This article has been written by Pushpdeep Kaur, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.

Introduction

The organizations around the world are drastically extending, with a goal of overseas markets. The franchise is a one-of-a-kind methodology that is primarily utilized in the services sector. A franchising model for any organization appears to be a manifestation for leveraging collaboration between franchisee commitment and franchisor management expertise. This model has proven to be a profitable business model that involves both domestic and foreign players. Currently, there are several types of franchising frameworks in operation. 

The negotiation, drafting, and agreement on the terms of the contract created by mutual understanding of the franchisee and franchisor can govern this model.

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Aim of the article

The foremost aim of this article is to enlighten the reader on the drafting attribute of the franchise agreement so that any further disputes will be prevented.  This piece will also address concerns about the statutes which govern this agreement. 

Meaning of franchise agreement 

The term ‘franchise’ has not been described in the Indian legal framework. However, its meaning can be deduced from the Finance Act of 1999, which states that a ‘franchise’ is an agreement that authorises the ‘franchisee’ to sell or produce goods, provide services, or continue pursuing businesses recognised with the franchise owner. A franchise agreement is a legally binding written agreement between both the franchisor and the franchisee. The agreement specifies the franchisor’s expectations of the franchisee, as well as how the business must be run. It is an agreement in which the franchisor (company) agrees to grant the franchisee its use of the enterprise name or company system.

The person or corporation that owns the trade-marks and business model is known as the “franchisor.” The franchisor grants the franchisee a license to use the trade-mark and business model in exchange for direct payment and ongoing royalty payments. The “franchisee” is the individual or corporation who owns and operates the business using the trade-mark and business model system licenced from the franchisor.

The agreement must be flexible enough to allow the franchisor to render contractual alterations to brands’ immediate requirements. Moreover, this agreement is intended to safeguard the franchisor’s intellectual property (IP) while also maintaining compliance in how every one of its licensees continues to operate underneath its brand. Even though the relationship is promulgated in a written agreement that is destined to last for a long period of time, the franchisor must be able to grow the brand and its consumer offering in order to remain competitive.

Franchise frameworks

The frameworks listed below are determined by the number of franchisors, the wide range of industrial sectors, as well as the level of pay:

  1. Single Unit Franchise- The far more conventional as well as traditionally common type of franchise model is indeed the single unit franchise (also known as direct unit franchise). Under this, the franchisee obtains the right and obligation to develop and operate one franchise from the franchisor. In this, Franchisees will invest their own wealth and use their own managerial skills. For example– When a franchisee buys their first franchise, they are referred to as a single-unit franchisee.
  2. Multi-Unit Franchise– Under this type, the franchisor grants an entity (the multi-unit franchisee) the right and obligation to start and operate multiple franchised units. The franchisee agrees to set up a certain number of places over a fixed period of time. The multi-unit franchisee should be monetarily and operationally capable of producing multiple units. For example– If a franchisee is successful with their first franchise, they may decide to open a second, third, or even fourth franchise with the same franchisor. A franchisee is considered a multi-unit owner if he or she owns more than one franchise unit.
  3. Area Development Franchise- This framework is equivalent to a multi-unit franchise. Under this, the franchisor provides an organisation or agency (the area developer) the right and obligation to help launch several franchised units. For example– Area developers are similar to multi-unit franchisees in that they agree beforehand to develop a certain number of franchise locations within a specific time frame and geographical area. This approach is best suited for franchisees seeking market exclusivity and possessing the financial resources to secure that exclusivity with the franchisor.
  4. Master Franchise- The master franchisee has both the right (and sometimes even the obligation) to recruit other franchisees and the right and duty to establish and operate a number of sites in a specified area. The franchisor gives the right to that of an entity (the master franchisee) for a particular country, province, or region, enabling the master franchisee to offer a full range of services and products via sub-franchising in almost the same manner in which the franchise owner operates its own company. For example- A master franchisee is equivalent to area development in a way that they are required to open a certain number of locations within a specific time frame and geographical area. The master franchisee, on the other hand, is able, and sometimes required, to sell franchises to other prospective franchisees. The master franchisee then serves as a go-between for the franchisee and the franchisor.

