Franchising: a growing opportunity in India

Franchising: a growing opportunity in India Franchising in India is becoming an increasingly popular business model, and could fast become an engine of the Indian economy By Swati Sharma, Anand and Anand Due to increasing globalisation and liberalisation, India is a promising market for foreign brands. Following growing demand in various economic sectors, India is becoming an attractive destination for foreign businesses. This article discusses how the franchise business model appears to be gaining strength in India. Franchising essentially entails using a firm s existing successful business model in order to grow. Although India has no law governing franchising, Chapter 5 of the Finance Act defines a franchise as an agreement by which the franchisee is granted representational rights to sell or manufacture goods or to provide service or undertake any process identified with franchisor, whether or not a trade mark, service mark, trade name or logo or any such symbol, as the case may be, is involved. Franchising involves two parties: the franchisor and the franchisee. The franchisee purchases the right to use the franchisor s business model, trademarks, associated IP rights, proprietary knowledge and goodwill. The Franchising Association of India, a not-for-profit association, reports that the franchise industry is growing at a rate of between 25% and 30% annually; it expects 50,000 more brands to invest in franchising in the next five years. This suggests that the franchising model could prove a considerable source of growth for the Indian economy. The terms franchising and licensing are often mistaken for synonyms, whereas in fact there are vast differences between the two. In legal terminology, in addition to contract law, franchising is governed by securities law, which regulates the franchisor-franchisee relationship and under which the party offering the services is bound by certain rules and regulations. Licensing is governed only by contract law, under which there are no such regulations. Within the context of franchising, territorial rights are granted to the franchisee; in a licensing context, the licensors can sell similar licences and products within the same area. Royalty payments are made in both cases. The biggest difference between the two terms is that under the franchising model, the franchisor gives its franchisee everything needed to conduct the franchise business, whereas under a licence, the licensor licenses only its trademark or technology or both to be used by the licensee in the manufacture of its goods and services. There are several types of franchising model: Product franchise the manufacturer decides how products are to be distributed to the party buying the franchise; Business franchise the franchisee purchases and distributes products for the franchise owner; Manufacturing franchise the franchisee manufactures the products under licence and sells them using the originator s trademark and name; and Business-format franchise this model is the most common; it is tried and tested and is proven to deliver results. Under this model, the franchisee sells the franchisor s products or services, trades under the franchisor s trademark or trade name and benefits from the franchisor s IP Monetisation 25

help, support and goodwill. In return, the franchisee pays franchise fees to the franchisor in the form of an initial fee and recurring royalty payments, which are based on either a pre-determined percentage or a percentage of sales, with minimum guarantee clauses. Franchising can be a lucrative option for start-ups looking for rapid growth. Expansion through a franchise model involves limited capital, overheads and time, but can result in significant capital growth, enhanced corporate image, company prestige and visibility, diversification and increased liquidity. Both the franchisor and franchisee can derive multiple benefits from a strong franchise arrangement. The benefits that a franchisor can derive from a franchise arrangement include: the ability to leverage its business format for expansion and higher revenues; consistency in its brand and business model; knowledge of new markets with local help; and shared or reduced financial risk. The benefits that a franchisee can derive from a franchise arrangement include: the assurances that come with going into business for oneself, but not by oneself; an established product or service with brand recognition; instant consumer awareness; international experience; consolidated advertising; consistent quality; business know-how; and help with site selection, design, training, support and sometimes even finance. Famous and emerging franchises Several proven examples demonstrate that franchising could be a boon for the Indian economy, especially in the retail, food and beverage, education, health and beauty and hospitality sectors. More than 75% of McDonald s worldwide restaurants are independently owned. Entrepreneurs can purchase a restaurant by making a down-payment; the remainder of the cost is paid according to terms and conditions agreed with the company. The company s main criteria for potential franchisees are business experience, an acceptable credit history, willingness to complete the company s training programme and sufficient liquid assets to invest in the business. The McDonald s model is a clear example of how A franchise agreement is a valid contract under the Contract Act and is governed by the criteria contained therein. When drafting a franchise agreement, extra care should be taken to ensure that there are no loopholes which could be used by either party to invalidate the contract 26 IP Monetisation

