This article has been written by Shivam Sharma pursuing a Diploma in International Contract Negotiation, Drafting and Enforcement from LawSikho.
This article has been edited and published by Shashwat Kaushik.
Table of Contents
Introduction
Intellectual property rights (IPR) are the rights given to a person over the creation of their minds, like patent rights over the creation, invention, and discovery of anything that is one of its kind and has a revolutionary impact on the market, copyrights over a written document or any visual representation, and the trademark or service mark of a company that distinguishes it from its other competitors. They usually give the owner or assignee an exclusive right to use his/her intellectual property. Such intellectual property is acquired and registered to exploit it for commercial purposes. Such commercial use of intellectual property can be done by its owner in several ways. Such as
- Business: Use of intellectual property to generate revenue by it (i.e., by manufacturing and selling products under a brand name, selling such distinguished products and services, and expanding the business as the person has exclusive rights over such trademarks and legal remedies against unauthorised use or infringement).
- Assignment: Assignment of intellectual property rights is the process of transferring ownership rights over an intellectual property by the owner (assignor) to another party (assignee) for consideration.
- Franchising and licensing: Franchising intellectual property rights refers to granting permission or licencing specific intellectual property assets to a third party (franchisees).
Franchising agreement
A franchising agreement is a legally binding contract between a franchisor (the owner of a business concept, brand, and intellectual property) and a franchisee (an individual or entity granted the rights to operate a business under the franchisor’s brand and business model).
The franchise agreement grants the franchisee the right to operate a business or offer, sell, or distribute goods or services identified or associated with the franchisor’s trademark. In exchange, the franchisee makes one-time or periodical payments to the franchisor in the amount, terms, and conditions established in the franchise agreement. The franchisee may have to make one-time, monthly, quarterly, or annual payments to the franchisor.
This agreement outlines the rights, obligations, responsibilities, and terms of the franchise relationship. Franchising agreements are complex legal documents tailored to the specific requirements and characteristics of each franchise system
Licencing and franchising can be used to commercially exploit all kinds of intellectual property, such as copyright, trademarks, patents, trade secrets, and confidential information.
McDonalds, Subway, Starbucks, and KFC are most well-known examples of franchising globally. All these food chains operate thousands of franchise locations worldwide. Franchisees are granted the right to use the brand trade name, menu operational system, and marketing strategies, and in return, they are liable to pay the franchisor with consideration. Royalty (or franchising fee in the case of franchising agreement)
Various clauses in a franchising agreement
A franchising agreement typically contains various clauses that outline the rights, responsibilities, obligations, and terms of the franchise relationship between the franchisor and the franchise, such as:
- Parties to the agreement
- Date and time of execution
- Grant of franchise (recitals)
- Definition and interpretation clause
- Franchise territory
- Operation standards
- Training and support
- Confidentiality and non-disclosure
- Rights and obligations of the franchisor and franchisee
- Consideration, mode of payment, and default
- Representation and warranties
- Non-compete clause
- Non solicit clause
- Term and termination
- Confidentiality and intellectual property rights
- Consequences of termination and applicable post-termination obligation
- Miscellaneous (boilerplate) provisions
Laws governing franchise agreement
- The Indian Contract Act, 1872:
- Enacted to govern the formation, interpretation, performance, and enforcement of contracts in India.
- Provides a framework for creating legally binding agreements, including those related to franchising.
- Outline the essential elements of a valid contract, such as offer, acceptance, consideration, capacity, and legality.
- Establishes rules for interpreting and enforcing contracts, including provisions on breach of contract and remedies.
- The Competition Act, 2002:
- Aims to promote competition and prevent anti-competitive practices in the Indian market.
- Prohibits agreements and behaviours that may restrict competition, such as cartels, price fixing, and abuse of dominant position.
- Includes specific provisions related to franchising, such as the prohibition of exclusive dealing arrangements and tying arrangements that could limit competition.
- Enforced by the Competition Commission of India (CCI), which has the authority to investigate and impose penalties for anti-competitive practices.
- The Indian Trademarks Act, 1999:
- Provides legal protection for trademarks used in India, including those related to franchising.
