Franchising & Licensing - A Successful Way of Doing Business in India

Franchising & Licensing - A Successful Way of Doing Business in India

Franchise rightly claims to be the wave of future business in India. A huge consumer base of over a billion people including a flourishing class of urban consumers having substantial disposable income with quality and brand awareness together with the attraction, which the Indian economy holds in terms of its human resources, has been instrumental in attracting foreign enterprises to the country. Though franchising business in India has witnessed impressive growth of around 30-35% over the last 4-5 years with an estimated annual turnover of US$ 4 billion, this is a mere fraction of the potential that India can offer. The Indian Franchise Association estimates that in next five years, there would be at least 50,000 franchises in the Indian market.

Franchising is a way of doing business and involves the use by a person (“Franchisee”), pursuant to a license, of another person's (“Franchisor”) business model, name, get-up, image and business identity along with his confidential know-how to exploit his intangible assets in a particular territory for a specified period with or without assured financial returns to the Franchisor.
A typical franchising arrangement provides the Franchisor the benefit of the Franchisee’s knowledge of the territory; access to local sales channels and marketing expertise; minimum capital outlay; minimum government approvals; lesser personnel problems; accelerated network growth and, probably, profitability.

There are three distinct models of franchising - Product Distribution Franchising involving a co-operation for the distribution of goods, mostly in retail business; Trade Name Franchising where the Franchisee uses the trademark/business name of the Franchisor in order to sell its own products or services and Business Format Franchising, a combination of the other two types of franchising, using the Franchisor's trademark/business name in order to distribute the Franchisor's goods or services. Today, the Business Format is a preferred model with more than 1,150 national and international franchise systems in India.

LEGAL FRAMEWORK

India does not have a consolidated franchise specific legislation. Some key laws which impact franchising in India include The Indian Contract Act, 1872, The Competition Act, 2002, The Trademarks Act, 1999, The Copyright Act, 1957, The Consumer Protection Act, 1986, labour laws, taxation laws and The Foreign Exchange Management Act, 1999. Significant contractual and legal issues that may impact a potential franchise relationship are:

(a) Enforcement of non-compete covenant. A major issue posed in this regard is the non-compete obligation of the Franchisee either during the franchise relationship or post termination of the relationship. A non-compete obligation falls in the domain of trade restraint under the Indian Contract Act, 1872.

Under Indian laws, a contract which is in restraint of trade cannot be enforced unless (i) it is reasonable between the parties; and (ii) it is consistent with public interest. While non-compete during the franchise relationship are generally enforceable, post termination negative non-compete covenants restraining the franchisee to enter into similar arrangements for similar goods and services are usually held unenforceable unless it passes the test of reasonableness.

(b) Payment Terms & Taxes. Remittance to a foreign entity is regulated by the Foreign Exchange Management Act, 1999 and the Regulations made there under. An Indian Franchisee is permitted to remit royalty towards license of trademark or technical know-how without any restriction on the percentage or duration of the royalty payments.

The payment made to Franchisor is subject to withholding tax liability @10% of the total royalty or fee in terms of the Double Taxation Avoidance Agreement between India and Germany. Services provided by a Franchisor to a Franchisee would also be subject to service tax in India @10.30% of the gross fee payable to the Franchisor. Where the Franchisor is a foreign entity, the service receiver in India is himself treated as the service provider for payment of service tax.

(c) Duration, Renewal and Termination. Under Indian laws, all agreements entered into between private parties are terminable in nature regardless of the interminable nature of the agreement. However, immediate termination of an agreement without assigning any reasons may expose the defaulting party to a claim for damages for wrongful termination.

It is therefore advisable for the franchisor to negotiate for a fixed term agreement (as against an open ended term) with suitable termination clauses for convenience and with a cap on maximum liability for damages under the agreement.

(d) Agency Issues. It is also best to avoid principal-agent relationship between the Franchisor and the Franchisee to avoid tortuous liability for damages arising from negligence to third parties.

(e) Post Termination Issues. Some issues that lead to disputes and which are adequately protected by existing Indian laws include misuse and potential infringement of intellectual property rights and confidential information post termination of the franchise relationship. Post termination inventory handling should also be addressed to enable the franchisee satisfactorily deal with unsold inventory/raw materials.

(f) Governing Laws and Implementation of Laws. Often jurisdictional hardships deter parties from taking legal recourse against breach. Therefore clarity on the governing law and jurisdiction for adjudication of disputes under international franchise arrangements (which can be a neutral foreign forum) need to provided. The Indian courts recognize that “the chosen court may be a court in the country of one or both the parties, and it may be a neutral forum….”

(g) Consumer Protection & Anti-Competition. Indian consumer protection laws enable a consumer to file complaints with the consumer forums for defective or deficient goods or services provided by the Franchisee. Similarly, anti-competition or restrictive trade practices promoted by the franchise arrangement can be questioned under the Competition Act.

LICENSING AND USE OF INTELLECTUAL PROPERTY RIGHTS

The manner of use of intellectual property rights (“IPR”) and their protection against misuse is one of the most important concerns of the Franchisor. Issues related to the scope (including geographical) of the trademark license, exclusivity of use, extent of transfer of know-how, misuse/unauthorized use and consequential damage caused to the trade mark are some of the important aspects that a licensing agreement must address.

India already has a host of IPR related laws including the Trademark Act, Copyright Act, the Patent Act, etc which extensively provide for protection and enforcement of IP rights. These include permanent and mandatory injunctions against infringement and passing off. India is also a signatory to international conventions on intellectual property rights including the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS), which offers protection to trademarks, copyright, service marks and designs of the foreign Franchisor. IPR laws have also been amended to make them compliant with exclusive right obligations under TRIPS and accordingly, Indian laws meet international standards for IPR protection. Indian courts are also proactive in enforcement of infringement actions.

Where the trademark is a registered trademark of the Franchisor and such mark is intended to be used by the Franchisee in India, it is recommended to get the Franchisee registered as the registered user thereof to enable the Franchisor freely claim the benefit of use of the trademark through the Franchisee. Further, under the trademark laws, the scope of the term “permitted user” has been expanded by allowing unregistered users of a registered trademark by the written consent of the registered proprietor to come within the ambit of the said term and such use accrues to the benefit of the proprietor (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 trademark, it can bring an action in its own right. Post termination covenants for protection of the Franchisor’s vested IP remain enforceable even after termination of the franchise agreement.

Conclusion

India, a multi ethnic country with the second largest entrepreneurial population in the world having sufficient exposure to international standard of services with a healthy commercial law environment is poised to grow phenomenally in the franchising sector in the coming years.

Contact:
Seema Jhingan
LexCounsel
C-10, Gulmohar Park
New Delhi 110049, India
Seema Jhingan, Partner (sjhingan@lexcounsel.in)
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Email: sjhingan@lexcounsel.in