India: Legal Aspects To Be Considered

Franchising is a popular way of conducting business as it is mutually benefiting. For the franchisor, it gives him the benefit of the franchisee's knowledge of the local environment; provides access to local sales and marketing expertise and channels; reduces investment and regulatory compliances etc. For the franchisee, they get to develop the business in a territory under the franchisor's established brand name in accordance with the franchisor's operating guidelines with assured business format and expected financial returns.

There is lack of a well thought out franchising arrangement that can lead to potential disputes among the parties and here are a few pointers to minimize its commercial and legal risks:

1 Licensing and Use of Intellectual Property Rights ("IPR"):

IPRs are an integral part of franchising and involves license of a trade mark, copyright, patent, design or trade secrets. Lack of clarity can lead to open issues such as what is the intended scope and purpose of the license, whether any exclusivity of use is granted and if yes, is it limited to a geographical area or a product/service, is the license for a fixed term andj liable for automatic renewal, what are the post termination rights and obligations related to unauthorized use of IPR and many more such issues. India has a host of IPR related laws such as the Trade Marks Act, 1999, Copyright Act, 1957 etc., that provide for extensive protection and enforcement mechanisms for IPRs and it is in the best interest of both the parties to carefully cover the essential terms in a franchise agreement.

2 Exclusivity and Territorial rights:

Another open issue that sometimes create heartburn is on the exclusivity rights of the franchisee as to the territory, goods and services that can be provided, applicable sales channels etc. Territorial and sales channel exclusivity are extremely significant considering the commercial implications on the franchisee, especially if the franchisor requires payment of a minimum assured return.

Therefore, clarity on such terms is important. For instance, in a dispute between a franchisee and Lakme , the franchisee had contended that the franchisor's proposed salon in Gurgaon breached the franchisee's territorial exclusivity. But lack of exclusivity in the agreement for the entire area of Gurgaon made the Hon'ble Bombay High Court to observe that there was no material on record to point that the franchisor's proposed salon fell within the prescribed perimeter even though it was within the 'territory' and the prayer of the franchisee to temporarily restrain/ injunct the franchisor from opening new salons pending arbitration initiation was not accepted. 

3 Mapping Expectations and Obligations of Franchisor and Franchisee:

Another crucial issue that leads to potential disputes amongst the parties relates to failed expectations and adherence to obligations by a franchisee such as the lack of adherence to specific operating guidelines, investment and infrastructure requirements, failure in meeting targets and financial returns to the franchisor. Similarly, franchisor's obligations related to periodic training and ongoing support, upgrading the franchisee with new methods and technologies, joint marketing and advertising campaigns, sharing of advertising costs are crucial to the franchisee and needs to be detailed out.

There is no separate franchise law in India and the Indian Contract Act, 1872 ("ICA") is applicable to the Indian franchise relationships which provides parameters for legally enforceable contracts, due performance, consequences of breach, liquidated damages etc. It is therefore important that the parties try to bridge all potential gaps by identifying potential "what if?" situations. Possibly the most famous franchisorfranchisee dispute in India in recent memory is that of McDonald's with one of its franchisees in India. This dispute, contested before multiple Courts/ Tribunals, broadly covers most of the issues discussed here ranging from termination by the franchisor of the joint venture to cessation of use of McDonald's IPR by the franchisee.

4 Payment Terms:

The manner, conditionalities and periodicity of payment of license fee and/or royalty to the franchisor must be carefully addressed to avoid the common non-payment issues. The parties should be aware of the withholding tax liability, imposition of goods and services tax, grossing up of fee liability on such payments etc. In the present pandemic situation impacting business sustenance continuity, the parties must consider incorporation of a detailed force majeure clause and cover discounts and discontinuation of payment in such a scenario.

5 Duration, Renewal and Termination and its Consequences:

The duration/term of the franchise agreement as also its renewal which may or may not be automatic based on achievement of certain targets/ milestones may also be considered. Under Indian laws, private party agreements including franchise agreements are terminable in nature. This is regardless of the fixed non-terminable tenure stated in the franchise agreement. It is therefore advisable for the franchisee to negotiate for an openended term (i.e., without a fixed term) with suitable termination clauses limited to breach with notice for cure (i.e., no termination for convenience by the franchisor), stipulate liquidated damages with limitation of liability, liability of payment of termination fees for wrongful termination by the franchisor, suitable exit options in the event of breakdown of relationship etc.

6 Post Termination Issues: 

SOME OF THE COMMON POST TERMINATION DISPUTES INCLUDE :

1. Misuse of IPR and confidential information/ trade secrets by franchisee. While there are various IPR protection laws against misuse and consequent infringement/passing off actions together with rights for permanent and mandatory injunctions under the Specific Relief Act, 1963, it is important to provide provisions restraining the franchisee from using the IPR of franchisor and return of all confidential information.
2. Negative covenant restraining the franchisee from directly/indirectly undertaking business competing with the franchisor's business post termination. Interestingly, negative covenants during the subsistence of the agreement are enforceable but post termination restraints are violative of section 27 of the ICA being agreement in restraint of trade and hence void and the franchisor would have tough time enforcing such covenants.
3. Inventory handling is a definite pain area post termination. It is advisable to specify provisions related to re-purchase of the unsold inventory and sale of unsold products by the franchisee within an agreed time. Vague clauses such as inventory shall be disposed as per mutually agreed terms should be strictly avoided. 

7Governing laws and implementation of laws:

Choice of governing law, place of jurisdiction, dispute resolution through arbitration vs. courts are crucial provisions. Often, jurisdictional hardships deter the parties from taking corrective actions against breach of agreement. International franchisors may prefer arbitration at a foreign venue, but Indian franchisors should opt for time bound arbitration within India. 

I am aware that there would be certain concerns regarding the bargaining power of the franchisee to firmly negotiate the agreement against an established franchisor. But in addition to the rights under the ICA, the franchisee is protected under the consumer protection laws that enable her to file complaints with the consumer forums for unfair or restrictive trade practices adopted by franchisee in supply of goods or services. Similarly, anti-trust or restrictive trade practices promoted by the franchise arrangement can be addressed through the Competition Act, 2002. Tortious liability could also arise out a franchise relationship in the event of negligence leading to loss or damages to third parties.

In essence, while all the issues cannot be predicted beforehand, it is important that most of the crucial issues discussed above are negotiated and covered under a carefully drafted and negotiated franchise agreement.

Originally published by Franchising In India

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