HOW TO DRAFT A FRANCHISE AGREEMENT

HOW TO DRAFT A FRANCHISE AGREEMENT

INTRODUCTION

A franchise agreement is a legally binding document that outlines a franchiser's terms and conditions for a franchisee. It is generally a written agreement between two parties. Although the agreement does not have any standard format, and the structure can vary from business to business, it governs the working of the franchisees and presents a layout of what is to be expected from the business. The central theme of the franchising agreement is to encourage partnership and the licensing of the intellectual property rights.

FRANCHISE AGREEMENT – MEANING

The franchise agreement is the legal agreement that creates a franchise relationship between a franchisor and a franchisee. Within a franchise agreement the franchisee is granted the legal right to establish a franchised outlet and operation wherein the franchisee, among other things, obtains the license and right to utilize the franchisors trademarks, trade dress, business systems, operations manual and sources of supply in offering and selling the products and/or services designated by the franchisor. There is no standard form of franchise agreement because the terms, conditions, and the methods of operations of various franchises vary widely depending on the type of business.

FUNDAMENTAL COMPONENTS OF A FRANCHISE AREEMENT

  • Location/territory. The franchise agreement will designate the territory in which you will operate and outline any exclusivity rights you may have.
  • Operations. This section details how franchisees are expected to run their units.
  • Training and ongoing support. Franchisors offer training and training programs for franchisees and their staff. Training may take place at corporate offices or out in the field. All ongoing administrative and technical support will also be outlined in the agreement.
  • Duration. The document will detail the length of the duration of the franchise agreement.
  • Franchise fee/investment. There will generally be an upfront initial franchise fee that grants the franchisee the right to use the franchisor's trademark and operating system. Those costs will be clearly outlined.
  • Royalties/ongoing fees. Here you will find the details of the franchisor's royalty structure. Most franchisors require franchisees to pay an ongoing royalty, usually a percentage of total sales, which is often paid on a monthly basis.
  • Trademark/patent/signage. This section will outline how a franchisee can use the franchisor's trademark, patent, logo and signage.
  • Advertising/marketing. The franchisor will reveal its advertising commitment and what fees franchisees are required to pay towards those costs.
  • Renewal rights/termination/cancellation policies. The franchise agreement will describe how the franchisee can be renewed or terminated. Some franchisors include an arbitration clause. This requires, in the event of any legal action, that an arbitrator review the case before it goes to court.
  • Exit strategies. Every franchise has its own resale policy. Some allow franchisees to sell their franchises at their discretion. Other agreements include buy back or right of first refusal clauses. These allow the franchisor to buy back the franchise at a rate determined by them or to match any potential buyer's offer.

IMPORTANCE OF FRANCHISE AGREEMENT

Franchising has been one of the profitable business models that involve the domestic players as well as foreign businesses. The arrangement connecting the two parties is legally the' franchise,' although the word most often applies to the individual company owned by the franchisee. The name and franchise scheme is most frequently referred to as franchising in the practice of establishing and distributing. To have this work out effectively and efficiently, it is best to have a detailed and discussed franchise agreement. A franchise agreement must be crafted to the mutual benefits of both the franchisor and the franchisee, which should also be valid to be enforced. Further, they should be crafted in a way that improves the understanding and to avoid costly disputes.

NEED OF A SPECIALITY LAWYER TO ENACT FRANCHISE AGREEMENT

It is best to consult with an attorney concentrating on franchising in the majority of cases. Although general business lawyers will be able to give business law advice, based on their previous experience working with other franchisors and franchisees, franchise-specific lawyers will be able to provide more advanced advice. They will be well versed in the reading of the franchise agreements and will know just what to look for to ensure that you only agree to terms that will benefit you. Likewise, as they are based exclusively on franchises, franchise lawyers typically work with the same businesses over and over again. As they are familiar with the work of any particular brand and will be able to give you the inside scoop, this experience will be a huge asset for you. They help in negotiating

Royalty payment structure: By automatic deductions from a franchisee's account, certain franchisors receive royalty fees, which may render painful financial months much more challenging. This deadline for reimbursement is sometimes negotiable.

