Overview
With the advent of globalization and liberalization, Franchise business models have been especially popular helping businesses to adopt proven business models for sustenance and prosperity. Franchising, is one of the most profitable business models adopted by domestic players as well as foreign businesses across the world. The franchise business model has been designed in a manner that ensures efficient distribution and homogeneity in the quality of products/services by allowing the franchisee to operate and run an already established business in exchange for conforming to uniform operational standards. Hence, the viability of a franchise business relies mainly on its distinctiveness and duplicability, along with the quality of the franchisor’s infrastructure supporting recruitment, training, site selection, supply chain, and marketing. There are various types of franchise systems that includes dealer arrangement, marketing arrangement, trademark-usage arrangement, product distribution arrangement, manufacturing arrangement, etc.
For a person who is looking to start a business of his own, the franchise may be a good option to start the business due to its instant innumerable benefits for a new business. A franchise business comes with a benefit of a recognized business product or service and being your boss at the same time. But, there may be other factors to be narrowed down to decide which franchise business to be adopted or at what costs and support from the franchisor business.
A franchise agreement is the master legal document that sets forth the rights and obligations of the parties to the business name, the franchisor, who allows the other party to use his business model and distribute his products/services, and the franchisee who buys such distribution rights from a pre-established and proven business of the franchisor through licensing. Burger King, Domino’s Pizza, KFC, Pizza Hut, Starbucks, etc. are some of the popular examples of franchise businesses having their franchise in India. The rights & obligations are transferred to a franchisee from the franchisor through the issue of a license. Thus, franchising a business could be regulated by negotiation, drafting, and agreement on the terms of the contract created by a mutual understanding of the parties involved.
Therefore, the franchise agreement rules out the expectations of the franchisor from the franchisee, how the business is to be operated, a list of products/services to be distributed, etc., and grants the franchisee to use the name of the enterprise & trademark to the franchisee in return. The license so allowed by the franchisor permits the franchisee the right to access and use the franchisor’s intellectual property, systems, and brand subject to fulfilment of the conditions provided. Furthermore, a franchise agreement affords protection for both parties by helping the franchisor to maintain the goodwill and profitability of the business brand on one side while helping to safeguard the large-scale investment made by the franchisee to acquire a license from the franchisor. Though, the definition of a franchise business model is simple however the agreement could be thorough and complex with a typical length of 25-30 pages this other attachments like exhibits and addenda could further increase its length to a further 2-3 times.
Regulatory Framework for Governing Franchise Relationship
Though there are no specific laws governing the administration of a Franchise Agreement, however, there are certain legislations applicable to the various provisions created in pursuance of the Agreement including-
i. The Indian Contract Act, 1872
ii. The Consumer Protection( Amendment) Act 2019
iii. The Indian Trade Marks Act, 1999
iv. The Copyright Act, 1957
How does a franchise agreement work?
Franchise agreements intend to assign the rights related to the use of the intellectual property & other resources such as trademarks, trade secrets, copyrights, etc. to the franchisee by the franchisor for an agreed period. Such rights are specific and leave little room for any confusion or expansion or error. The provisions so provided and are agreed to be enforced in a way to maintain the brand representation with consistency as per the standards prescribed by the franchisor to ensure consistency and trustworthiness equally among consumers.
What are the considerations for an effective Franchise Agreement?
Following are the considerations to be kept in mind while drafting a Franchise Agreement-
i. Intellectual Property Rights involved-
It is one of the most significant clauses to be included in a franchise agreement. The Franchisor & Franchisee may mutually agree upon the extent to which the franchisee could make use of the IPR rights registered in the name of the franchisor i.e. franchisor name, trademarks, service marks, logos, slogans, designs, and other branding indicia. Apart from this, the franchisor may also grant the franchisee to use of other IPRs such as any trade secret, any operating manual, and proprietary software systems. Such contractual license is the foundational basis of the Agreement, in the absence of which the franchisee cannot use the IPR related rights without any infringement.
ii. Training & Support Services
It is of utmost importance for the franchisor and his business to maintain the quality and homogeneity of its products/services being offered in any place in the world. Therefore, the Franchisor will provide training services and support to the franchisee or its employees in pursuance of the Agreement. Such obligation to provide support to the franchisee shall be applied before opening and during the effective term of the franchise.
iii. Advertising & Promotional Costs
The franchise agreement should also mention the obligations of the franchisor to support the franchisees with marketing & promotional activities. However, the franchisor may also put conditions to spend a specific percentage of the sum regarding the local advertisement of the franchise on the franchisee for a certain amount of time.
