In this part, we will be discussing about the legal issues faced by the parties under Franchise Agreement and Safeguards required during the course of Franchise period.
While the concept of Franchise Agreement seems very fascinating. However, due to the absence of specific law governing Franchising in India, there are various risk factors involved which should be dealt with before entering executing the Franchise Agreement.
Since there is no specific law governing Franchising in India. Therefore, the Franchise Agreement which is the essence of the Franchising is governed by various law including the Indian Contract Act, 1872 (hereinafter referred to as “the Act”).
For any Agreement to be valid and enforceable it is quintessential for the Agreement to satisfy all the essentials mentioned under Section 10 of the Act:
- Parties should be competent
- Agreement- An offer and acceptance to the offer
- There shall be a Lawful object
- There shall be Lawful consideration
- Free consent of the parties should be there
That, if all the conditions are satisfied, the Agreement shall be enforceable by law.
1. The first and foremost legal issue faced in the Franchise Agreement is regarding the non-compete clause putting restrictions on the Franchisee to provide similar services or goods to third party post termination of the Franchise Agreement.
However, it is quintessential to understand that under the common law the validity of reasonable post-contractual restraint is upheld, however under Section 27 of the Indian Contract Act, post-contractual restraints are considered to be void.
However, there are two exceptions to the rule.
- Firstly, non-compete Agreements are supplementary to the sale of goodwill.
- Secondly, the Franchise Agreements that are made in the advancement of a trade shall not fall under the ambit of Section 27.
Analyzing the judicial precedent:
In Gujarat Bottling Co. Ltd. v. Coca Cola Co. & Ors (1995 SCC (5) 545), the Court dealt with the issue of competing with the business of franchisor during the period of the franchising relationship.
The factual matrix includes the Coca Cola Co. imposed an embargo on Gujarat Bottling Co. for entering into another Agreement with a beverage manufacturing business during the term of an ongoing Franchising Agreement. This ban was imposed on the groundwork of the non-compete clause, hence the Hon’ble Supreme Court ruled that it shall not fall under the ambit of restraint of trade.
The Agreement between Gujarat Bottling and Coca Cola was declared a valid contract, as the terms and conditions of imposing an embargo to enter into an Agreement with a competing company shall not be considered as a restraint to trade. However, the Court failed to address the validity of the non-compete clause vis-à-vis Section 27 post-termination of the franchising Agreement.
2. Second issue that arises in the Franchise Agreements is the liability of the Franchisee to compensate the Franchisor for the acts performed beyond the course of business or in breach of the Franchisor’s direction. Therefore, it is paramount to comprehend and determine the nexus between the Franchisor and the Franchisee before finalizing the Agreement to avoid liabilities for the act not committed by the Franchisor or the Franchisee.
3. Third issue that arises in the Franchise Agreements is indulgence in Unfair Trade Practices or creation of Monopoly of particular goods or service. Therefore, to resolve this issue The Monopolies and Restrictive Trade Practices Act, 1969 (MRTP Act) has been enacted, which states that the Franchise Agreement shall be made in compliance with the laws applicable, to ensure that their business is not being classified as monopolistic or restrictive in nature. Further, it is quintessential to note that the franchising Agreement may fall under the ambit of ‘restrictive trade’ Agreements, hence it is important to register the Agreements with Director General as per Section 33 of the MRTP Act.
4. Another issue that arises in the Franchise Agreement is the protection of Intellectual Property Rights (IPRs) during Franchising, since all Franchising Agreements require transfer of some form of IP, either an invention or a patent for the invention or a design or copyright, since the IP license lies at the core of a Franchise, certain embargoes have to be imposed on the Franchisee with respect to the use of IP, to ensure that there is no fraudulent conduct leading to malpractice, resulting in damage to the goodwill of the Franchisor.
However, with the advancement of technology, Franchising and its business operations are taking place through e-commerce platforms, the issues like privacy and security are going to be highlighted.
Therefore, moving forward the drafting of Franchise Agreement needs to be airtight to avoid legal disputes and the clash of laws of different countries. In the case of international Franchise Agreements, various aspects should be analyzed such as exchange control issues under Foreign Exchange Management Act, 1999 (FEMA, 1999) International Dispute Resolution, double taxation avoidance, etc., before finalizing the Agreement.
In India, there is no well-defined, specific Franchise Law. However, the Franchise model in India is based on several business laws and regulations other than the Indian Contract Act that safeguards the interest of parties and help in avoiding conflicts.
Some of the key legislations are:
- The Competition Act, 2002: This Act was introduced to restrict big Franchises from creating a monopoly in the market by prohibiting certain arrangements that cause or likely to cause an appreciable adverse effect on the competition. The Franchisor or Franchisee needs to avoid monopolistic or restrictive trade practices in the market.
- Consumer Protection Act, 1996: If a dispute arises between the consumer and a Franchise, this Act comes to the rescue. A consumer can file a complaint against the Franchisor or the Franchisee for any defective goods or services supplied by them. Furthermore, Franchisee can as well file a complaint against the Franchisor as a consumer under this Act if any risk arises.
- The Foreign Exchange Management Act, 1999: It controls all the international brands that have their Franchises in India and it also controls the payments made in foreign currency for example 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. However, no prior Government approval is required for royalty payments upto 2% for exports and 1% for domestic sales on use of the trademarks and brand name of the foreign collaborator without technology transfer.
- Labour Laws: Now, under the Franchise Agreement based on the amount of control the Franchisor have over Franchisee over the business operations, various Labour issues can arise between the Franchisor and the Franchisee, which could be resolved under this legislation.
- Intellectual Property Laws: These laws protect trademarks, patents and registered designs and legal actions can be brought against the person who infringes them. The acts for IPR include the Copyright Act (1957), The Patents Act (1970), The Trademarks Act (1999) and the Designs Act (2000).
- Income Tax Act, 1961: This act governs the aspect of tax in Franchises, wherein the parties are required to comply with local tax regulations, for example as per Section 9(1)(vi) of the Income Tax Act, 1961 the Royalties paid by the Franchisee to the Franchisor for the use of the Franchisor’s IPRs, would be subject to tax at the rate of 20% on gross amount paid.
As discussed earlier, although Franchise industry is witnessing a tremendous growth in India and there are indeed business and commercials laws present to govern the Franchise industry to a great extent but a proper planning towards regulating and developing a legal framework is need of the hour, because due to the absence of specific legislation dealing with Franchising in India, various risk factors as discussed above gets involved when parties enter into a Franchise Agreement.
Therefore, it is quintessential to negotiate and formulate an airtight Franchise Agreement to avoid a leak of legal disputes in the Franchise Agreements. However, until a specific law is not present to govern Franchising in India it will remain unambiguous and distinct.
For any query or feedback, please feel free to connect with email@example.com or firstname.lastname@example.org