Mater Franchising arrangements will be the flavor of the afternoon as it offers the franchisor the main benefit of the franchisee's understanding of the neighborhood 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 along with sustained economic growth; ever expanding market with a thriving class of urban consumers; quality consciousness amongst India individuals are a few of the factors contribution to franchising being increasingly used as a style by foreign companies for entering India for the initial time. An average master franchise arrangement enables the master franchisee to develop the business in certain territory under the franchisor's manufacturer and trademark with or without the right to manufacture these products relating with the franchisors' operating guidelines along with assured financial returns to the franchisor.
There is 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 a few lines from a report presented by the International Institute for the Unification of Private Law (UNIDROIT, an independent intergovernmental organization of which India is really a member) which states that "the building blocks of an effective franchising industry in just about any country is based on the existence of a "healthy commercial law environment" that has been defined together with a 'general legislation on commercial contracts, with an adequate company law, where there are sufficient notions of joint ventures, where intellectual property rights come in place and enforced and where companies can rely on ownership of trademarks and know-how in addition to on confidentiality agreements' ;.The Indian legal environment is characterized by each one of these key attributes, a well known fact established by ever expanding international franchise relationships with India.
To judge the necessity for a new legislation, let us first understand a few of the keys issues/concerns involving a franchising arrangement that generally results in potential disputes or disconnects involving the parties and how they're protected or may be protected within the realm of current Indian legislation:
(1) Licensing and Utilization of Intellectual Property Rights: IP rights are an intrinsic part of most franchising arrangements and every franchising agreement involves transfer of some type of IP right, either as a license of a trademark/service mark/trade name, or a copyright, or a patent, invention, design or a trade secrets. The method of use of the IP rights and their protection against misuse is among the most crucial concerns of the Franchisor. Some of the disputes that arise during implementation of the franchise agreement relate with the scope and purpose of the trademark license, exclusivity of use 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 use of the trademarks post termination, limited directly to utilize the trademarks for the purposes of disposal of pending inventory (in the lack of which the inventory may go waste), destruction of stationary containing trademarks/trade names, return and ceassation of use of IP rights. India already has a number of IPR related laws like the Trademark Act of 1940, Copyright Act, 1957, the Patent Act, etc that offer for extensive protection and enforcement mechanism for the intellectual property rights including permanent and mandatory injunctions against infringement and passing off. India can be a signatory to the international conventions on intellectual property rights like the Agreement on Trade Related Areas of Intellectual Property Rights (TRIPS), thereby offering protection to trademarks or brands, in addition to copyright and designs of the foreign franchisor. Recognition and protection can be extended to service marks in India enabling the foreign franchisor to license its mark to a franchisee to provide the services synonymous with him to the consumers in India. IPR laws have also been recently amended to produce 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's therefore evident it is not the lack of IPR laws or its enforcement that cause potential disputes but lack of carefully drafted and negotiated agreements involving the franchisor and the franchisee linked to IPR issues that cause potential IP related litigations.
(2) Obligations of Franchisor and Franchisee: Another crucial issue that cause potential disputes amongst the parties relate with 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 steadfastly keep up 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 these products 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 regarding 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 all or any the franchise arrangements and offers up specific parameters for legally enforceable agreements, lawful object and purpose of 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's not the lack of commercial law but lack of carefully drafted agreements that generally fail the parties. It's therefore important that the 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 this doesn't demand a specialized law that is already in existence in the form of the Indian Contract Act but a reasonably detailed and well negotiated contract. Whatever the case a good specialized law can only provide a wide frame work, the facts and the nitty-gritty of the relationship needs to be always contractually agreed.
(3) Payment Terms: Delay in payment or non-payment of license and/or royalty payments could be another part of concern for the franchisor. Which means way and the changing times at which such payments can be made must certanly be carefully addressed. In the case the franchisor is really a foreign entity, applicability of prior approvals and terms and conditions for foreign remittance should really 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. As an example, 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 need prior government approval. Detailed tax laws are actually in place to deal with the withholding tax liability on such payments which might get reduced dependant on the provisions in the applicable double taxation avoidance agreement. The main element issue is that both franchisor and franchisee should be produced aware beforehand on the payment and taxation related regulations.
(4) Duration, Renewal and Termination and its Consequences: Another serious concern of a franchisee is the extendibility of the word of the franchising and licensing agreement. Typically, extension of the word is the sole discretion of the franchisor based on annual sales turnovers and performance of the franchisee. Quite often a franchisee struggles with the franchisor for renewal of the word especially once the franchisor is lined up with a number of other franchisees offering higher royalties. The other possible scenario is when 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 particular abrupt termination or non-renewal situations. To begin 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. This is regardless of 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 lack of specific clause authorizing and enabling either party to terminate the agreement, from the nature of the agreement, that is private commercial transaction, the same could be terminated even without assigning any reason by serving an acceptable notice.
Keeping this in perspective, it is 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 under the Indian Contract Act, it is advisable to stipulate liquidated damages or substantial termination fees payable by the franchisor on breach of express termination provisions. Suitable exit options also needs to be provided if both parties are not ready to continue. Some of the key post termination issues that cause 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. DUI While there are adequate IPR protection laws against misuse and consequent infringement/passing off actions along with rights for permanent and mandatory injunctions under the Specific Relief Act, it is very important to provide provisions constraining the franchisee from utilising the IP rights of the franchisor and return of most confidential information obtained during the word of the agreement.
(ii) Protection of franchisees against negative covenants particularly associated with non-competition post termination. It must be understood that the negative covenant restraining the franchisee from directly or indirectly undertaking business competing with the business of the franchisor through the subsistence of the agreement may not be violative of section 27 of the Contract Act, but post termination negative covenants may not be enforceable under Indian laws. Therefore protects the franchisee against unreasonable negative covenants imposed by the franchisor post termination.