iv. Term of Effective Agreement
A franchise agreement is generally required to be signed for long-duration say between ten-twenty years normally to afford protection to both the franchisee as well as the franchisor including the provisions related to renewal. To eliminate any further hassle, the parties may choose to renew the agreement for a further term of ten years automatically unless any party gives notice of intention of non-renewal of the agreement.
v. Effective Territory
The franchise agreement will provide the effective territory of the franchise to be provided to the franchisee in pursuance of the Agreement. Further, it will also specify whether the territory will be a protected or an exclusive territory. Effective territory holds significance for a business as they help a franchise business to limit market saturation. If the market is already over-saturated there remain lesser chances for growth & profitability. For instance, X purchased a franchise business ABC after payment of a large sum as a franchise fee, only to later find that Mr. H is already having a successful franchise of ABC only two km away. Thus, it is important for the franchisor and franchisee to carefully choose an effective territory to rule –out any cases of market over-saturation and its negative effects on franchisees.
vi. Fees and Expenses
The franchise agreement shapes the costs and expenses to be incurred for franchising ownership of the business. For which, the franchisee is required to make payment of several costs that include the initial franchise fee, ongoing fees such as the monthly royalty, advertising, promotional fee, or any other fees.
Further, in case of failure of the franchisee to make timely payment of franchise fee, the franchisor may also reserve rights to charge late fees and interest. The agreement will also provide for the due dates of the payment of the franchise fee and including the person responsible for payment and the manner of payment. Moreover, the franchisor may levy any additional costs from the franchisee for any additional services such as providing training & operations support, travel expenses of employees to attend training, etc, or similar expenses.
vii. Selection of Business site
Usually, a franchisee chooses the site for his business workplace. Since, the franchisor needs to ensure that everything is up to the standards of his business and to finalize everything including favourable business site/workplace or other approvals (in case of a restaurant-chain franchise approval of furniture, tapestry, upholstery, signs, etc). They may also have a final say in the choice of the vendors/service providers for the use of the products/services by the franchisee in day-to-day operations.
viii. Termination & Consequent Obligations
There may be circumstances where the franchisee wants to terminate the agreement earlier than the decided term of the agreement or the franchisor may reserve any specific rights to terminate the agreement upon happening of certain events. Some of the causes may include failure to pay periodical franchise fees timely, filing bankruptcy or failing to undertake repairs or maintenance timely, etc. including the failure on the part of the franchise to “resolve the defaults” after receiving advanced notice of 14 days to cure certain defaults.
If the franchise business relationship terminates early, there may be some obligations prescribed on the part of the franchisee which could be prescribed under the Franchise Agreement. The list could be medium to long in size depending upon the obligation placed upon the franchisee that may include discontinuance of using the brand name & other IPRs, taking down signs, returning operation manuals, and paying all remaining amounts in total.
ix. Non-Compete Clause
The franchisor needs to put certain restrictions regarding the protection of business. To ensure safety, the franchisor may provide limitations for franchisees not to start or be part of any competitive business during the pendency or after the termination of the agreement. For instance, the franchisee or any affiliate company may not be permitted to operate a competing business during the agreement term or for a certain number of years after the termination of the agreement.
x. Dispute Resolution
Like any other franchise business relationship the relationship between franchisor and franchisee, they are also prone to disputes and sometimes may even lead to termination of the agreement. Therefore, there should be a mechanism in place to decide any disputes if they occur between parties to be decided in the event of arbitration. The parties may decide a particular mechanism to be followed to resolve any dispute cordially regarding the matters provided in the Agreement i.e. mediation, conciliation, and arbitration. The parties may also agree upon the governing law and the exclusive jurisdiction of the courts to which the disputes shall be referred in case of failure to resolve the case through mediation, conciliation, and arbitration.
xi. Insurance and Indemnification
The franchise agreement will also include the mandatory requirement for the franchisee to adopt a sufficient insurance cover for the franchise business throughout the term of the franchise along with the clause of indemnification. The franchise will be required to “indemnify, defend and hold harmless” the franchisor against any necessary claims, costs, and damages arising out of the franchisee’s business activities.
xii. Maintenance of Records, Inspection & Audits
In pursuance of this Agreement, the franchisee will be under the obligation to maintain records and allow the franchisor the right to inspect records and provide timely report (financial and operations) reports. Since, royalty payments are a percentage total of the gross sales, reporting sales numbers is equally important for the franchisee for the franchisor. The franchisee shall be under the obligation to provide information regarding additional information including tax returns and audit records to the franchisor.