franchising can be a successful new business trend in India. McDonald s has flourished in India due to the fact that it has understood the tastes and palate of the local market and has customised its menu for the Indian population. Most foreign food and beverage companies have adapted to the principle of localisation in order to succeed in India. Dominos serves paneer (a type of cheese) pizza throughout the country and KFC and Subway are serving Jain (vegetarian) food in the state of Gujarat. Examples of other franchises which are taking India and the world by storm include Chi Kitchen & Bar (cuisine), Mahindra First Choice Wheels (used cars), Van Heusen (clothing), EduKart.com (education), Koutons Retail (fashion), The Yellow Chilli (restaurant chain) and VLCC (beauty and wellness). Legal implications As mentioned, there is no specific act related to franchising in India as yet. Even IP laws do not mention franchising. Only the Service Tax Rules include a definition of franchise agreement. The various laws that govern franchising in India include: the Contract Act 1872; the Competition Act 2002 (the Monopolies and Restrictive Trade Practices Act 1969); the Trademarks Act 1999; the Patents Act 1970; the Copyright Act 1957; the Designs Act 2000; the Geographical Indication of Goods Act 1999; the Consumer Protection Act 1986; labour laws; taxation laws; the Foreign Exchange Management Act 2000; the Specific Relief Act 1963; the Consumer Protection Act 1986; the Sale of Goods Act 1930; the Stamp Act 1899; the Registration Act 1906; and the Easement Act 1882. Contract Act A franchise agreement is a valid contract under the Contract Act and is governed by the criteria contained therein. When drafting a franchise agreement, extra care should be taken to ensure that there are no loopholes which could be used by either party to invalidate the contract. Competition law: restraint of trade It is important to understand the implications of restraint of trade in franchise agreements. The franchisor will always include a clause relating to competition in the franchise agreement. This clause could restrict the franchisee from dealing with competing goods while the franchise agreement remains valid. Such a clause cannot be treated as restraint of trade, as ruled in the landmark case of Gujarat Bottling Company Limited v The Coca-Cola Company (AIR (1995) Supreme Court 237). In that case the court held that in franchise agreements for the distribution of goods and services, a clause restricting the franchisee s right to deal with competing goods is intended to facilitate the distribution of the franchisee s goods, and cannot be regarded as restraint of trade. Meanwhile, in IEC School of Art & Fashion v Gursharan Goyal (1998 PTC 493 (Del)) the court held a franchise agreement containing a clause that restrained the franchisee from operating a similar business under any name after termination of the agreement to be void. Over a period of time, the courts have come to recognise some restraints as reasonable. Restraints, whether general or partial, may be found acceptable if they are reasonable and any restraint in the freedom of contract can be shown to be reasonably necessary for the purpose of freedom of trade. Such restraints would include obligations: not to engage in a similar business for the term of the agreement; not to acquire financial interests in the capital of a competing undertaking, so as to influence economic conduct; not to disclose know-how, unless it is already in the public domain; to disclose improvements in exploiting the franchise, including through the licence of such additional know-how; and to inform the franchisor of infringements and passing off, and to take action or assist in respect thereof. IP Monetisation 27

Consumer protection and product liability If a consumer finds any fault with the franchised product or service, he or she is entitled to file a complaint under the Consumer Protection Act; such complaints can sometimes be made in respect of both the franchisor and franchisee, despite the fact that the franchisee may have sole responsibility for manufacturing and distributing the goods as per the franchise agreement. A clause confirming the franchisee s responsibility for all faulty goods produced should be included in the contract to safeguard the franchisor. IP rights and trademarks Under the Trademarks Act, a franchisee is regarded as a permitted user. A franchisee may also be recorded as a registered user if the franchise agreement is recorded with the Trademarks Registry. A registered user is recognised under the act only in respect of a registered trademark. Common law principles are applicable for franchises and licences relating to pending or unregistered trademarks. Conclusion To ensure the success of its franchise model, a franchisor must: build, protect and manage a strong and highly esteemed brand in order to be able to franchise it for high royalty rates; establish franchising guidelines, including product categories, price range and distribution channels; franchise only to well-managed, wellreputed and well-financed companies, as the brand s reputation is at stake; limit franchising partners by product and territory; implement a comprehensive training programme; and monitor how the brand is being protected and guard against misuse and infringements. A franchise arrangement is akin to a marriage, and therefore parties entering into such a deal should choose their partners carefully, identify roles for each party, work on the marriage and, if needs be, part ways amicably. 28 IP Monetisation

Contributing profiles Anand and Anand ANAND AND ANAND IP365 Leading Innovating Inspiring Anand and Anand First Channel Building, Plot 17A, Sector 16A Film City, New Dehli 201301, India Tel +91 120 405 9300 Fax +91 120 424 3056 Web www.anandandanand.com Swati Sharma Partner swatisharma@anandandanand. com Swati Sharma has significant experience in the field of contractual and commercial exploitation of intellectual property. In addition to the drafting of licensing, distribution and franchise agreements, she has advised various companies on establishing operations in India, including advice on adopting the best business model. As a brand strategist, Ms Sharma has extensive experience of advising on the choice and protection of brands and on maximising brand visibility. She has also advised on packaging and labelling laws, copyright issues and intellectual property in takeovers and joint ventures. Ms Sharma has spoken at workshops conducted by the Franchising Association of India on the operation of franchising in different sectors. IP Monetisation 29