FRANCHISING IN INDIA: AN OVERVIEW OF LAWS AND OBSTACLES

This blog is authored by Aiswariya Pratap Jena a fourth year student at School of Law, K.I.I.T. University

Introduction

India is one of the fastest growing economies in the world. The observable rise in the GDP, coherent to the onset of globalization has been attracting international brands to the Indian soil. Hence, the need for standing apart and making the brands manifestly recognizable requires the registration of the franchise in a new market. It ensures that brands like McDonald’s, KFC, Nike, etc. are easily set apart from each other.

What is franchising?

Although there are no laws which strictly regulate franchising in any statute, it has been defined as an agreement by which the franchisee is given legal representation to sell goods or provide service or undertake any process identified with the franchisor under the Finance Act, 1999. The Black’s Law Dictionary defines a franchise as a license from the owner of a trademark or trade name permitting another to sell a product or service under that name or mark.

To register the franchise, a brand (or Franchisor) has to enter into a licensing agreement with the Franchisee, who pays a hefty fee for carrying out business under the name of the brand/franchisor.

Types of Franchise Agreements

Broadly, there are two types of franchising agreements:

1. Product Franchising: The franchisee sells the product that is manufactured by the franchisor, to the customer. For eg., A Nike store branch in Delhi (franchisee) sells the brand’s shoes that has been manufactured by the franchisor.

2. Business Franchising: The franchisee is provided with essential raw ingredients and ultimately, manufactures and distributes the product under the brand name. For eg., A McDonalds franchise store in Mumbai produces and sells food from a standardised menu and from raw ingredients that is provided by the franchisor.

Other than this broad distinction, there are various other types of franchising agreements, such as Trademark Licensing agreement, dealer/distributer arrangements among many others.

An overview of laws

Since there is no clear legislation governing franchising agreements in India, the same is executed under several corporate laws.

Indian Contract Act, 1872

A franchise agreement, being contractual in nature, is understandably governed by the Indian Contract Act, 1872. A contract is an agreement enforceable by law, and should constitute the following elements in order to constitute a contract:

(a) an agreement, i.e. an offer and an acceptance of the offer

(b) lawful consideration for the agreement

(c) lawful object and purpose of the agreement

(d) free consent of the parties to the agreement and

(e) capacity of the parties to enter into an agreement.

In order to have legal enforceability as per the Act, a contract must comply with these elements. At times, the nature of the contract can be such that the franchisor delegates some authority to the franchisee to carry out business transaction on their behalf. This is said to be an agency. In such cases, the franchisor (also called the principal) would be answerable for acts performed by the franchisee (the agent).

Laws safeguarding the protection of Intellectual Property Rights

The primary purpose of a franchise agreement is to ensure the growth of a business model that is based upon an intellectual property and is characterised by it. For example, Starbucks is widely recognised across the world due to the logo under which the product is marketed. Hence, in order to maintain such exclusivity and differentiation in the market, a trademark, that is, a protection of the brand name is sought to be obtained. Hence, there is a need for the protection and safeguarding of such intellectual property.

a) Copyright Act, 1957

In case of character merchandising, where a product is sought to be endorsed based on the good will of a character or an individual, it is necessary to ensure that the license for the same is obtained in writing. It must be signed by both the parties, specifying the rights licensed, the royalty payable if any, the term of the license and the territory for the rights are licensed.

b) The Trademarks Act, 1999

For distribution of rights to transact business under a trademark or a trade name, the franchisor must ensure that the transmission does not create exclusive rights to use the trademark in more than one person, with respect to using the trademark for the same types of goods and services or similar description of goods or services and such similarity should not be likely to create any confusion or deception.

c) The Patents Act, 1970

A patent is a new product or a process involving an inventive step and is capable of industrial application. Although the process of obtaining a patent can be tedious and requires the compulsory presence of an inventive step, the licensing of it for profit making purposes can generate a large revenue. For example, Candy Crush game is an app in which the developer/ patent holder, King Digital Entertainment entered into a licensing agreement with Indian Jewellery designer, Mrinalini Chandra and this has generated a hefty revenue for both the patent holder and the licensee. Legally, it is required that patent license be reduced to writing and the license holder should be registered with the controller of patents.

d) The Design Act, 2000

“Design” means features of shape, pattern, configuration, ornament or composition of colours or lines which is applied in three dimensional or two dimensional or in both the forms using any of the process whether manual, chemical, mechanical, separate or combined which in the finished article appeal to or judged wholly by the eye. This Act would apply to cases where such a “design” is distinctive feature of a franchise. A license obtained under the Act would be valid only if it is reduced to writing and registered with the controller within six months from its execution or until the period allowed by the Controller.