Right to close: Not all franchisees, if things don't go as expected, are able to close their shop. Instead, they are obligated to continue operations until the completion of the contract period or until their franchise can be sold. In certain situations, an agent can negotiate the right of a franchisee to shut down sooner if the company does not take off as expected.

Litigation statute of limitations: A franchisee may wish to pursue litigation to settle the matter if a conflict exists between the franchisee and the franchisor. Many franchise arrangements contain a provision for a time of consultation during which the parties involved can seek to find an amicable settlement before engaging attorneys. Although this is a fine policy in and of itself, a substantial part, if not the whole duration, of the time, contained in the statute of limitations for the case will sometimes be included for the settlement period. It is necessary to ensure that there is no issue with the statute of limitations and resolution provisions.

ADVANTAGES & DISADVANTAGES OF FRANCHISING

Advantages

  1. Rapid expansion: Today scalability is important to quickly capture market share and establish market dominance. In traditional business models, the promoters would require large amounts of capital or bank loan to expand their business. However, in a franchise model, the franchisee provides the capital and the franchisor provide the brand and technical know-how to quickly expand with the minimum capital requirement.
  2. Branding: One of the primary responsibility of the franchisor is to use best efforts in advertising and promoting its brand name. Therefore, the franchise business is typically better advertised and branded when compared to traditional business. Also, in the case of a franchise business, since advertising or branding cost is shared by all the franchisees, the overall cost of branding is lower in a franchise model.
  3. You can use a recognised brand name and trade mark. You benefit from any advertising or promotion by the owner of the franchise - the 'franchisor'.
  4. Financing the business may be easier. Banks are sometimes more likely to lend money to buy a franchise with good reputation.
  5. A franchise enables a small business to compete with big businesses, more so than an independent small business, due to the pool of support from the franchisor and network of other franchisees.

Disadvantages

  1. Commitment or lock-in period: Typically franchisee’s are made to commit to the franchisor a lock-in period until which they would be mandatorily expected to operate the business irrespective of profits or loss. During the lock-in period, the franchisee will not be allowed to change the business model or change franchisor.
  2. Independence of franchisee: In a franchise model, though the franchisee is an owner of a business, the franchisee cannot act independently. The franchisor regulates the franchisees and it is necessary to submit various reports to the franchisor.
  3. The inflexible nature of a franchise may restrict your ability to introduce changes to the business to respond to the market or make the business grow.
  4. The franchise agreement usually includes restrictions on how you can run the business. You might not be able to make changes to suit your local market.

LEGAL ASPECTS OF FRANCHISING

The franchise sector in the Indian context is at an emerging stage and there’s no specific law relating to the franchise business in India, and as such, it touches various industry-specific and business laws within the country. India has no franchise laws – there is no requirement to register franchise offerings or to provide franchise disclosure documents, and no specific laws restricting franchise terminations, transfers, or other aspects of franchise relationships.  Franchising is governed by several statues and rules and regulations. Some of the key ones as described below:

