Importance of a Quality Franchise Agreement
The franchise industry in India has seen strong growth over the last decade. Despite the economic downturn, the annual growth rate of the franchise industry in India has remained positive and currently stands at between 30% and 35%. The success story of franchising in India is a testament to the enormous potential and promise that India holds for the franchising industry.
In India, franchising has gained considerable popularity in many sectors, such as education and training, health care and welfare, information technology services, and in particular, the retail sector, including food and beverages. , fashion and lifestyle, etc. However, product and service franchising in India is still in its infancy, presenting interested foreign companies with a huge untapped business opportunity.
A rapidly growing middle class population with a rapidly growing disposable income and propensity to spend is one of the main reasons for the flourishing of the franchise industry in India. In addition, the entrepreneurial nature of the Indian population and the rise in brand and quality awareness among urban consumers provide another impetus for franchising in India.
Aside from a huge consumer base second only to China, exposure to international standards of goods and services, and availability of skilled, tech-savvy and relatively cheaper human resources, India has one of the fastest growing retail sectors. According to Business Monitor International’s India Retail Report for the third quarter of fiscal 2010, retail sales are expected to grow from $353 billion in 2010 to $543 billion in 2014. Combined, these factors present a huge business opportunity. lucrative for foreign companies that want to franchise their business, brands or their products.
Franchising is a relatively modern distribution channel that allows foreign brand owners to exercise a substantial degree of control over how and how their products or services are offered and sold to consumers. It ensures efficient and rapid cross-border market penetration for the franchisor, an opportunity to push their brand beyond the limits with minimal capital investment and risk.
In a nutshell, a franchise is a business model based on a license granted by one entity (the ‘Franchise’) to another (the ‘franchisee’) that allows the use/exploitation of the franchisor’s intangible assets, such as the brand/name commercial, business model and concept, image, marketing techniques and other intellectual property in order to make sales or provide services in a defined geographic location in exchange for a sum of money.
India does not have a consolidated legislation regulating franchises, although private sector bodies have been pushing for specific franchise legislation to be enacted. Some key laws affecting franchising in India include the Indian Contracts Act of 1872, the Competition Act of 2002, the Trade Marks Act of 1999, the Copyright Act of 1957, the Patents Act of 1970, the Consumer Protection Law of 1986, the Foreign Exchange Law Management Law, 2000, labor and tax laws.
Importance of a Quality Franchise Agreement
The ‘quality’ in any agreement, regardless of its object, is, among other things, essential to mitigate or avoid disputes between the contracting parties. The ‘quality’ of an agreement can be assessed on many parameters, including: clarity of purpose, holistic/gap-free character; unambiguous provisions/terms/conditions with no possibility of contradiction; form of presentation; and most importantly, enforceability.
A ‘franchise agreement’ is a contract between the franchisor and the franchisee that defines their relationship and the rights and obligations inter se.
‘Quality’ takes on even more importance in a franchise agreement due to the inherent business and operational complexities present in such agreements. A quality franchise agreement must affect the underlying symbiotic relationship between the franchisor and the franchisee.
A quality franchise agreement must guarantee clear, unequivocal and hermetic coverage of all critical issues, such as the roles and obligations of the parties, confidentiality and protection of intellectual property; payment terms and taxes; duration, renewal and termination; agency issues; post-termination issues; negative pacts; applicable law and jurisdiction (especially in international franchise agreements).
In addition, a good franchise agreement must ensure that quality control mechanisms do not blur India’s competition laws. For example, in certain situations, a provision that requires a franchisee to source products exclusively from the franchisor or any other specified entity may be considered anti-competitive and contrary to the provisions of the Competition Act 2002.
Naturally, the importance of a quality franchise agreement for a franchisor and a franchisee differs considerably, as explained below.
The franchisor’s perspective:
The importance of a quality franchise agreement for a franchisor cannot be stressed enough. Of utmost importance to the Franchisor is the protection of its brand, image, reputation, know-how, business concept and other intellectual property rights, as well as limiting exposure to potential risks and liabilities resulting from the conduct of the franchisee.
It is important that the franchise agreement is carefully drafted to ensure clarity of the franchisee’s duties and services, including in the areas of investment and infrastructure, adherence to specific operating guidelines to maintain consistency, reporting requirements, maintenance of the quality; annual market penetration goals; financial returns such as royalties and payment of fees, etc.
A quality franchise agreement must provide adequate safeguards and security against the franchisee’s misuse of the franchisor’s intellectual property rights. In addition, it must provide sufficient quality control mechanisms to the franchisor, including control over the franchisee’s managerial discretion, to enable it to control its business concept and protect its brand and reputation. Consequently, the franchise agreement must unequivocally and comprehensively address vital issues, such as the temporal and territorial scope of the license, the rights and property licensed, the nature of the license, the restriction of use of the rights and property licensed, quality control measures, including periodic audits to ensure compliance with the business concept, product supply, training, type of products to be sold under the franchise, etc. The business concept object of the license and the mode and form of operation must be clearly stipulated to allow the franchisee to adjust to it. However, the drawback of excessive control over a franchisee and the franchisee’s products is that the Franchisor may become liable for acts of the franchisee in third party claims. A quality franchise agreement should ensure that the relationship is principal to principal and that the franchisor is not responsible for the acts and omissions of the franchisee.
Another crucial issue for the Franchisor is the protection of competition by its franchisee. It is common practice to include non-compete covenants during and after termination in most franchise agreements. However, a quality franchise agreement, like any other agreement, should have a carefully crafted non-compete clause to ensure that it is legally enforceable and not a redundant term. Unreasonable post-termination non-compete clauses that are contrary to public policy and restrict trade would apply.
A quality franchise agreement must ensure that the franchisee fits the business concept. It must have strict provisions to deal with situations of non-compliance and non-compliance with the business format and brand misuse by the franchisee. In addition, the franchise agreement must protect the flow of income from the franchisee to the franchisor.
Issues related to governing law and jurisdiction, post-termination obligations to ensure protection against breach of confidentiality and intellectual property, inventory management are equally critical and must be properly addressed in a franchise agreement to ensure effective control and systematic business expansion.
The Franchisee Perspective:
‘Quality’ is as serious an issue for the franchisee as it is for the franchisor. Since the initial investment in the business is that of the franchisee, a quality franchise agreement is essential for the franchisee to capitalize on their investment.
For a franchisee, a quality franchise agreement should have clearly defined payment terms with no hidden fees or costs and a clearly defined area of operation. You must protect the franchisee from infringement of the intellectual property rights of others due to the franchisee’s use of the franchisor’s intellectual property. In addition, the franchise agreement must allow the franchisee to take full advantage of the brand and other intellectual property rights authorized by the franchisor and ensure continuity of supply (where applicable). Therefore, a well-defined and clear business concept and format is as important for the franchisee as it is for the franchisor. It helps the franchisee to avoid implementation problems and ensure the profitability of the company. A quality franchise agreement should allow the franchisee to obtain maximum support for the implementation of the franchisor’s business concept through training, updating of concepts and evolving technologies, etc. The relationship between the franchisor and the franchisee must be that of independent parties and the agreement must be carefully drafted to avoid an inference of agency.
Therefore, a quality franchise agreement is the fulcrum on which the success of a franchise rests, which in itself underlines the importance of “quality” in franchise agreements.
Seema Jhingan