Consumer Protection Act, 1986

It provides a safeguard to the consumer against the franchisor and franchisee. In the era of mass consumerism, the needs and wants of the consumer is often neglected, especially by giant franchises. For deterring such neglect, the Act states that a complaint can be filed with consumer forums for unfair practices, which results in defects in goods and services and is hazardous to life.

Competition Act, 2002

The Competition Act aims to promote competition and freedom of trade, protect consumers and prevent anti-competitive activities, that can lead to monopoly and dominance of bigger franchises.

Foreign Exchange Management Act, 1999

With the expansion of international brands to Indian market, there is a need to govern the payment in foreign currency in a cross-border franchise agreement. Further, as per the FEMA rules, prior approval of the Reserve Bank of India (“RBI”) is required for making remittances outside India for use/and or purchase of trademark/franchise in India.

The Arbitration and Conciliation Act, 1996

This Act governs the matters of dispute resolution between the franchisor and the franchisee.

A franchisor looking to expand should keep in mind 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. A franchising agreement should also comply with the FDI policy, the Companies Act, 2013 and any prevailing foreign exchange control regulations, along with other laws governing the same.

Legal issues and obstacles

There are many advantages of the expansion of a franchise transcending national borders. It helps in revenue generation, which in turn, helps in the growth of the economy and the GDP. It provides employment to many as expansion of the franchise expands the need for a workforce.

However, there are several shortcomings and obstacles associated with the same. As there is no specific legislation that addresses the needs of governing the rapidly expanding franchising agreements in India, the existing statute may fall short on such specific type of agreements.

There is still a lacuna of laws governing the myriad of intellectual property rights issues that could arise in the franchising business, since the major point of consideration is the distribution of intellectual property.

Although the Indian Contract Act, 1872 allows for execution of a contract without the reduction of it to writing, it would not efficiently formalise the objective of a franchise agreement, especially when the agreement is between a big franchise and the franchisee. In cases where such agreement is in the nature of an agency, the franchisor would also incur tortious liability due to the branch of duty of the franchisee since their relationship would be that of a principal-agent. This may deter franchisors to expand into Indian territory. Further, there may be unwillingness on behalf of the franchisor due to a heavy burden of taxation of 20% on the royalties paid for use of their intellectual property, as stated under Section 9(1)(vi) of the Income Tax Act, 1961.

* There are times when the position of the franchisee may be jeopardised and a better bargaining position may be available to the big shot franchisor. In the case of M/S Gujarat bottling Co.Ltd. & Ors vs The Coca Cola Co. & Ors, Coca Cola Co. had forced a limitation on Gujarat Bottling Co. Ltd from getting into an agreement with any other beverage company during the term of their agreement. When the case came up before the Hon’ble Supreme Court as being in restraint of trade under Section 27 of the Contract Act, it was observed the growing trend of regulation of the franchisee and their business transactions with other franchises. Such a condition restricting the right of the franchisee to deal with competing goods is for facilitating the distribution of the goods of the franchiser and it cannot be regarded as in restraint of trade. This is yet another example of the dire need of a clear legislation governing such agreements.

Due to hegemonic patterns of consumerism, the competition keeps on rising and leads to domination of local brands. For example, an e-retail site like Amazon will exert more effect on the consumers due to mammoth operation scale, rather than a smaller company with a similar business model.

India is a democracy where the electoral method of selection of representatives will always be consequential to the economic growth. These ever changing factors can also have an adverse effect on the foreign investments and the exchange of currency between the franchisor and the franchisee based on their transactional agreement.

Conclusion

As there is an ever expanding increase in international brands and their franchises in the country, the need for a more regulatory and legal framework is becoming extremely necessary. In 1999, a firm step was taken towards consolidating the franchising industry in India, by establishing the Franchising Association of India (“FAI”) as corporate social responsibility for the promotion of franchising. However, there needs to be better effort in the right step, not only for aiding the process of globalisation, but also for the sake of expansion of the economy.