McDonalds, Subway, Pizza Hut, KFC, Domino’s Pizza, and The Hard Rock Café – iconic brands, household names but above all, franchise behemoths. These franchises have made inroads to the farthest corners of the planet, from the barbed wire surrounding the single McDonalds in Cuba, Guantanamo Bay to Dominos’ Almond Citrus Seafood pizza in Vietnam. Four decades ago, Colonel Sanders introduced Kentucky Fried Chicken in Japan and this kickstarted the race for international franchising which has expanded into approximately 160 countries since.
The reasons for its growth around the world are essentially the same: the advantages accruing to both the franchisor and the franchisee, taken together with a growing middle class, a growing ‘youth market’ and increasingly western cultural hegemonic patterns of consumption1.
Even a cursory glance along the streets of India is evidence enough that India too has fallen prey to the franchising trend. McDonalds’ big yellow ‘M’ graces our highways from Mohali to Mangalore and the KFC in Arunachal Pradesh is a hit, proving that franchises are meeting a demand across cities in tiers 1, 2 and 3. One of the most prominent reasons for this growth in the franchising business is that India is home to approximately 136 Crore (1.36 billion) people and has the fifth largest economy in the world with its gross domestic product figures having crossed 2.8 trillion USD in 20192.
In a franchise arrangement, the brand owner; i.e. the Franchisor provides a third party; i.e. a Franchisee rights to sell, manufacture, promote goods or services or undertake any process identified by the franchisor by maybe using the business name, trademark, service mark, logo, and our technical know-how of the franchisor to conduct business under the existing brand name and business model.
In this article, we discuss prevalent practices in the franchise industry in India from a legal perspective and certain legal issues that one should consider at the outset of taking up a franchise or using the franchise model in India.
India Vs. Other Countries: Franchising Law
Franchising in India compared to in the US, parts of Europe, Japan or other developed nations, is not regulated by a specific statute governing the franchise model. In the absence of a specific statute, provisions governing franchises in India find its legal basis in a variety of other Indian laws, the Indian Contract Act 1872 being one that governs the contractual aspects of franchise agreements. Other Indian laws that impact franchise arrangements in India are foreign exchange control regulations (Foreign Exchange Management Act, 1999 (FEMA) along with the rules and regulations framed under the FEMA), competition laws (Competition Act, 2002), intellectual property statutes (Trade Marks Act, 1999; Copyright Act, 1957; Patents Act, 1970 and the Design Act, 2000), tax laws (Income Tax Act, 1961), data privacy laws (Information Technology Act, 2000), and dispute resolution laws (Arbitration and Conciliation Act, 1996; Specific Relief Act, 1963).
India Vs. Other Countries: Franchise Disclosure Requirements
As of February, 20203, there are 34 jurisdictions that have some form of franchise-specific law or regulation that requires the delivery of a disclosure document to a prospective franchisee before the prospective franchisee purchases the franchise. A franchisor under the Indian law is not subject to any pre-contract disclosure requirements nor any statutory obligation that requires it to provide any information to the prospective franchisee. In India, a general principle is followed that parties owe each other a duty of good faith and fair dealing, which can be interpreted to impose a pre-sale disclosure obligation. This however makes franchising a risky business in India and a franchisee should be sure to conduct a thorough due diligence of the franchise business and be doubly sure before concluding a franchising agreement.
Local Vs. International Franchising: Entry Strategy
Foreign franchisors can select from business structures that are commonly used for setting up a franchise business – grant of a single franchise per person or the grant of master franchise rights to one person, or a franchise agreement area wise. A foreign franchisor is not required to incorporate an entity in India, though franchisors do prefer to establish presence in India vide a subsidiary or a joint venture to exercise better control over the franchised business. For example, Subway has set up a subsidiary in India that manages all franchising rights in India and McDonald’s entered India through joint ventures with two Indian parties.
An Indian subsidiary of the franchisor ensures that the franchisor retains maximum control over the franchise business but also means that the franchisor needs to actively engage in day-to-day management of the franchisees. A joint venture arrangement is generally not a preferred structure for franchise arrangements because of the higher chance of disputes arising between the parties, case in point McDonald’s joint venture with Connaught Plaza4.
A franchisor looking to incorporate a subsidiary or a joint venture entity should keep in mind that this is subject to India’s foreign direct investment policy (FDI Policy) which prescribes details regarding entities that may be set up by a foreign national, the percentage stake of a foreign national/entity and the required approvals, for the same, along with conditions that must be adhered to by the Indian entity in the operation of its business. The JV agreement should also comply with the FDI policy, the Companies Act (2013) and any prevailing foreign exchange control regulations. A franchisor’s subsidiary or joint venture entity will also need to comply with all applicable laws of India such as employment, labour, tax laws, and privacy laws including any sector-specific laws.
