This article is written by Kshitij Pandey, pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
India is one of the biggest franchise markets in the world. The country has one of the largest consumer markets due to its large population and growing economic prosperity. This provides an opportunity for numerous Food and Beverages (F&B) Restaurant franchising in India. In the recent past, the country has taken several steps like privatization of many sectors, liberalisation and globalisation of the Indian economy to facilitate business in the country. With increasing ease of doing business, India has become one of the leading commercial and economic hubs on the Globe and there are a lot of international entities coming to the country with various franchise opportunities. Franchising business growth is very impressive in India. According to Franchise India, franchising has registered a growth of around 30-35% over the last four-five years, with the overall turnover estimated to be around Rs. 938 billion. In India, the share of the Franchise sector has crossed 1.8% in the GDP and it is estimated to increase to about 4% by 2022. Presently, in India, there are more than 3,800 domestic franchisors with different franchise models. Franchising the products, under several formats, by various industries like F&B, education, retail, health and wellness, and consumer services is a preferred choice for their growth. The restaurant franchise is one of the major contributors to the franchise business in the country. According to Grant Thornton’s report, the share of F&B sector franchising has grown the fastest, having a CAGR of 41% from 2012 to 2017, with market share increasing from 5% to 9% during this period. This article discusses their legal perspective of Restaurant franchises in India.
What is franchising?
Franchising is a method of selling products or providing services. This involves two parties:
- One, known as a franchisor, who has already established a business system and for his specialised product with its own well-known trademark.
- Other is a franchisee, who gets the right to do business using the trademark and business system of the franchisor in return for royalty/fee payment.
According to the Blacks Law Dictionary, “franchise” means a license from the owner of a trademark or trade name, permitting another person to sell a product or service under his name or mark.
Types of generic franchising
There are, generally, two types of franchising:
Business format franchising
In this type of franchising, the franchisee gets the right to use the franchisor’s trade name, products and services as well as an established system for operating the franchise business. The franchisor provides support like site selection and its development, standards adopted by the brand, operating manuals with support in day to day operation strategies, training, quality control, marketing strategies and business development support to the franchisee. Restaurants, convenience stores as well as personal and business services are some of the examples of this type of franchising.
Product distribution franchising
This model involves the dealers or distributors, who get the right to use only some specific system or format of the franchisor’s business. A typical example of this type of franchising is automotive dealerships.
Restaurant franchising in India
- Restaurant franchising involves granting access to an established brand with rights to some other entity to use name, recipes, look and feel, trademarks etc. to conduct business, in return for some franchise fee. In the agreement, the terms & conditions for every aspect like menu, design and layout, service, staff etc. are covered and these are to be followed by the franchisee under the defined protocols.
- Following the economic liberalization of the 1990s, several foreign companies with strong brand names have established restaurants in India through franchising. Global franchise companies in India include Auntie Anne’s, Barista Lavazza, Baskin Robbins, Booster Juice, California Pizza Kitchen, The Coffee Bean, Domino’s, Dunkin Donuts, Hard Rock Café, Johnny Rockets, KFC, McDonald’s, Pizza Hut, Starbucks, Subway, TGI Friday’s, Wimpy’s etc.
- Like their global counterparts, the popular Indian brand owners with a large customer base are also following the franchise model to expand their business further. Barbeque Nation, Moti Mahal, Haldiram, Sagar Ratna, Swagath, are a few of the most famous franchises in India. These restaurant chains have carved out an important place for themselves in the Indian F&B industry.
What is a franchise agreement?
In a franchise agreement, the expectations for behaviour and acts for the legal and commercial relationship between the franchisor and the franchisee are delineated to run a business under the franchisor’s brand name. A major part contains the conditions put by the franchisor, which the franchisee must follow, but there are provisions for protecting the interests of the franchisee also. A good franchise agreement will also have provisions like dispute resolution and governing laws covering both the parties, in case anything goes wrong.
Types of restaurant franchise agreements in India
In such franchising contracts, the brand owner of the popular restaurant chain grants the right of the franchising activities in a particular territory to a person or entity, which is called a ‘master franchisee’. Then, within this territory, the ‘master franchisee’ assumes the role of the franchisor. In this type of agreement, the franchisor (brand owner) grants the right to a master franchisee, who can provide all the products and services of the franchisor. The master franchisee has also the right to appoint further franchisees. Examples of this type are Taco Bell, Papa Johns, Yo China etc.