  • The Contract Act: The Indian Contract Act, 1872, governs the contractual relationship between the franchisor and the franchise.
  • The Consumer Protection Act: The Consumer Protection Act, 1986 provide remedies to the consumers in case of any defects in products or services and holding the producer/service providers liable.
  • The Monopolies & Restrictive Trade Practices Act, 1969: The MRTP Act prohibits the imposition of restrictions with respect to the pricing of products and sources of supply. It should be ensured that the franchising terms of agreement monopolistic or restrictive. The MRTP Act also requires registration of the agreements which could include restrictive trade practices. The ones relevant in the context of the franchising setup include exclusivity in product dealing; exclusive supply provisions; resale price-fixing conditions and restrictions on methods used.
  • Competition Act, 2002: Following the globalisation of the Indian economy, the competition law has shifted the focus from restricting monopolies to encouraging healthy competition. Some of the provisions aren’t effective yet. However, provisions relating to anti-competitive agreements as well as abuse of dominant position have come into force.
  • The Trademarks Act, 1999;The Trademarks Act provides the rules and regulations with respect to the registration of trademarks as well as service marks.
  • The Foreign Exchange Management Act, 1999 : FEMA and relevant rules and regulations oversee the payments in foreign exchange. Franchising arrangements usually include payments such as a franchise fee, royalty payments for use of system and trademarks, advertisement contributions, and training expenses, which could be remitted to a foreign franchisor.
  • The Arbitration and Conciliation Act, 1996. This act governs the Indian law of arbitration (and as a result of case law, the evolving landscape of the enforceability of arbitration awards in which the seat of arbitration is outside of India). Part I of the act addresses domestic arbitration and awards and Part II of the act addresses international arbitration and awards. Following the Bharat Aluminium Co vs. Kaiser Aluminium Technical Service Inc. decision (“BALCO”), Part I of the act does not apply to foreign seated arbitrations, thereby dissuading parties from approaching Indian courts for interim relief. While arbitration in India continues to evolve, for the time being, it does seem clear (as a result of BALCO), that Indian courts cannot set aside arbitral awards made, or otherwise intervene in arbitrations seated, outside India (and therefore, the Indian courts will give effect to party autonomy and choice of an arbitration seat).

TAXATION

Income Tax Act, 1961 governs the tax aspects of any franchising arrangement in India, and generally provides that a foreign franchisor’s income in the form of royalties or franchise fees would be treated and taxed as business income subject to a tax deduction at the applicable rates. Of course, this would be subject to any tax treaty between India and the relevant country (including withholding tax provisions related to the franchisee’s royalty payments to the foreign franchisor). Where a franchisor receives royalties, franchise, or service fees, tax needs to be paid under the Income Tax Act, irrespective of the fact whether the franchisor is an Indian or a foreigner. According to Section 9 of the Income Tax Act, certain income such as interest and royalty are deemed to arise and to accrue in India under specified circumstances. Business profits under the franchise business are taxed up to 30%.

There’s a withholding tax on fees for technical services and the prevailing rate is 10%. However, it’s subject to the relief provided under a tax treaty, if any

STATISTICAL DATA ON FRANCHSING IN INDIA

According to KPMG India, the key industries with the highest prospects of successfully franchising in India are: (i) retail; (ii) food and beverages; (iii) health, beauty, and wellness; (iv) consumer services; and (v) education and training.

Franchising in India has witnessed a four-fold growth since 2013 and is estimated at USD 50.4 billion currently. A majority of this growth can be attributed to professionals, especially from the IT background. The franchising industry in India is growing at 30-35% year-on-year and is pegged to touch USD 100 billion by 2024. India is already the second-largest franchise market in the world, after the US, with over 4,600 active franchisers and nearly 2, 00,000 outlets operated by almost 1.7 lakh franchisees. However, the Indian franchise market is still very young; the industry accounts for roughly 2% of the national gross domestic product (GDP).

Franchising is growing at an impressive pace in India. According to Franchise India, franchising has witnessed a growth of around 30-35% over the last four-five years and the overall turnover is estimated at around INR 938 billion. Currently, the sector contributes nearly 1.8% to the Indian GDP and is estimated to contribute to around 4% by 2022. Globally, India is the largest franchise market in the world after the United States with about 4,600 operating franchisors and 0.15-0.17 million franchisees in 2017. Of these, around 26% of franchise buyers were women in an individual capacity or as a couple-led family business.

CONCLUSION

Franchised outlets in India have built such a massive consumer base mainly by focusing on Indianisation or customisation of products or services, thus connecting with the customer segment and catering to their specific needs. The demographic shift that India is experiencing with its middle class has led to an increase in their disposable income. Due to this shift, there has been a consistent growth in the number of consumers for branded products and franchised names.

With the rapid privatisation in India across various sectors such as education, healthcare, telecommunication, and others, there is a constant rise in the influx of international brands in the country. With this increase, the scope for franchising has also gone up. The newfound entrepreneurial spirit of young Indians has led many individuals to enter the franchise business. Presently, around 35% of all the franchise owners have been first-timers in business. These entrepreneurs choose franchising due to the range of benefits it offers such as reduced risk, association with an established brand, training, and support, etc