Essential Ingredients of a franchise agreement: 

The key aspects of a franchise agreement are stated below:

  1. Relationship Overview- Firstly, the relationship between the franchisor and the franchisee is described. The agreement discloses the contracting parties, intellectual property ownership, and also the franchisee’s overall responsibilities to manage the brand guidelines, among several other things.
  2. Duration of Agreement- It refers to the franchisor- franchisee’s tenure.  In general, franchise owners provide a franchise opportunity for 5 – 10 years. One of the most important aspects of the agreement is indeed the length of the relationship. It could also be stretched if the relationship remains peaceful and they both really want to continue working together.
  3. Franchise Fee- Under the agreement, the franchisee’s obligation to pay a certain amount is also outlined. Franchisees typically pay an initial and enduring fee to the franchisor when they first join the franchise model. There are numerous other fees delineated in the agreement. The franchise fee is the sum of money that a franchisee pays to the franchisor in exchange for the right to use the brand name, logo, and other aspects of the franchise’s identity.
  4. Business Operations- The most substantial cost of having a franchise unit is that you can benefit from the franchisor’s knowledge and expertise. As a consequence, it’s indeed critical to include all comprehensive information on the level of support provided by the franchisor as well as the franchisee’s other commitments. Activities such as buying goods and services and adhering to franchisor-mandated operational standards and account management etc., are covered under this.
  5. Site Development and Selection- The franchisee’s primary duty is to identify the optimal location for the franchise unit. Typically, prior to starting the unit, the franchisee chooses his or her preferred location and awaits franchisor approval. Besides that, each and every description about the site must be written down in the agreement in order for it to be an approved franchise unit of the company.
  6. Support and Training- The majority of franchisors offer franchisees training and support. These trainings are usually provided before and at the ongoing levels in the company’s headquarters on a number of disciplines including supply chain, product quality, as well as other management-related inquiries. The franchise agreement specifics the training period and work schedule.
  7. Utilization of Intellectual Property– Another significant benefit of owning a franchise is the ability to use some of the brand’s intellectual property (as directed by the franchisor). The franchise agreement specifies what is permitted to the franchisee, how the franchisee may be using the brand’s intellectual property, and the franchisor’s rights to develop the platform.
  9. Insurance- Franchise agreements will specify the minimum insurance coverage that a franchisee must have prior to opening and throughout the period of contract.
  10. Record-keeping and the Right to Audit the franchisee’s records: The franchisor specifies the records which its franchisees should maintain, the operating system that franchisees might be using, and the franchisor’s privileges to access and review that data.
  11. Renewal of Agreement- The franchise agreement renewal is one of the most underappreciated clauses of the agreement. Every franchise agreement has a termination date. This typically happens after 10, 15, or 20 years. When the agreement term expires, franchisees have the choice of renewing the agreement or discontinuing franchise units entirely. The renewal rights clause contains the terms & conditions for renewing a franchise agreement.
  12. Termination- The franchisor may terminate the agreement by giving the franchisee written notice if he/she has committed any serious violation of his/her obligations indicated in this agreement, or if any amount required to be paid under the terms has not yet been paid, at the latest, within 21 days after its due date.
  13. Resale of Franchise- A franchise reselling refers to, when an individual decides to purchase a current franchise business as a viable business from a franchisee who owns the franchise rights. It may be the sale of a company or the sale of the franchisee’s holdings. It is common for a franchisee to be given the authority to sell its franchise business, which must be clarified in the franchise agreement. When an individual purchases an operating franchise business from such a franchisee, he/she will be looking at two parties: the franchisee from whom he/she is purchasing the business as well as the franchisee’s franchisor. The person needs to negotiate the purchase cost and the terms of the sale with the franchisee; however, the franchisor must first give his approval.
  14. Other Provisions- The franchisee’s successor rights, default, termination, indemnification, dispute resolution, resale rights, transfer rights, rights of first refusal, sources of supply, local advertising requirements, governing law, general releases, personal guarantees, and roll-up provisions are also included in the to-be-drafted agreement.

Hence, these are the essential ingredients along with some other provisions that must be specified in a franchise agreement.

The signing of franchise agreement:

Both parties should carefully analyze franchise agreements with the assistance of a lawyer.

Prior to actually signing, compare the Franchise Agreement to the Franchise Disclosure Document (FDD) to ensure that the franchise going to offer is underlined in the FDD relates to what is clarified in the agreement. Also, if any oral statements were made, make sure they are penned down in the contract.

The Franchise Agreement governs your relation with the franchisor once signed, and any differences of opinion or misconceptions will be subject to arbitration (in most of the cases) or any other terms as stated in the agreement.

Applicable laws

There is no special legislation in our country (India) which interacts with franchise agreements totally, however, franchise as a business hits on various business laws and sector specific laws of the country. Because every franchise agreement describes a contractual relationship between franchisor and franchisee, therefore, the provisions of the Indian Contract Act of 1872 must be followed in these contractual arrangements.  

Franchisees may include disclosure requirements in their contracts. Under this, the franchisor’s misrepresentation allows the franchisee to initiate legal proceedings (Civil or Criminal) for damage caused as well as for misrepresentation of the facts and criminal breach of trust.

In India, franchising as stated above, is governed by various business applicable statutory enactments rather than franchise-specific legislation. Among them are the Indian Contract Act of 1872.

Consumer Protection Act of 1986

As per Section 2(1)(c) of the Act, a consumer can file a grievance with the consumer courts if a trader uses unfair or restrictive trade practices, or if the goods or services supplied by the trader have defects or deficiencies, or if the goods being offered for sale are defective. In the scenario of a franchise, both the franchiser and the franchisee may be held liable for any defective goods or services provided to the consumer. Therefore, provisions in the franchise agreement should be clearly vetted to lessen liability arising from such consequences.

Standards of Weights and Measures Act of 1976

If a franchise agreement includes the sale or distribution of goods by weight, measure, or number, the Act of 1976 and the rules promulgated under it can also become applicable.

Intellectual Property Law

These types of agreements facilitate the transfer of certain form of intellectual property, such as a patent, copyright, or a trademark or trade name. The intellectual property licence is at the soul of a franchise, hence, the laws governing intellectual property licencing are the essential part of franchising agreement. Also, it is the franchisor’s responsibility to ensure that the intellectual property rights licenced to the franchisee are not misused in any way.

Companies Act

If the franchisor or franchisee is a company, the provisions of the Companies Act, 1956 or 2013 accordingly, as well as other rules and regulations governing companies in India, will apply. Here, an important consideration is that the company’s directors may become responsible and liable for its activities.

Foreign Exchange Management Act of 1999 

A franchise agreement between an Indian native and a non-resident would be subject to the Foreign Exchange Management Act of 1999, and the rules enacted thereunder.

According to Rule 5 read with Schedule III (16) of FEMA Rules of 2000, approvals of the Reserve Bank of India is mandated for transfer of payments outside India for use/and or purchase of franchise in India.

Transfer of Property Act, 1882

To determine whether the franchising scheme is feasible, a careful examination of the property laws would be required. If the scheme is not feasible, necessary steps must be taken. 

Information Technology Act, 2000 

Section 69 and Section 72 of the Act states the importance of defending privacy rights against state action. Nonetheless, in order to gain the confidence of a cautious consumer, the franchisor and franchisee must protect their privacy rights.

Income Tax Act, 1961

As per Section 9(1)(vi), Royalties paid by the franchisee to the franchisor for the use of the franchisor’s intellectual property rights would be taxed at 20% of the gross amount paid.

Conclusion 

Every aspect of the franchise must be analyzed when drafting a proper franchise agreement because a franchise agreement is supposed to convey the individuality of every franchise proposition and describe the interplay of the intended franchise relationship, replicating another franchise system’s agreement is undoubtedly the single biggest mistake a new franchise owner could perhaps render.

Sample draft for franchise agreement

FRANCHISE AGREEMENT

This Franchise Agreement is entered into on this day of ______month, year, at ______ place.

BY AND BETWEEN

______, a company established under Companies Act, and having its registered office at ______, and having registration number ______, and being represented by its Authorised Signatory/Director ______, hereinafter referred to as the ‘Franchisor’ (unless repugnant to the context, this expression shall mean and include successors-in- interest/office and assigns) of the First Part;

AND

______, a company established under Companies Act, and having its registered office at ______, and having registration number ______, and being represented by its Authorised Signatory/Director ______, hereinafter referred to as the ‘Franchisee’ (unless repugnant to the context, this expression shall mean and include successors-in- interest/office and assigns) of the Second Part;

(Parties of the First Part and Parties of the Second Part are hereafter collectively referred to as the ‘Parties’ and individually as ‘Party’).

RECITAL CLAUSE– 

NOW THIS AGREEMENT WITNESSETH AND IT IS HEREBY MUTUALLY AGREED AND DECLARED BY AND BETWEEN THE PARTIES HERETO AS UNDER:

SCOPE- The Franchisor appoints the Franchisee its franchisee for a period commencing on the date of this Agreement and continuing until the appointment is terminated by either party giving to the other at least ____months’ written notice or otherwise in accordance with the provisions of this Agreement and subject to the terms and conditions of this Contract the right to:

  1. carry on the business of [details] as a franchise business using the concept and image of the Cafe (“the Business”);
  2. carry on the Business from the premises at [address] (“the Property”);
  3. use the rights as set out in this Contract (“the Rights”); and
  4. carry on the Business in accordance with the methods of operating the Cafe using the know-how and systems for operating the Cafe contained and detailed in the operations manual (“the Manual”);
  5. carry on the Business as otherwise required in writing from time to time by the Franchisor in accordance with this Contract.

FRANCHISOR and FRANCHISEE RESPONSIBILITIES- During the term of this Contract, the Franchisor will undertake the following:

  • Support in the Business as reasonably requested or required pursuant to the terms of this Contract.
  • To operate the Business properly and strictly in accordance with the Agreement.
  • To provide the required training.
  • To review and audit the Business from time to time for quality control purposes, etc. (other responsibilities to be included).

FEES AND PAYMENT-

The Franchisee agrees to pay on the dates due without deduction or set-off: 

  • The Initial Franchise Fee on the date of this Contract.
  • The Management Fee within _______business days of the end of each calendar month.
  • The Service Fee within ______ business days of the end of each calendar month.
  • The Franchisor’s legal costs and expenses incurred in preparation and implementation of this Agreement.
  • The fees and sums due by direct debit or other method specified by the Franchisor from time to time.

CONFIDENTIALITY and INTELLECTUAL PROPERTY- 

  • Unless otherwise expressly agreed in writing between the parties, all right, title, and interest in and to all trade marks, logos, trade names, copyrights, , patents, designs, and all other intellectual property rights (“the Intellectual Property”) in and relating to the Franchisor, the Cafe, or to the Cafe’s website) shall belong to the Franchisor.
  • The Franchisee agrees to maintain secret and confidential all information (whether technical or otherwise) obtained pursuant to this Contract.
  • This Clause shall survive any termination of this Contract and continue in force for a period of ______ years after any termination.

TERMINATION–

This Contract may be terminated as follows:

  • By a mutual agreement in writing between both parties.
  • By either party upon at least ______days’ written notice expiring at any time on or after _______from the signing of the Contract.
  • By either party by giving written notice to the Franchisee having immediate effect if the Franchisee breaches this Contract and fails to remedy that breach (if capable of remedy) within _____ days of being given a written notice identifying the breach and requiring it to be remedied.
  • This Contract shall terminate without notice in the event of the death of the Franchisee.
  • Post- Termination- (Details as decided by the parties).

ACKNOWLEDGEMENTS-

The parties acknowledge as follows:

  • The Franchisee shall comply with all reasonable and lawful instructions of the Franchisor from time to time relating to the marketing and carrying on of the Business in the Territory, the Manual and shall generally carry out its franchise in such manner as it thinks best to promote the interest of franchised business.
  • The Franchisee agrees that the Franchisor may during the period of notice ending on the date of termination of this Contract appoint a successor to the Franchisee and may introduce that successor to customers and potential customers and allow that successor to make itself known as the Franchisor’s Franchisee so as to be able to commence business from the day after expiry of this Contract.
  • Any change of ownership or control in the Franchisee must be first approved in writing by the Franchisor.
  • The Franchisor shall be entitled to inspect the Franchisee’s books of account at any time by service of reasonable notice to the Franchisee (of not less than _____ days) of such proposed inspection or audit which shall be during reasonable business hours.

Assignment-

 The Franchisee shall not without the prior written consent of the Franchisor sub-contract, assign or otherwise assign any or all of its rights and obligations under this Contract.

Waiver-

Any indulgence granted by the Franchisor to the Franchisee in respect of the performance by the Franchisee of its obligations under this Contract or any neglect or failure by the Franchisor to enforce any of the terms of it shall not be construed as a waiver or variation of this Contract or otherwise prejudice any of the Franchisor’s rights under it.

Severance-

If any part of this Contract becomes invalid, illegal, or unenforceable such provision shall be severed from this Contract and the parties shall in such an event negotiate in good faith in order to agree the terms of a mutually satisfactory provision to be substituted for the invalid, illegal, or unenforceable provision which as nearly as possible gives effect to their contractual intentions as expressed in this document.

GOVERNING LAW & LANGUAGE & JURISDICTION-

  • This Agreement is in the English Language and no translation into any other language shall be a valid interpretation.
  • This Agreement is governed by and shall be construed in accordance with the existing Indian Laws. The Courts at ______shall have exclusive jurisdiction in respect of this Agreement.

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