Single-unit or direct franchising
In India, it is considered as one of the most prevalent models for franchising, in which the owner also works as the primary operator or the manager for his restaurant. The franchisee has to invest their own capital and apply their management skills to enhance their business. Examples are Moti Mahal, Pind Balluchi, Sagar Ratna.
In this type of contract, the franchisor grants franchise rights to more than one business unit. The ownership of all these units is with one franchisee, which is responsible for the growth of all such units. Examples are Nirula’s, Subway etc.
In this type of contract, the brands like Pizza Hut, Berco’s etc. establish the offices in the franchising territory to provide help to franchisees for expanding and establishing the business in the territory.
Legal provisions for restaurant franchising agreement
In India, there is no specific law, which solely governs all aspects of franchising. However, various aspects of franchising business can be dealt with provisions in various business and industry-specific laws in India. As of February 2020, there were 34 jurisdictions that had some form of franchise-specific law or regulation that requires the delivery of a disclosure document to a prospective franchisee before the prospective franchisee purchases the franchise. In absence of strict requirements, under Indian law, for any pre-contract disclosure and any statutory obligation to provide any information to the prospective franchisee, a general principle of good faith and fair dealing is followed. A franchisee should conduct thorough due diligence before concluding a franchising agreement.
Various aspects of franchise agreements and related laws in the country as under:
Enforceability of the franchise agreement
Technically, franchising is a contractual relationship. Therefore, franchise agreements can be governed by various provisions in the Indian Contract Act, 1872 (“Contract Act”). Under the Contract Act, the following are some of the conditions for a valid contract:
- Offer or Proposal;
- Acceptance of the offer;
- Lawful Consideration, which is not forbidden by law
- Lawful object and purpose;
- Free consent of the parties;
- The capacity of the parties to enter into the contract;
Therefore, each and every franchising agreement has to essentially meet the criteria mentioned under Section 10 of the Contract Act, for the Franchise Agreement to be legally enforceable. Even though the Contract Act does not stipulate that a contract must be in writing, it is preferable to have a formal and written franchise agreement to clearly lay down the rights and duties of both parties.
The Indian Contract Act is the main law governing the fundamental aspect of contractual obligations between a franchisor and a franchisee. It decides fundamental principles of the agreement like offer, acceptance, consideration, breach of contract and other essential activities.
There may be an issue of competing with the franchisor’s business during the term of the franchising. In the landmark case of Gujarat Bottling Co. Ltd. and others v. Coca Cola Co. and others, the Supreme Court 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 or trade names during the subsistence of a franchise agreement including the period of notice, is not in contravention to Section 27 of the Contract Act. This issue must be considered while formulating the contract.
Similarly, as per the Contract Act, the franchisee may also have an obligation to compensate the franchisor for liabilities arising due to actions outside the course of the business or in contravention to the franchisor’s directions. In case, a third party takes action on the representation of an agent and suffers any losses, it may create some concerns for the franchisor also. Further, any limitation on the authority of the franchisee will not bind any third party unless he is or is made aware of such limitation. Therefore, it is very important to consider the anticipated relationship between the franchisor and franchisee while finalising the franchise agreement.
Protection of intellectual property rights
A franchising agreement involves the transfer of some form of intellectual property, either an invention or a patent for the invention or a business trade secret (eg. McDonald’s and Barista coffee). The intellectual property licence lies at the core of a franchise, the laws governing licensing of intellectual property are very important in a restaurant franchise agreement. This aspect can be dealt with under different enactments like the Trademarks Act, 1999, Patent Act, 1970, Design Act, 2000, Copyright Act 1957. These statutes govern various aspects of a franchise agreement including the trademark, patent, design, copyright etc. Trademark Act protects the trademark, unique identification of any brand, through proper registration. In the restaurant business also this is applicable for example, a particular dish of a franchisor may have its unique recipe. No one knows how to prepare the same taste like a McDonald’s burger. This aspect of the product is regulated by patent law. In McDonald’s Corporation & Anr v. National Internet Exchange of India & Ors, McDonald’s submitted that the defendants were fraudulently misusing the Mcdonald’s trademark and copyright. It was also submitted that the respondents were engaged in registering misleading domain names incorporating the McDonald’s trademark and were operating fake websites inviting applications to McDonald’s franchise and collecting monies from the applicants illegally. Mcdonald’s sought an injunction restraining the respondents from carrying out such activities. The injunction was granted by Delhi High Court on the basis of the prima facie case presented by McDonald’s.
While preparing a franchising agreement, it should be ensured that the franchisor has the authority to grant, to a franchisee, intellectual property rights, mentioned in the agreement. The agreement must always specify the exact nature of and the extent to which, rights are granted. Disputes involving post-term use of the franchisor’s trademark by the franchisee are one of the litigious issues in franchising, which may be avoided by careful drafting of the franchise agreement.
