expertise and channels; reduces investment; requires negligible government approvals; provides freedom from recruitment of local workforce and consequently lowers the financial risk of the franchisor. The present regulatory restrictions on retail trading by foreign companies in conjunction with sustained economic growth; ever expanding market with a thriving class of urban consumers; quality consciousness amongst India consumers are some of the factors contribution to franchising being increasingly used as a design by foreign companies for entering India for the initial time. A normal master franchise arrangement enables the master franchisee to produce the business in certain territory underneath the franchisor's manufacturer and trademark with or without the right to manufacture the merchandise relating with the franchisors' operating guidelines in conjunction with assured financial returns to the franchisor.
There is a lot of discussion on the requirement of enacting a specialized law to regulate this growing sector in India. Before I proceed with my thoughts about them, I would like to quote several lines from a report presented by the International Institute for the Unification of Private Law (UNIDROIT, an independent intergovernmental organization that India is a member) which states that "the inspiration of an effective franchising industry in virtually any country is based on the existence of a "healthy commercial law environment" which has been defined as one with a 'general legislation on commercial contracts, with a satisfactory company law, where you will find sufficient notions of joint ventures, where intellectual property rights have been in place and enforced and where companies can depend on ownership of trademarks and know-how as well as on confidentiality agreements' ;.The Indian legal environment is characterized by every one of these key attributes, a fact established by ever expanding international franchise relationships with India.
To judge the need for a new legislation, let's first understand some of the keys issues/concerns involving a franchising arrangement that generally leads to potential disputes or disconnects between the parties and how they are protected or could be protected within the realm of current Indian legislation:
(1) Licensing and Use of Intellectual Property Rights: IP rights are an intrinsic part of franchising arrangements and every franchising agreement involves transfer of some form of IP right, either as a license of a trademark/service mark/trade name, or perhaps a copyright, or perhaps a patent, invention, design or perhaps a trade secrets. The method of usage of the IP rights and their protection against misuse is one of the most crucial concerns of the Franchisor. A number of the disputes that arise during implementation of the franchise agreement relate to the scope and intent behind the trademark license, exclusivity useful and geographical scope, protection of confidentiality, extent of transfer of the know-how, misuse and damage caused to the brand and goodwill of the franchisor, etc. Similarly, post termination related issues include unauthorized usage of the trademarks post termination, limited right to use the trademarks for the purposes of disposal of pending inventory (in the absence of that your inventory may go waste), destruction of stationary containing trademarks/trade names, return and ceassation of usage of IP rights. India already has a number of IPR related laws such as the Trademark Act of 1940, Copyright Act, 1957, the Patent Act, etc offering for extensive protection and enforcement mechanism for the intellectual property rights including permanent and mandatory injunctions against infringement and passing off. India can also be a signatory to the international conventions on intellectual property rights such as the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS), thereby offering protection to trademarks or brands, as well as copyright and designs of the foreign franchisor. Recognition and protection can also be extended to service marks in India enabling the foreign franchisor to license its mark to a franchisee to supply the services synonymous with him to the consumers in India. IPR laws have been recently amended to create them compliant with exclusive right obligations under TRIPS and accordingly, the laws meet international standards for IPR protection. Even the Indian courts are very sensitive and proactive pertaining to enforcement of infringement actions. It is therefore evident it's not the absence of IPR laws or its enforcement that lead to potential disputes but not enough carefully drafted and negotiated agreements between the franchisor and the franchisee linked to IPR conditions that lead to potential IP related litigations.
(2) Obligations of Franchisor and Franchisee: Another crucial issue that lead to potential disputes amongst the parties relate to implementation of the obligations of a franchisee like the duties and services to be rendered by the franchisee, the investment and infrastructure of the franchise, adherence to specific operating guidelines or manual to maintain uniformity, reporting requirements, quality maintenance of the product or services delivered; creation of an agency between franchisor and franchisee, appointment of sub-contractors to manufacture and sub-franchisee to offer the merchandise and franchisor and franchisee's liability owing to their acts/omissions; meeting of annual market penetration targets; minimum stock purchase/import obligations; financial returns to the franchisor, including royalty and fee. Similarly, obligations of the franchisor linked to periodic training as to the conduct of business, upgrading the franchisee with new methods and technologies, ongoing support, recommendations on general operational, management, accounting and administrative practices, joint marketing and advertising campaigns, sharing of advertising costs generally cause heart burns to the franchisee.
