Importance of a Quality Franchise Agreement


The Indian franchising industry has seen robust growth over the past decade. In spite of the economic recession, the annual growth rate of the franchising industry in India has remained positive and is currently pegged at 30%-35%. The success of the franchising story in India is a testament to the huge potential and promise that India holds for the franchising industry.

In India, franchising has gained considerable popularity in numerous sectors, such as, education and training, healthcare and wellness, information technology services, and in particular, the retail sector including, food and beverage, fashion and lifestyle, etc. However, franchising of products and services in India is still in its infancy thus presenting to interested foreign enterprises a vast untapped business opportunity.

A fast growing middle class population with a faster growing disposable income and propensity to spend is one of the paramount reasons for the mushrooming of the franchise industry in India. Additionally, the entrepreneurial character of India’s population and increased brand and quality awareness amongst urban consumers provides another impetus to franchising in India.

Apart from a huge consumer base, next only to that of China, exposure to international standards of goods and services and availability of skilled, technology savvy and relatively cheaper human resources, India has one of the fastest growing retail sectors. As per Business Monitor International’s India Retail Report for the third quarter of the financial year 2010, retail sales are expected to grow from $353 billion in 2010 to $543 billion in 2014. Clubbed together, these factors present a highly lucrative business opportunity for foreign enterprises wishing to franchise their business, brands, or their products.

Franchising is a relatively modern distribution channel that permits foreign brand owners to exercise a substantial degree of control over the manner and mode in which their products or services are offered and sold to consumers. It ensures efficient and rapid trans-border market penetration to the Franchiser, an opportunity to take its brand beyond boundaries with minimum capital investment and risks.

Simply put, a franchise is a business model premised on a license granted by one entity (the ‘Franchiser’) to another (the ‘franchisee’) permitting use/exploitation of the Franchiser’s intangible assets such as brand/trade name, business model and concept, image, marketing techniques and other intellectual property for the purpose of making sales or providing services in a defined geographic location in return for a sum of money.

India does not have a consolidated legislation regulating franchising, although private sector bodies have been lobbying for enactment of 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 Patents Act, 1970, the Consumer Protection Act, 1986, the Foreign Exchange Management Act, 2000, labour and taxation laws.

Importance of a Quality Franchise Agreement

‘Quality’ in any agreement, regardless of its subject matter, is, inter alia, seminal for mitigation or avoidance of disputes between contracting parties. ‘Quality’ of an agreement may be assessed on numerous parameters including: clarity in purpose, holistic/loophole free character; unambiguous provisions/terms/conditions with no scope for contradiction; manner of presentation; and most important enforceability.

A ‘franchise agreement’ is a contract between the Franchiser and the franchisee which defines their relationship and inter se rights and obligations.

‘Quality’ assumes even more significance in a franchise arrangement due to the inherent commercial and operational complexities present in such arrangements. A quality franchise agreement must effectuate the underlying symbiotic relationship between the Franchiser and the franchisee.

A quality franchise agreement must ensure clear, unambiguous and water tight coverage of all critical issues, such as, roles and obligations of the parties, confidentiality and intellectual property protection; payment terms and taxes; duration, renewal and termination; agency issues; post termination issues; negative covenants; governing law and jurisdiction (especially in international franchise arrangements).

A good franchising agreement should in addition ensure that quality control mechanisms do not flout India’s competition laws. For instance, in certain situations a provision obliging a franchisee to source products exclusively from the Franchiser or any other specified entity may be regarded as anti-competitive and in contravention of the provisions of the Competition Act, 2002.

Naturally, the importance of a quality franchise agreement for a Franchiser and a franchisee differs considerably as discussed below.

The Franchiser’s Perspective:

The importance of a quality franchise agreement for a Franchiser cannot be stressed enough. Of paramount importance for the Franchiser is 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 franchisee’s conduct.

It is important that the franchise agreement is carefully drafted to ensure clarity on duties and services of the franchisee including in the areas of investment and infrastructure, adherence to specific operating guidelines to maintain uniformity, reporting requirements, quality maintenance; annual market penetration targets; financial returns such as royalty and fee payment, etc.

A quality franchise agreement should provide adequate fetters and security against misuse of the Franchiser’s intellectual property rights by the franchisee. Further, it must provide enough quality control mechanisms to the Franchiser, including control over managerial discretion of the franchisee, to enable it to control its business concept and protect its brand and reputation. Consequently, the franchise agreement must unambiguously and comprehensively address vital issues, such as, the temporal and territorial scope of the license, the rights and property licensed, nature of the license, restriction on use of licensed rights and property, quality control measures, including periodic audits to ensure that the business concept is adhered to, sourcing of products, training, type of products to be sold under the franchise, etc. The business concept being licensed and mode and manner of operation must be clearly stipulated to enable the franchisee to conform to it. However, the downside of excessive control over a franchisee and franchised products is that the Franchiser may become susceptible to liability for acts of the franchisee in claims by third parties. A quality franchise agreement should ensure that the relationship is on principal to principal basis and the Franchiser is not liable for the franchisee’s acts and omissions.

Another crucial issue for the Franchiser is protection from competition by its franchisee. It is common practice to include non-compete covenants during and post termination in most franchise agreements. However, a quality franchise agreement, like any other agreement, must have a carefully crafted non-compete clause to ensure that it is enforceable under law and not a redundant term. Unreasonable post termination non-compete clauses which are against public policy and in restraint of trade would be enforceable.

A quality franchise agreement should ensure that the franchisee conforms to the business concept. It must have stringent provisions to deal with situations of breach and non-adherence to the business format and misuse of brand by the franchisee. Also, the franchise agreement must protect the revenue flow from the franchisee to the Franchiser.

Issues related to governing law and jurisdiction, post termination obligations to ensure protection against breach of confidentiality and intellectual property, inventory handling are equally critical and need to be adequately addressed in a franchise agreement to ensure effective control and systematic business expansion.

The Franchisee’s Perspective:

‘Quality’ is as serious an issue for the franchisee as it is for the Franchiser. As the initial investment in the venture is that of the franchisee, a quality franchise agreement is essential for a franchisee to capitalize on its investment.

For a franchisee, a quality franchise agreement must have clearly defined payment terms with no hidden fees or costs and a clearly defined area of operation. It must protect the franchisee from infringement of third party’s intellectual property rights due to use of Franchisers intellectual property by the franchisee. Further, the franchise agreement must enable the franchisee to optimally leverage the brand and other intellectual property rights licensed by the Franchiser and ensure continuity of supply (wherever applicable). Therefore, a clearly and properly defined business concept and format is as important for the franchisee as it is for the Franchiser. It helps the franchisee avoid implementation issues and ensure profitability of the venture. A quality franchise agreement should enable the franchisee to extract maximum support for implementation of the business concept from the Franchiser by way of training, up-gradation of concepts and evolving technologies, etc. The relationship between the Franchiser and the franchisee should be that of independent parties and the agreement must be carefully drafted to avoid an inference of agency.

Thus, a quality franchise agreement is the very fulcrum upon which the success of a franchise rests which by itself underscores the importance of ‘quality’ in franchise agreements.

Seema Jhingan

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