In a business format type restaurant franchise agreement it is crucial for the agreement to decide on the amount of know-how and trade secrets to be transferred to the franchisee as well as protection of the franchisor’s confidential information from third parties. In this regard, the franchisee can be restricted by a negative covenant from competing with the franchisor during the franchise agreement. Such negative clauses can also prevent sharing of any confidential information, trade secrets and know-how during and even post-termination of the agreement.
Competition and unfair trade practices
Under the Competition Act, 2002, practices related to production, supply, distribution, storage, acquisition or control of goods or provision of services, which may cause substantial adverse effects on competition within India, are legally barred. In the agreement, it should be ensured that there is not an element of antitrust or restrictive trade practice to restrict market competition and promote monopoly.
Monopolies and Restrictive Trade Practices (MRTP) Act, 1969 mandates that agreements relating to restrictive trade practices for the provision of services or for the production, storage, supply and distribution or control of goods must be registered with the Director-General. Both parties in the franchise agreement must refrain from monopolistic or restrictive practices. The Commission under the MRTP Act is empowered to grant an injunction to prevent such trade practices and compensation for any losses or damage suffered thereby, may also be awarded.
Liability under Law of Torts
In a franchising arrangement, the breach of any duty by any of the parties i.e. the franchisor or franchisee, which causes a loss or damage to the other party or to any third party, may result in a civil action for negligence. If there is a principal-agent or an employer-employee relationship between the franchisor and the franchisee, the franchisor can be held liable for any torts committed by the franchisee during the agreement.
Corporate and taxation liabilities
The provisions of the Companies Act, 2013 and other rules and regulations in India, applicable on companies are to be abided by the franchisor and franchisee if they are registered as a company. The directors of the company may become liable for their actions. If the franchisor enters into a joint venture with franchisees, the sector and industry-specific regulations would be applicable. For example, in order to open a fast-food restaurant franchise, the franchisor or franchisee needs to obtain requisite licenses from the concerned government department.
The franchisor or franchisee’s income would be subject to tax rates applicable to companies as per the Income Tax Act, 1961. This statute regulates the mechanism of international franchising also. All the royalties or the franchise fee are taxed at applicable rates in the country.
Under the Consumer Protection Act, 2019 the consumer is provided with different types of safeguards against unfair trade practice. In case, there is any defect in the product or deficiency in services, a consumer can file a complaint against the franchisee as well as the franchisor.
Foreign exchange control
In the case of a franchise agreement between an Indian resident and a non-resident, the provisions under the Foreign Exchange Management Act, 1999 (“FEMA”) and the rules framed thereunder needs to be considered.
For transfer of funds outside India, for use or purchase of trademark/franchise in India, the FEMA rules, mandates for prior approval of the Reserve Bank of India (“RBI”).
International brands, having a franchise in India such as KFC, Subway etc. have to abide by this Act and related rules. There are different sets of rules for prior approval of the Government for royalty payments on use of the trademarks and brand name of the foreign collaborator with or without technology transfer.
Property and labour
Laws relating to real estate and leasehold property form an important part of franchising. Depending on the Terms & conditions of the legal relationship between franchisor and franchisee related to franchise business operations, different labour laws would be applicable. In respect of restaurant franchises, the court had observed that the franchisees are independent contractors as they selected their suppliers, fixed the prices, made large initial investments and made hiring decisions.
The Arbitration and Conciliation Act, 1996 is applicable in resolving disputes wherever possible. Alternate dispute resolution through arbitration may be a solution to the disputes arising between Franchisee and franchisor.
Essential elements of a franchise agreement for restaurant
A ‘franchise agreement’ is, necessarily, a legally binding contract to be followed by both of the parties i.e. franchisor and franchisee. These agreements are mostly non-negotiable. The franchisor, normally, makes a similar contract for every franchisee and mostly they are non-negotiable in nature. For some old franchisee businesses like Subway, contracts are very well defined for many years and many provisions of their contract are hardly negotiable. Though franchise agreement clauses differ from business to business. There are few common clauses that these agreements should necessarily cover:
The franchise agreement should lay down the nature of the business, the geographical scope, etc. the subject matter and the term of the franchise. The franchise agreement should clearly mention whether it is a fine dining restaurant, cafe chain, take away or fast food outlets, pizzerias, Mobile food outlets and kiosks. This section is crucial to the agreement as it is the preamble to the agreement and would be referred to for interpreting the true intent of the parties. For example, if the franchisor is a well-known restaurant brand in India that wishes to start a chain of restaurants throughout different cities. In that case, the scope must set out the basis for the agreement by outlining the intention of both the parties to start the chain of restaurants, the areas in which these restaurants would be commenced, the validity period of the agreement, and the exclusive or non-exclusive nature of the agreement.