The Indian Contract Act, 1872 is applicable to any or all the franchise arrangements and makes for specific parameters for legally enforceable agreements, lawful object and intent behind an agreement, lawful consideration for an agreement, performance of an agreement, statutory interventions in unfair or unconscionable transactions, consequences of fraud, misrepresentation and undue influence, voidability and rescission/repudiation of agreement, contracts in restraint of trade, contingent and conditional contracts, performance of reciprocal promises, discharge and frustration of contracts, consequences of breach and rights linked to liquidated damages, enforcement of indemnification rights, agents and principal relationship and obligations thereto. It is not the possible lack of commercial law but not enough carefully drafted agreements that generally fail the parties. It is therefore important that a franchisee tries to bridge all potential gaps by identifying and analyzing "what if?" situations keeping in perspective the franchisee's financial, technical, manufacturing, marketing, human resource, sales and business planning capabilities.
All of this doesn't need a specialized law which is already in existence in the proper execution of the Indian Contract Act but a fairly detailed and well negotiated contract. Regardless even a specialized law can only just provide a wide frame work, the details and the nitty-gritty of the relationship has to be always contractually agreed.
(3) Payment Terms: Delay in payment or non-payment of license and/or royalty payments could be another section of concern for the franchisor. Therefore the way and the changing times of which such payments can be made must be carefully addressed. In case the franchisor is a foreign entity, applicability of prior approvals and terms and conditions for foreign remittance should be informed to the foreign party. The Foreign Exchange Management Act, 1999 and the Regulations made there under specifically address the outbound payment related issues. For instance, an Indian franchisee can remit royalty towards license of trademark upto the quantity of 1% of domestic sales and 2% of exports without prior government approval. If the licensor also provides technical understand how to the Indian licensee, the Indian company can remit royalty upto 5% of domestic sales and 8% of exports and lump sum payment of upto US$ 2 million without prior government approval. Payment of royalty above the percentages specified above would want prior government approval. Detailed tax laws are actually in position to manage the withholding tax liability on such payments which can get reduced dependant on the provisions in the applicable double taxation avoidance agreement. The important thing issue is that the franchisor and franchisee should be manufactured aware before hand on the payment and taxation related regulations. DUI
(4) Duration, Renewal and Termination and its Consequences: Another serious concern of a franchisee could be the extendibility of the word of the franchising and licensing agreement. Typically, extension of the word is the sole discretion of the franchisor centered on annual sales turnovers and performance of the franchisee. Quite often a franchisee struggles with the franchisor for renewal of the word especially when the franchisor is arranged with a number of other franchisees offering higher royalties. One other possible scenario is each time a franchisee is suddenly informed of an abrupt termination of the franchise agreement leaving the franchisee with costs of salaries, infrastructure and interest on working capital and other debts. Now do we want a law to tackle with this specific abrupt termination or non-renewal situations. To start with, it should be clearly understood that all agreements entered into between private parties (whether under franchise domain or some other commercial arrangements) are terminable in nature. That is regardless of the terms in the franchise agreement that the contract is interminable. The Indian Contract Act 1872 and the Specific Relief Act, 1963 supported by various Supreme Court judgments are clear that even yet in the absence of specific clause authorizing and enabling either party to terminate the agreement, from the nature of the agreement, which is private commercial transaction, exactly the same could be terminated even without assigning any reason by serving a fair notice.
Keeping this in perspective, it's advisable to negotiate for an open ended term (i.e., no fixed term) agreement with suitable termination clauses on breach with adequate notice period for rectification of breach/default. Though non-provision of the agreed notice will render the franchisor liable for damages underneath the Indian Contract Act, it's advisable to stipulate liquidated damages or substantial termination fees payable by the franchisor on breach of express termination provisions. Suitable exit options must also be provided if both parties are not ready to continue. A number of the key post termination conditions that lead to potential dispute and are adequately protected by the existing Indian laws include:
(i) Misuse of IPR rights and Confidential Information post termination is generally a mater of concern for the franchisor. While you will find adequate IPR protection laws against misuse and consequent infringement/passing off actions in conjunction with rights for permanent and mandatory injunctions underneath the Specific Relief Act, it is essential to supply provisions constraining the franchisee from using the IP rights of the franchisor and return of confidential information obtained during the word of the agreement.
(ii) Protection of franchisees against negative covenants particularly relating to non-competition post termination. It should be understood that a negative covenant restraining the franchisee from directly or indirectly undertaking business competing with the business of the franchisor through the subsistence of the agreement might not be violative of section 27 of the Contract Act, but post termination negative covenants might not be enforceable under Indian laws. As a result protects the franchisee against unreasonable negative covenants imposed by the franchisor post termination.
