Franchising & Licensing – A Successful Way to Do Business in India

Franchise rightfully claims to be the wave of future business in India. A huge consumer base of over a billion people, including a thriving class of urban consumers who have significant disposable income with quality and brand awareness, and the human resource appeal that the Indian economy holds have been instrumental in attracting foreign companies to attract the country. Although the franchising business in India has seen an impressive growth of around 30-35% over the past 4-5 years with an estimated annual turnover of US$4 billion, this is just a fraction of the potential that India can offer. The Indian Franchise Association estimates that there will be at least 50,000 franchises in the Indian market in the next five years.

Franchising is a way of doing business and involves the use by a person (“Franchisee”) of the business model, name, trade dress, image and business identity of another person (“Franchisor”), together with their confidential information, under a License Know- how to use its intangible assets in a specified territory for a specified period of time with or without a guaranteed financial return to the franchisor.

A typical franchising agreement offers the franchisor the benefit of the franchisee’s local knowledge; Access to local sales channels and marketing expertise; minimum capital investment; minimal regulatory approvals; fewer staffing issues; accelerated network growth and likely profitability.

There are three distinct franchising models – product distribution franchising, which involves cooperation for the distribution of goods, primarily in retail; trade name franchising, in which the franchisee uses the franchisor’s brand/company name to sell its own products or services, and business format franchising, a combination of the other two types of franchising, in which the brand/company name of the Franchisor is used to distribute goods or services of the Franchisor. Today the business format is a preferred model with more than 1,150 national and international franchise systems in India.

LEGAL FRAMEWORK

India has no consolidated franchise specific legislation. Some important laws affecting franchising in India are Indian Contract Act, 1872, Competition Act, 2002, Trademarks Act, 1999, Copyright Act, 1957, Consumer Protection Act, 1986, Labor Codes, Tax Codes and The Foreign Exchange Management Act, 1999. Key contractual and legal issues that may affect a potential franchise relationship include:

(a) Enforcement of Non-Compete. An important issue in this context is the franchisee’s non-compete obligation either during the franchise relationship or after the relationship has ended. A non-competition clause falls within the scope of trade restrictions under the Indian Contracts Act 1872.

Under Indian law, a contract which constitutes restrictions on trade cannot be enforced unless (i) it is equitable between the parties; and (ii) it is compatible with the public interest. While non-compete clauses are generally enforceable during the franchise relationship, post-termination negative non-compete clauses that prevent the franchisee from entering into similar agreements for similar goods and services are usually considered unenforceable unless it passes the reasonableness test.

(b) Payment Terms and Taxes. Remittance to a foreign company is governed by the Foreign Exchange Management Act 1999 and regulations made under it. An Indian franchisee is entitled to remit royalties for the licensing of trademarks or technical know-how with no limitation on the percentage or duration of royalties payments.

Payment made to the Franchisor is subject to withholding tax at 10% of the total royalty or fee as defined in the India-Germany Double Taxation Treaty. Services provided by a franchisor to a franchisee would also be subject to service tax in India at 10.30% of the gross fee payable to the franchisor. If the franchisor is a foreign company, the service recipient is itself treated as a service provider for payment of service tax in India.

(c) Term, Renewal and Termination. Under Indian law, all agreements made between private parties are terminable regardless of the non-terminability of the agreement. However, terminating a contract without notice may expose the defaulting party to a right to damages for wrongful termination.

It is therefore advisable that the franchisor negotiate a fixed-term contract (as opposed to a permanent contract) with appropriate termination clauses for convenience and with a cap on the maximum liability for damages under the contract.

(d) Agency Issues. It is also best to avoid a principal-agent relationship between the franchisor and franchisee in order to avoid tortious liability for damages resulting from negligence to third parties.

(e) Post Termination Issues. Some issues that give rise to disputes and are adequately protected by existing Indian laws include misuse and potential infringement of intellectual property rights and confidential information after the franchise relationship has ended. Post-termination inventory handling should also be considered to allow the franchisee to deal satisfactorily with unsold inventory/raw materials.

(f) Governing Law and Implementation of Laws. Frequently, court hardships prevent the parties from taking legal action against the infringement. Therefore, there is a need to clarify the applicable law and jurisdiction to decide disputes arising under international franchise agreements (which may be a neutral foreign forum). The Indian courts recognize that “the court chosen may be a court in the country of either or both parties and a neutral forum…”.

(g) Consumer Protection and Non-Competition. Indian consumer protection laws allow a consumer to make complaints to the consumer forums about faulty or defective goods or services provided by the franchisee. Likewise, anti-competitive or restrictive trade practices encouraged by the franchise agreement may be challenged under the Competition Act.

LICENSING AND USE OF INTELLECTUAL PROPERTY RIGHTS

The manner in which intellectual property rights (“IPR”) are used and protected from misuse is one of the most important concerns of the franchisor. Issues related to the scope (including geographic) of the trademark license, exclusivity of use, extent of know-how transfer, misuse/unauthorized use and consequential damage to the trademark are some of the important aspects that a license agreement needs to address.

India already has a variety of laws related to intellectual property rights including trademark law, copyright law, patent law, etc. which comprehensively provide for the protection and enforcement of intellectual property rights. This includes permanent and mandatory injunctions against infringement and disclosure. India is also a signatory to international conventions on intellectual property rights, including the Treaty on Trade-Related Aspects of Intellectual Property Rights (TRIPS), which provides protection for the foreign franchisor’s trademarks, copyrights, service marks and designs. Intellectual property rights laws have also been amended to bring them into line with exclusive legal obligations under TRIPS and accordingly Indian laws meet international standards for the protection of intellectual property rights. Indian courts are also proactive in enforcing infringement claims.

If the trademark is a registered trademark of the Franchisor and that trademark is intended for use by the Franchisee in India, it is recommended that the Franchisee be registered as a registered user so that the Franchisor can freely claim the benefits of the use of the trademark by the Franchisee. In addition, under trademark laws, the scope of the term “permitted user” has been expanded by allowing unregistered users of a registered trademark to come within the scope of that term through the written consent of the registered owner, and such use falls under the Advantage of the owner (franchisor).

In the case of misuse of the mark by a third party, the franchisor and the franchisee can bring a joint action, and in cases where the franchisee is a registered user of the mark, he can bring an action himself. Post-termination agreements protecting the franchisor’s vested intellectual property will remain enforceable after the termination of the franchise agreement.

Conclusion

India, a multi-ethnic country with the second largest entrepreneurial population in the world, with sufficient exposure to international service standards and a healthy business legal environment, is poised to experience phenomenal growth in the franchising sector in the years to come.