Location and territory
The physical area/territory is assigned by the franchisor to its franchise through the provisions in the franchise agreement. There are two types of franchise territories:
- Exclusive territory: In an agreement with an exclusive territory, the franchisor cannot sell other franchises in that particular area. The territory assigned is exclusive to that franchisee.
- Non-exclusive territory: When a franchise is sold in a non-exclusive territory, the franchisor can have other franchisees in the same territory.
Term and renewal
This clause contains the time duration for the initial term as well as the renewal period, if any, of a franchise agreement. According to the provisions mentioned in the agreement, a franchisee is authorised to operate the franchised unit for a specific period. The renewal clause provides the opportunity for the franchisee to continue further with the franchise, as per the terms and conditions mentioned in the agreement.
Licensing, confidentiality and intellectual property rights (IPR)
IPR has become the core of franchising agreements. It is necessary to delineate the intellectual property such as trademark, service mark, trade name, copyright, patent, trade secrets or know-how etc. associated with the franchisor and the exact intellectual property it is licensing to the franchisee. All such licensing must conform to the relevant intellectual property legislation in India.
The franchisor restaurant should define the limit, the manner and the circumstances for use of the intellectual property rights. Through the provisions in the franchise agreement, it is to be ensured that the IPR given by the franchisor is not misused by the franchisee and cause any damage to the market value and goodwill of the brand.
In the event the franchisor has transferred or may transfer some trade secrets like the recipe of signature dish or confidential information to the franchisee, the agreement should stipulate that such information will be kept confidential during as well as after expiry of the agreement.
The franchisee is granted to use the franchisor’s proprietary marks only in connection with the operation of the franchised unit in the franchise agreement at the location from where such franchise is operating. An owner of a Kareem’s cannot use Kareem’s proprietary mark at any other place except the particular restaurant.
Fees and royalty
The non-refundable franchise fees which the franchisee has to make to the franchisor and also the one-time fees if any needs to be mentioned. The manner in which and the times at which such payments are to be made must also be included. Royalty clauses giving the details of the non-refundable portion of the payment (usually in percentage) which the franchisee is obliged to make to the franchisor should also be mentioned.
Obligations of the franchisee
In the agreement, the franchisor should stipulate the duties that the franchisee must confirm so as to protect the franchisor’s goodwill and brand. All the conditions necessary to protect the franchisor’s brand must be included while drafting these stipulations. At the same time, the terms and conditions must be conducive for a successful and profitable business by the franchisee. These conditions are compulsions for the concerned party and they must be complied with, otherwise, it may result in a breach of the contract. These obligations may include:
- The adequate financial resources and infrastructure to carry out the business operations by the franchisee. The franchisor can specify that the premise is of a certain size at a certain location and a minimum amount of infrastructure to operate the franchise.
- To maintain the premises and ambience of franchised units in conformity with the standards. These include equipment, signs, fixtures, furniture, and other infrastructures.
- Obligation to maintain the reputation and the goodwill of the brand.
- to provide periodic reports on the functioning of the franchisee’s business
- It is the responsibility of the franchise to meet and maintain the highest standards and an obligation to maintain the standards and ratings applicable to the operation of the franchised business.
- To abide by the products and operations standard requirements. The franchisee should use only the Menu Authorized by the franchisor. There may be a condition that the franchisee restaurant’s business must be confined to the preparation and sale of only such Menu Items and other food and beverage products as the brand owner has designated and approved in writing from time to time. A condition about the sourcing ingredients for the franchisee restaurant may also be put in the agreement.
- A duty to maintain the supply of goods i.e food & beverages at all times. For example, the restaurant brand owner should stipulate that the franchisee unit must supply some particular type of F&B items like south Indian/North Indian dishes, Sweets, Lassi, Coffee etc. with quality of food and service matching to the brand owner’s expectations.
- To display a hoarding or signboard outside the restaurant so as to attract people.
- Most franchise agreements explicitly require the franchisee to obtain the approval of the franchisor for transfer or assignment of interest in the franchise unit. There may also be clauses providing the franchisor rights of first refusal to take over the franchise, in case the franchisor wants to transfer ownership.
- Franchisee to act equitably and in good faith to include any and every possible action of the franchisee.