- A trademark is defined as a mark capable of distinguishing the goods or services of one person from those of others.
- Establishes the process for registering trademarks and provides for the exclusive rights of trademark owners.
- Prohibits the unauthorised use of registered trademarks, including by franchisees, and provides remedies for trademark infringement.
- The Copyright Act, 1957:
- Offers legal protection for original works of authorship, including literary, dramatic, musical, and artistic works.
- Extends protection to copyright works used in franchising, such as logos, designs, and marketing materials.
- Provides exclusive rights to copyright owners, including the right to reproduce, distribute, and adapt their works.
- It prohibits the unauthorised use of copyrighted works, including by franchisees, and provides remedies for copyright infringement.
- The Foreign Exchange and Management Act, 1999:
- Regulates the transfer of funds and other financial transactions related to international franchising.
- Governs the repatriation of profits, royalties, and other payments from franchisees located in India to franchisors located abroad.
- Outline the procedures for obtaining necessary approvals and licences for foreign exchange transactions related to franchising.
- Enforced by the Reserve Bank of India (RBI), which has the authority to monitor and regulate foreign exchange transactions.
Termination of franchising agreement
The Termination of the Franchising agreement refers to the legal process of ending the contractual relationship between the franchisor and the franchisee.
Termination of a franchising agreement is a significant legal step that requires careful consideration and adherence to the terms outlined in the franchise agreement itself, as well as any applicable laws and regulations.
Reasons for termination of the agreement
Breach of the contract (franchising agreement)
- Failure to pay royalty: If the franchisee fails to pay the initial franchising fees, ongoing royalties, advertising fees, and other payments as stipulated in the agreement.
- Noncompliance with the operational standard: Breach of operational standards, including failure to maintain quality standards, follow branding guidelines, meet customer service expectations, or adhere to product/service specifications.
- Violation of franchising policy: Noncompliance with the franchising policies and procedures, such as marketing requirements, supplier agreements, reporting obligations, or territorial restrictions.
- Misuse of intellectual property: Unauthorised use or infringement of the franchisor’s trademark, logos, trade secrets, copyrights, and other intellectual property.
Failure to meet the performance requirement
- Underperformance: If the franchisee consistently fails to meet performance targets, sales, and goals.
- Loss of business reputation: Actions or conduct that tarnish the franchise’s reputation, such as unethical practices, poor customer service, or any legal violation.
Bankruptcy or insolvency
- Franchisor bankruptcy: If the franchisor becomes bankrupt or insolvent, resulting in an inability to support the franchise system, provide necessary service, or maintain brand standards.
- Franchisee bankruptcy: If the franchisee files for bankruptcy or becomes insolvent, leading to an inability to fulfil financial obligations or operate the business effectively.
Mutual agreement
- Voluntary termination: Both parties may agree to terminate the franchise agreement mutually, often due to strategic business decisions, market changes, and other mutually beneficial reasons.
Expiration of term
- End of the Contract Term: If the franchise agreement has a fixed term rather than a perpetual term and it expires without renewal, then it leads to the termination of the franchise agreement.
Legal or regulatory compliance
- Noncompliance with the law: Violation of local, state, or central laws, regulations, and industry standards that impact the franchisee operation.
- Failure to obtain licences and permits: Inability to obtain the necessary licences, permits, certifications, and approvals required to operate the franchise legally.
Material misrepresentation or fraud
- Miss Representation: Providing false, misrepresenting or inaccurate information in the representation clause of the franchise agreement; and non-disclosure of any material fact.
- Fraudulent activities: Engaging in fraudulent activities, deceptive practices, or other illegal conduct that undermines the integrity of the franchise operation
Force majeure events
- Natural disasters: Unforeseeable events beyond the control of either of the parties, such as Natural Disasters, Acts of Terrorism, War, Civil unrest, and Government actions that make it impossible or impracticable to continue the franchisee operation
Notice requirements for termination
The franchise agreement typically specifies the notice period required for termination. This notice period provides both the franchisor and franchisee with sufficient time to prepare for the termination and minimise disruptions to their business operations. The notice must be in writing and should be delivered according to the agreement’s terms, which may include specific requirements for the form and manner of delivery, such as certified mail or personal service.
The notice should state the grounds for termination, which may include material breaches of the franchise agreement, such as failure to meet sales quotas, non-payment of royalties, or violations of the franchisee’s operating standards. It’s important to note that the grounds for termination must be clearly and specifically stated, as they will form the basis for any legal proceedings that may arise from the termination.
The notice period may vary depending on the specific terms of the franchise agreement. It’s common for franchise agreements to include a provision for a cure period, which allows the franchisee to address the grounds for termination within a specified timeframe. During this cure period, the franchisee can take steps to remedy the breach or violation and bring their business operations into compliance with the franchise agreement.
If the franchisee fails to cure the breach or violation within the specified timeframe, the franchisor may proceed with the termination of the franchise agreement. It’s important for both parties to carefully review the termination provisions of the franchise agreement and to comply with the required notice period and procedures to ensure a smooth and orderly termination of their business relationship.
Termination procedure
Following the formal notification of termination, both the franchisor and franchisee may engage in discussions and negotiations regarding the terms and conditions of the termination. This can involve a range of issues, such as:
- Return of assets: The franchisee may be required to return any assets provided by the franchisor, such as signage, equipment, and marketing materials.
- Payment of outstanding fees: Any outstanding fees or royalties owed by the franchisee to the franchisor should be settled during this process. This includes any outstanding royalties, advertising fees, or other payments due under the franchise agreement.
- Resolution of disputes: If there are any outstanding disputes or disagreements between the parties, they may be addressed during the termination discussions. This could include issues related to intellectual property, customer lists, or non-compete agreements.
In addition to these discussions, the franchisor may conduct an audit or inspection of the franchisee’s business. This is done to assess the franchisee’s compliance with the termination conditions and to facilitate the transfer of assets or operations. This audit may involve:
- Financial review: The franchisor may examine the franchisee’s financial records to ensure that all outstanding payments have been made and that the franchisee has complied with any financial obligations under the franchise agreement.
- Inventory assessment: The franchisor may take inventory of the franchisee’s assets, including products, supplies, and equipment, to determine what should be returned or transferred to the franchisor.
- Compliance with standards: The franchisor may inspect the franchisee’s business premises to ensure that the franchisee has complied with all brand standards and guidelines during the term of the franchise agreement.
The purpose of this audit or inspection is to ensure a smooth and orderly transition of the franchise business back to the franchisor and to protect the franchisor’s brand reputation and intellectual property.
Asset return and transition
Upon termination, the franchise is usually required to return all franchisee-related assets, including signage, equipment, inventory, and intellectual property materials, as specified in the agreement.
The franchisor may provide guidance and assistance in transitioning the business back to the franchisor’s control or to the new franchisee, if applicable.
Financial settlements
The termination process of a franchise agreement often entails various financial settlements between the franchisor and franchisee. These settlements may include:
- Refunds and deposits:
- The franchisor may be required to refund any initial fees or deposits paid by the franchisee upon entering the franchise agreement.
- Conversely, the franchisee may be responsible for refunding any outstanding balances or fees owed to the franchisor.
- Payments for outstanding royalties or debts:
- The franchisee will typically be obligated to pay any outstanding royalties or debts due to the franchisor upon termination.
- This may include unpaid franchise fees, marketing fees, or royalties on sales made during the franchise period.
- Compensation for investments:
- In some cases, the franchisee may have made significant investments in the franchise business, such as renovations or equipment purchases.
- During termination, the franchisor may be required to provide compensation for these investments to the franchisee.
- The amount of compensation may be determined through negotiations or based on the terms of the franchise agreement.
- Settlement of franchise assets:
- Upon termination, the franchisee may be required to return or dispose of franchise-related assets, such as signage, uniforms, or promotional materials.
- The franchisor may provide guidelines or instructions for the proper handling of these assets.
- Non-compete agreements:
- Some franchise agreements include non-compete clauses, which prevent the franchisee from engaging in similar businesses within a certain geographic area or time frame after termination.
