IP Licensing Agreements – The First in The Series of 5 Important IP Contracts

Here is the fifth and the last article of the series, 5 Important IP Contracts.  In this article, Varshita Dogra of VIPS discusses Confidentiality or Non-Disclosure Agreements.

This article is written by Varshita Dogra and updated by Harsh Kedia, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com.

Franchise agreement

Franchise agreement, technically, are not IP contracts but a major part of Franchise agreement deals with intellectual property. Franchising is essentially a structured and sophisticated form of licensing. A company would engage into franchising its business, when it has strong and distinguishable intellectual property, such as its trademarks, trade dress, copyright, know-how, trade secrets, relevant industrial designs, patents, business concepts or methodologies, in order to capture new markets and expand its presence.

The expertise of an IP lawyer would be desirable/beneficial while drafting a Franchise agreement. Franchising is one of the most effective way to exploit another company’s IP as it provides the person taking the franchisee with an infrastructure that enables successful protection. When properly structured and run, franchising provides benefits and satisfaction to both the parties.

Although licensing forms the heart of a franchise agreement, there are a lot of technical differences between a licensing agreement and a franchise agreement. A franchise agreement involves a number of formalities required for setting up a franchise. It also goes into detail about maintaining quality and standard of product or service being provided. The control of a franchisor is comparatively more than that of a licensor in the usage of intellectual property by the franchiser.

There are two types of franchising :

1. Product and trademark franchise, wherein the franchisee uses the franchisor’s trade name and sells the franchisor’s products. Such form of franchising is popular in businesses like motor vehicle dealerships, soft drink bottlers and gas stations.
2. Business format franchising, wherein the franchisee uses the franchisor’s entire business concept including the trade names, goodwill, know-how, trade secrets, etc. of the franchisor. This form of franchising can be commonly seen in fast food chains such as McDonalds, Pizza Hut, Dominos etc.

Key Clauses in a Franchise agreement

As there is no specific law in India governing the franchising industry, it is even more crucial that the Franchise agreement is drafted well. It can prove to be fatal for either the franchisor or the franchisee if the agreement is not made with proper precaution.  

The agreement sets out the type of franchise arrangement, the grant of the license, the extent of the rights granted and the duties, rights and obligations of the parties as per the agreed terms. Usually, these agreements are in the form of dos and donts as a list of things to adhere to and things to strictly avoid during the course of business. Franchisors exercise control and supervision over the exploitation or use by the franchisee of their IPRs, know-how and confidential information.

• Use of intellectual property by the franchisee

It is necessary to specify in a Franchise agreement, the details of the intellectual property in regard of which the rights to use are being licensed. It must also be specified that the marks so being licensed are only with regard to the operation of the franchised unit at location where such franchise is settled. Most of Franchise agreement have a clause requiring the franchisee to notify the franchisor in case there has been infringement of the intellectual property by any third person. It is necessary to specify in the Franchise agreement, the prohibition on usage of the trademark by the franchisee; post termination of the franchise agreement.

• Fees and royalty clause

Usually Franchise agreement include payment of a non-refundable franchise fees which is a one-time fee and royalty as well. This clause also specifies the mode of payment and due dates, for payment of both the franchise fee and the royalty as decided between the franchisor and franchisee.

• Business Operations (only in business format franchising)

This clause contains detailed information about the level of support that will be provided by the franchisor for running the business and responsibilities of the franchisee. It specifies the details of the goods and services that can be offered by the franchisee and fixed quality standards for these goods and services. Generally for a business format franchising, it is also required that the franchisee exclusively purchase raw material or goods from franchisor and maintain accounts as per the franchisor’s requirements. The franchisor also makes sure to include a clause granting right to the franchisor to inspect the unit at regular intervals.

• Confidentiality Clause

One of the biggest concerns for any franchisor is to ensure confidentiality of the intellectual property (trade secrets, know-how, patents, etc.) while entering into a Franchise agreement. Strict clause for confidentiality specifying the penalties for non-compliance is a must in any Franchise agreement. In order to ensure that the franchisee keeps the information confidential, it is also suggested to enter into a separate confidentiality agreement which specifically deals with protection of the confidential information of the franchisor.

• Advertising and Brand Promotion

Franchisors spend a significant amount of resources for promotion of their brand. Therefore, a franchise agreement also covers the aspect of advertising and brand promotion. Usually, the responsibility lies on the franchisor to promote the brand and the franchisee is supposed to contribute by taking active part in brand building activities.

• Training, Supervisions and Support

Training with respect to know-how, trade secrets and working of the business model of a franchise is necessary to ensure that the franchisee is able to meet the standards set forth in the agreement by the franchisor. It is the duty of the franchisor to provide as much support, training and supervision as required by the franchisee.

• Assignment or transfer of franchise

A transfer of franchise usually cannot be made, unless expressly stated in theFranchise agreement. If the franchisor seeks to allow transfer of franchise, a clause specifying that the transfer cannot be made without approval of the franchisor would be appropriate.

• Indemnity Clause

Franchise agreement usually cover indemnity rights requiring the franchisee to indemnify and defend the franchisor for incidents arising at or in connection with the franchisee’s business or location and requiring the franchisee to name the franchisor as an additional insured on its insurance provisions. Suits against a franchisee and its franchisor as co-defendants are increasingly common. Whether because plaintiffs are simply seeking deeper pockets or because plaintiffs do not understand the nature of franchising, plaintiffs often name the franchisor as a co-defendant whenever suing its franchisee for incidents arising in connection with the franchisee’s location or business. For example, a restaurant patron may sue a franchisee and franchisor in connection with a slip-and-fall at the franchisee’s restaurant. A franchisee may sue its franchisor and sister franchisee for the other franchisee’s alleged encroachment. Although indemnification clauses are generally enforceable, they are subject to certain limitations and defenses. A party cannot be indemnified for its own negligence absent an explicit, conspicuous commitment to do so that includes the word “negligence” in the indemnification clause.

Due to globalisation and liberalisation the business relations between the countries have expanded in a very rapid speed and this increased the growth of business outside the home territory. For any business the first and foremost motive is to gain more and more profits and this can happen by diversifying and expanding the business. Various methods were used to expand and grow the businesses throughout the globe. Among those, franchising is one of the techniques adopted by the people to grow and expand their businesses. 

Though franchising is not well defined in the Indian law but in a normal context it means permitting any other person to use the business of the company. Franchising is a way by which a franchisor grants certain rights pertaining to the business and allows the franchisee to use such rights; for example trademarks, intellectual property etc. Franchisor is the one who permits the other person i.e. to the franchisee to carry out the same business activity as that of the franchisor. This is one of the best ways to expand the business without transferring any actual rights to franchisee. The franchisee only gets a certain right along with some obligations but they are not treated as partners or shareholders of the company. We all witness business by way of franchising in our surroundings on a daily basis. For example, Dominos which is an American multinational pizza restaurant chain, but we can find several outlets across the globe. This is done by way of franchising. There are few types of franchising agreements which prevails in India. Some of these are:

Product Franchises

In product franchises the franchisor grants the right to see the products manufactured by the franchisor. This is the most common type of franchise business. For example, there are certain brands which manufactures products like cakes, etc. like Mio Amore, a famous brand which deals in cakes and pastries and by granting rights to various franchisors, these are sold in the market. In turn the franchisee pays an amount to the franchisor according to the agreement between them. 

Manufacturing Franchises

When the franchisor grants the right to the franchisee to manufacture as well as sell such products in the markets then such agreement is referred to as a manufacturing franchise. The most common example for this type of franchise agreement is dominos and pizza hut. The franchisee manufactures the foods which are to be sold by him in the name of such brands. The franchisee is provided with all the relevant raw materials and recipes which are originally used by the franchisor for making such products. 

Business franchise ventures

In this type of franchise agreement, the franchisee buys and sells from the franchisor. The only difference between business franchise ventures and other types of franchise agreement is that in the former case the franchisee is restricted from selling the products to the client which is decided by the franchisor.

Franchising though appears to be a very easy and convenient way of expanding the business, but if we see from the perspective of the franchisor and the franchisee, there are certain difficulties which they face while performing this activity. No doubt there are many pros of this style of business but yet there are certain cons too. Through this article I am going to talk about the various problems faced by both the parties in general as well as the legal issues which they face. Any franchising agreement which is made internationally are governed by many laws for example the Indian Contract Act 1872, Competition laws, Intellectual Property Laws, Foreign Exchange laws, Income tax laws and many other laws. It is very important to keep in mind the laws governing the agreement before executing it. 

Franchising Agreement

There are no specific laws in India which governs any franchising agreement. But acts like Indian Contract Act 1872, Sales of Goods Act 1930 or Specific Relief Act 1873 applies to commercial agreements and franchising agreement comes under commercial agreements. For any agreement to be legally enforceable, the contract should not violate any of the following elements mentioned in the Indian Contract Act. they are:

1. An agreement, i.e. an offer and an acceptance of the offer;
2. lawful consideration for the agreement;
3. lawful object and purpose of the agreement; 
4. free consent of the parties to the agreement; and 
5. capacity of the parties to enter into an agreement.

If such franchising agreement violates any of the essentials then such contract shall not be legally enforceable. 

Another issue that could arise is of competing with the franchisor’s business during the term of the franchising relationship. In the landmark case of Gujarat Bottling Co. Ltd. and others v. Coca Cola Co. and others (1995 AIR 2372, 1995 SCC (5) 545), the Coca Cola Co. had imposed a restriction on Gujarat Bottling Co. Ltd from entering into an agreement with any other beverage manufacturing company during the term of their contract. When the case came up before the Supreme Court as being in restraint of trade, the Court held the following: 

“There is a growing trend to regulate distribution of goods and services through franchise agreements providing for grant of franchise by the franchiser on certain terms and conditions to the franchisee. Such agreements often incorporate a condition that the franchisee shall not deal with competing goods. Such a condition restricting the right of the franchisee to deal with competing goods is for facilitating the distribution of the goods of the franchiser and it cannot be regarded as in restraint of trade.”

The Court therefore held that a negative agreement restraining the franchisee from manufacturing, bottling, selling, dealing or otherwise being concerned with the products or beverages of any other brands or trademarks/trade names during the subsistence of a franchise agreement including the period of one years’ notice, is not violative of Section 27 of the Contract Act. However, the Court did not address the issue of a negative covenant post-termination of the agreement. This is an issue that the parties must bear in mind while formulating the contract.

Intellectual Property

As we know there are certain transfer of rights and obligations in franchising, the most important right which is transferred is Intellectual Property. As most of the businesses grow because of the inventions they had made or because of the trademark of such company, it is the foremost duty of the franchisor to ensure that there should not be any misuse of such intellectual property rights of the company. For example, the business of Dominos, Coca-Cola depends upon the secret of the ingredients or drinks they manufacture. If such an agreement is not made with regards to the intellectual property laws prevailing in the country, then there is large possibility of exploitation of such intellectual property rights. Such franchising agreement should comply with the IPR laws according to the business of the franchisor. 

Consumer protection

In most type of franchising agreement, the franchisee acts as the agent of the franchisor. This is because it is the franchisor who decides the way in which the business is to be conducted, the norms which are to be followed and at the end of the day the franchisee needs to inform the franchisor about the business. As per the Indian Contract Act 1872, the principal is liable for the acts of the agents done in the course of the business. There may be circumstances under which the franchisee violates some of the provisions of the consumer protection act and therefore a legal suit may be brought against such franchisee. The franchisor while making such agreement has to deal with such future circumstances and execute in that manner. 

Confidentiality

As we know most of the agreement consists of a confidentiality clause which restricts either party to keep the information of the business with them. In case the information pertaining to the contract are shared by any third party then in such cases the other party should be indemnified. Mere indemnification can only give monetary relief to the victim but every business runs from different ideas. If the main idea is shared by any competitor then the whole business can go into losses. In the case of franchising it is necessary for the parties to execute a clause which fully restricts them from sharing any information. 

Competition law and unfair trade practices

Due to the growing trade practices is the one of the most important tasks of the government to prohibit unfair trade practices. In India Competition Act 2002, has been enacted to prevent restrictive trade practices or control power of the dominating companies. There may be cases in which the franchisor wants the franchisee to sell a particular product at a particular price or the franchisee makes false representation or provides false reports to the franchisor. To avoid such cases the agreement between the parties needs to be drafted in a very careful manner. 

Corporate and securities issues

All the companies in India are regulated by the Companies Act 2013 and in case the franchisor or the franchisee is a company then the regulations made under Companies Act should be kept in mind. All the companies are registered in India and it is mandatory to provide financial statement to the ROC (Registrar of Company) If in any case the franchisee makes any false report then the franchisor can be held liable or in case the franchisor makes some defaults then the franchisee will also get affected. Same is in the case of securities laws. If the company is listed in any stock exchange then such company comes under the purview of the SEBI (Securities and Exchange Board of India) and the SEBI regulations are appliable to them. If the franchisor is an Indian company the franchisee is a company from other country or vice versa then the FEMA (Foreign Exchange Management Act, 1999) regulations will be applicable. The parties before getting into a contract should comply with all these regulations. 

Taxation

The franchisee in turn of using the intellectual property of the franchisor pays royalty fee. Such fees are chargeable. 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%. Therefore, the parties should look into the tax laws before executing the final document.

Conclusion

These were some of the legal problems which are faced in the case of franchising. Though it is not mandatory to register such agreement in India, but is always advisable to register such agreement. After the new economic policy of 1991, the rate of expanding business throughout the world has increased at a very rapid speed and the government of India has taken several measures to allow the foreign companies to invest in India and setup their companies. Most of the company by the way of franchising and on a single brand basis conducts business in India. Franchising provides a ready-made market for the parties as the brand name is already known to the public and the parties don’t need to incur expenses on advertising the products it is much easier for the franchisor to set up such business outside the home country. From the viewpoint of the franchisee they are benefited as they don’t need to struggle in finding customers. There is already goodwill of such company in the market so the cost of promoting the business is reduced. All the franchising agreements should be made keeping in mind the international laws as well the domestic laws. 

To know exactly how a franchise agreement looks like and what are the common and basic clauses which are used while drafting any franchise agreement, you are requested to go through the sample franchise agreement template by clicking on the link mentioned below. 

Sample Franchise Agreement- https://www.wonder.legal/in/creation-modele/franchise-agreement-in

Sources:

• Legal issues in franchising by Nishith Desai Associates.
• The law reviews.
• FranchiseIndia.
• Clear tax.
• Franchise Asia

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