For local franchisors direct franchising is a more commonly used method of franchising. This allows the franchisor, who is knowledgeable of the local market, to develop a successful franchise network and carry out due diligence of potential franchisees.
Present Vs. Not Present: Franchise Authority
Indian laws do not require the franchisor to be registered with any professional or regulatory body before establishment of a franchise system. This system of registration is however only prevalent in very few jurisdictions, the United States being one of them.
Do’s Vs. Don’ts: Franchising Agreement
The relationship between the franchisor and franchisee is governed by a contract; i.e. Franchise Agreement. In India, the general practice is to execute a comprehensive, usually fairly lengthy franchise agreement, which covers the licensing of any technology, process, know-how, trademarks and so on. For this franchise agreement to be valid and binding, essentials such as lawful consideration, free consent, lawful object and purpose, capacity of parties as set forth in the Indian Contract Act, 1872 must be check marked. We have set forth some important clauses of a franchise agreement that should be looked into at depth while franchising.
- Franchise Fees
A franchisor usually requires a franchisee to pay a fee. Fees that are typically payable to franchisors are an initial fee for joining, royalty fees on sales, renewal fees, franchise advertisement and marketing fees, training expenses, payments for other services. Penal interests are also usually payable on delayed payments. There is no cookie cutter method for calculating the fees or interest to be paid by the franchisee. In the case of payments to international franchisors, provisions of FEMA should be complied with.
The term of a franchise agreement is subject to the discretion of the franchisor and franchisee and there are no provisions that impose a minimum or maximum term.
- Termination Rights
It is important that the agreement provide for the rights of the franchisor on termination of the franchise arrangement especially due to default of the franchisee. Upon termination of the franchise agreement, does the franchisor have a right to either buy the entire franchise business, or to buy selected assets of the franchise business.
- Post-Termination Restrictive Covenants
Post-term restrictive covenants such as non-compete, non-solicitation, confidentiality are common in franchise agreements and are recommended to protect the franchisor’s trade secret and goodwill in the franchise business. Courts in India have recently enforced post-term non-compete provisions if “reasonable” and not a complete restraint of trade. Non-solicitation provisions are usually enforceable, both during the term and post-term.
- Dispute Resolution
Franchising transactions entered into between an international franchisor and an Indian franchisee may provide for non-Indian law and jurisdiction of courts outside India or by arbitration. When choosing an appropriate dispute resolution mechanism, it is important that the provisions enable the foreign franchisor to seek effective remedies against the franchisee in India. In respect of foreign venues for international commercial arbitration, the Indian Arbitration & Conciliation Act, 1996 confers jurisdiction on Indian courts to provide appropriate interim relief pending the arbitration, provided that the parties have expressly agreed to the same in the arbitration agreement. It is likely that interim relief may be required against the Indian franchisee to prevent misuse of intellectual property, the franchise systems, and other assets, thus making it essential for a franchise agreement to clearly mention that the franchisor retains the right to approach Indian courts to seek interim relief in India pending conclusion of arbitration proceedings. In absence of such express provisions, the franchisor may lose its right to seek interim relief from Indian courts5.
- Relief for Breaches
Relief that a franchisor or franchisee is entitled to depends on the terms of the franchise agreement as well as local laws governing the agreement. Indian law allows the non-defaulting party to seek relief in the form of damages, injunctions, and specific performance of contracts, depending on the nature of damage caused. The Indian Contract Act, 1872 states that a party that breaches its contractual obligations is liable to pay damages to the non-defaulting party for reasonable and foreseeable monetary loss caused to the non-defaulting party. Where monetary damages are not an adequate remedy for breach of a contract, a non-defaulting party may approach the competent court to seek specific performance of a contract.
Today we see that franchising in India has metamorphosed, with both foreign and domestic trademarks, signages, advertising slogans and merchandizing becoming familiar icons in the Indian landscape. However, in decades ensuing the liberalization of India’s economy in 1991, the rapid growth of the franchising industry outpaced it’s legislative or regulatory response. In spite of the astounding increasing year on year growth of the franchise industry and its tremendous prospective potential in India, we lack franchise specific regulations. The absence of franchise specific laws results in various challenges for franchisors and franchisees alike as can be witnessed in the legal battle fought between McDonalds and one of its Indian JV partners – Vikram Bakshi. Franchise specific regulations may just be the need of the hour to further spur the growth of the franchise industry.