- Financial settlements related to non-compete agreements may include compensation for the franchisee’s lost income during the restricted period.
- Franchisee’s obligations:
- The franchisee may be required to fulfil certain obligations upon termination, such as providing notice to customers, employees, and suppliers.
- Failure to meet these obligations may impact the financial settlements or result in additional fees.
- Dispute resolution:
- If any disputes arise during the termination process, involving financial matters or otherwise, the parties may attempt to resolve them through mediation or arbitration.
- In some cases, legal action may be necessary to reach a resolution.
The financial settlements involved in the termination process of a franchise agreement are crucial for ensuring a fair and equitable outcome for both the franchisor and franchisee.
Post-termination obligations
Certain obligations may continue after termination, such as non-compete clauses, confidentiality or non-disclosure agreements, or restrictions on the use of the franchisee’s trademark or proprietary information.
Renewal of franchise agreement
Renewal of a franchise agreement refers to the process by which the existing contractual relationship between the franchisor (owner of the franchise business) and the franchisee (operator of the franchise business) is extended beyond the initial term as decided in the franchise agreement.
Renewal of the franchise agreement may involve the following steps:
Step 1
Start by reviewing the terms and conditions related to renewal outlined in the existing franchise agreement. The term typically specifies the renewal process, conditions, and timing.
Step 2
Determine the timeframe for providing a notice of renewal of notice intent as stipulated in the franchise agreement. This notice is usually required well in advance of the expiration date to initiate the renewal process.
Step 3
The franchisor may conduct a performance evaluation of the franchisee’s business during the term leading up to renewal. This evaluation may include financial performance, operational compliance, customer satisfaction, and adherence to brand standards.
Step 4
The franchise agreement may offer different renewal options, such as:
- Renewal by mutual agreement: Both parties mutually agree to renew the agreement based on negotiated terms and conditions.
- Automatic renewal: The agreement may specify automatic renewal unless either party provides notice of non-renewal within a certain period.
- Franchisor’s discretion: The franchisor may have sole discretion to approve or deny renewal based on specific criteria.
Step 5
If the franchise agreement allows the negotiation of renewal terms, the franchisor and franchisee may engage in discussions to modify certain terms, such as renewal fees, royalties rate, territory expansion marketing obligation, or operational requirements.
Step 6
Once renewal terms are agreed upon, the parties typically enter into a renewal agreement or an amendment to the existing agreements. This document outlines the renewed terms, the duration of the renewal, and any changes or modifications from the original agreement.
Step 7
The franchisee may be required to pay renewal fees as specified in the renewal agreement. These fees may cover administrative costs, updates to training material, access to updated systems or technologies, or other benefits associated with renewal.
Step 8
The franchisee may need to demonstrate continued compliance with franchise standards, attend refresher training programmes, and implement any new operational protocols for branding initiatives introduced during the renewal process.
Step 9
Both parties should have the renewal agreement reviewed by legal counsel to ensure compliance with legal requirements, protection of rights, and clarity of terms. Once finalized, the renewal agreement is executed by both parties.
Step 10
After renewal, the franchisee continues operating the franchise business under the renewed terms and benefits from ongoing support, training, market initiatives, and brand recognition provided by the franchisor.
Conclusion
These grounds of termination and the procedure of the termination may vary depending on specific provisions outlined in the franchise agreement, applicable laws, industry standards, and the discretion of the franchisor based on the circumstances in each case. Both parties need to understand the rights, obligations and potential consequences related to termination under the franchise agreement and both the franchisor and the franchisee need to communicate effectively, collaborate on renewal terms, and adhere to contractual obligations through the renewal process to maintain a positive and mutually beneficial franchise relationship.
References
- https://www.law.cornell.edu/wex/franchise_agreement#:~:text=A%20franchise%20agreement%20is%20a,associated%20with%20the%20franchisor’s%20trademark.
- https://vakilsearch.com/franchise-business-agreement
- https://legamart.com/articles/termination-of-the-franchise-agreement/
- https://www.linkedin.com/advice/3/how-do-you-exit-renew-franchise-agreement