xiii. Physical Premises & Maintenance
In cases where the franchise is a restaurant or retail premises frequently visited by the consumers, the franchise agreement may also provide for a clause for Repairs and maintenance at the sole expense of the franchisee. Since the physical well-being of the place is connected with the franchisor’s enterprise, the franchisor may reserve the right to undertake inspections during a certain period once every 5 to 10 years or even before. Such repairs/renovation might involve expenses such as the replacement of upholstery, furniture, or fixtures to meet the franchisor’s business standards.
xiv. Transfer and Re-Sale Related Rights
Franchise agreements will set out the rights related to the transfer of ownership in a franchise to a prospective buyer. Sometimes, a franchisor may retain pre-emptive rights regarding the transfer of license, which means in the event a franchise decides to shut his business operations and transfer the franchise-related rights to any third party, it will be under an obligation to offer the franchisor first. And even if they don’t, they also reserve the rights related to the approval of buyers. Furthermore, they may impose additional requirements on the purchaser including the requirement to submit an application and make a payment of an initial fee.
xv. Negotiation
Before entering into the contractual relationship, franchisees often wish to make negotiations regarding the terms of the franchising agreement. Though they have the right to do so in every way, the franchisor may refuse to negotiate much. The nature of a franchise system is in a way that it often becomes necessary to keep all requirements uniform in the Agreement. Still, the prospective franchisee may make minor negotiations such as an instalment schedule for the initial franchise fee. If the franchise is a well-established one, there are lesser chances to make one-off concessions. Still, if the franchisee is a new franchise, there would be likely some chances to leverage in negotiation.
What are the benefits of drafting a Franchise Agreement?
Buying a franchise business comes with a whole lot of benefits for the franchisee, especially in cases where he has little experience in the business to build a business from its very base and similarly, long-term monetary benefits in terms of royalty fees & another franchise fee to the franchisor. Provided are some of the benefits of a Franchise Agreement-
i. Better Brand Management
The Franchise Agreement offers scope to the business & branding aspects of an already established business including any penalties for any mismanagement or violation of business branding mannerisms that are clearly defined to protect the brand image & goodwill of the franchise business at all times. Therefore, a franchisee who purchases a franchise business is in a win-win position as he gets to receive guidance related to the business & brand management, efficient running operations, employee training & other operations from how to manufacture products to how to clean machinery to everything. This saves costs, time & losses the franchisee would have to bear in case of starting a brand-new business. Since, most of the provisions of the franchise agreement are governed by the Indian Contract Act, 1872, franchises may include the disclosure requirements as a part of the contract.
ii. Defining the business relationship
The franchise agreement identifies the legal relationship between the franchisee and the franchisor, including both parties’ benefits and restrictions. It ensures the franchisor holds better control over the business operations and guides the franchisee throughout out of his skills & experience over the business’s operations. It helps the parties to enforce the terms of the contract without any misinterpretations that lead to a long-lasting business relationship between the franchisor & the franchisee.
iii. Better Growth Opportunities
Where the franchisee gets the advantage of the goodwill and brand loyalty of the franchisor’s business, the franchisor can reap the rewards of the expansion of the business without having to manage everything. It may also help the franchisor to ensure business presence in the areas which may have been challenging without franchising and hence better growth & profitability.
iv. Legal Protection & Security
A franchisor entrusts the IPR and other trade secrets necessary in the day-to-day business operations of the franchise business to the franchisee in pursuance of the Agreement. However, without a legal agreement, there may be risks related to leakage of such sensitive information or the franchisee making money unethically by revealing such secrets to the competitors. Similarly, a franchise agreement also prevents the franchisee to start any similar business or getting involved in any similar business after termination of the agreement. Similarly, the franchise agreement avoids levying any arbitrary costs or interests by the franchisor on the franchisee.
v. Saves Costs
Having a franchise agreement in place helps the parties to avoid unnecessary costs incurred in complex, costly & painfully long procedures and helps them to enforce provisions agreeably.
Conclusion
Therefore, a franchisee agreement should include all important clauses based on the rights & obligations in the business which also requires legal prowess to draft a comprehensive agreement and the same could be crafted by a legal professional who could balance the agreement to be beneficial for both of the parties concerned and fulfils other purposes such as improving understanding between, to avoid any disputes and establish trust & mutual co-operation during the term of the Agreement.