- to use the premises of the franchised unit solely for the purpose of conducting the business franchised. For example, if it is a purely vegetarian restaurant then it can not serve non-veg items
- to advertise the brand and carry out promotion campaigns.
- the franchisee to get insurance to cover its business operations.
Many times a franchise agreement is a one-sided contract in the initial draft favouring the franchisor. However, the franchisee can negotiate and manage to include clauses that protect the franchise. The franchisee may also want the franchisor to fulfil certain conditions and may impose some obligations on the franchisor. These obligations may include:
- Assistance in locating and negotiating a place to start the franchise outlet, based upon the needs of the franchisor.
- To provide a copy of the franchisor’s confidential and proprietary documents including the operating procedures, specifications, standards, trade secrets, know-how etc.
- To provide training to the employees of franchisees as to how to conduct the business operations and also continue to upgrade the franchisee with new methods, equipment and services. The time duration of the training along with the place and cost to be incurred etc. should be specified in this clause.
- To give exclusive authorisation for a particular area to promote the franchise. For example, the franchisee may get assurance that in a particular area there will not be any other restaurant as a franchisee of the same brand owner.
- Assistance in getting government, regulatory and legal approvals from different agencies.
- To provide continuous support and advice to franchisees during business operations.
Default notice termination
A provision should be made for notifying either party before making any changes to the agreement or before rescinding or terminating the agreement due to any default. The notice must be given for a reasonable period. This provision is essential to make the contract equitable.
This clause should also contain conditions of default and termination of the franchise agreement. Grounds for termination may include the defaults like the material breach of the agreement, legal incapacity of any party to perform the agreement, bankruptcy or insolvency and changes in the legal and regulatory framework in the country.
There must be a provision to prohibit the franchisee from using the intellectual property rights and/or the business format of the franchisor, as a consequence of the termination of the agreement. The franchisee must also be obligated to return all confidential information obtained during the term of the agreement. The franchisor may also covenant that the franchisee should not open a competing business within the same location.
Negative covenants related to non-competition and protection of intellectual property and confidential information may be included in franchising agreements. Under such a clause, the franchisor can put a condition that the franchisee will not start any competing business in the nearby vicinity so as to capitalize on the franchisor’s brand equity.
Under this clause, the court, having jurisdiction for legal recourse, in a case of conflict between the franchisor and the franchisee needs to be mentioned. An arbitration clause specifying the seat of arbitration and the institution to appear in case of disputes as well as the manner in which the arbitration is to be carried out should be mentioned. For example, the clause may stipulate that the Indian Arbitration and Conciliation Act, 1996 would be applicable. A classic example of a restaurant franchise dispute was a dispute between McDonald’s and one of its Indian franchisees. McDonald’s terminated the franchise arrangement with Connaught Plaza Restaurants Private Ltd (CRPL) for non-payment of royalties, but the termination of the agreement was challenged by CRPL and it continued use of the McDonald’s system despite the termination citing the reasons like interests of consumers, employees and vendors. Both parties litigated since 2013 at various levels in the Indian court system including Company Law Board (CLB) and through arbitration proceedings in the London Court of International Arbitration (LCIA) before a settlement was reached. McDonald’s announced an out-of-court settlement with the fast-food chain in May 2019 agreeing to buy out Bakshi from their joint venture that operated outlets in north and east India.
After the expiration or termination of the franchise agreement, the franchisee still may have some obligations toward the franchisor. The franchisor may reserve the right to purchase or designate a third party that will purchase the whole or any portion of the assets of the franchised unit including the land, building, equipment, signboards, furnishings, supplies etc.
The franchise agreement should have adequate provisions for indemnification of the parties for any liabilities arising out of the other party’s breach of contract. An inclusive list of situations in which parties would be liable for indemnification may be included to avoid disputes.
Though various laws in India can protect the interests of franchise arrangements and govern such agreements, there is a growing need to improve the regulatory and legal framework for harmonising different legal provisions for restaurant franchising. In the past three decades, the rapid growth of the restaurant franchising industry has been registered even without matching legislative or regulatory reforms. In spite of the tremendous growth of the restaurant franchise industry and its excellent potential for future growth, in India, we lack industry-specific laws and regulations. In absence of specific laws, the agreement for restaurant franchises needs to be exhaustive with provisions from various applicable laws on different aspects of the business establishment and operation. A comprehensive agreement with all the necessary clauses may avoid litigation and in case of a clash of interests, the agreement can help is an amicable settlement of disputes by saving money and time required for protracted litigations.
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join: