The Art of drafting Franchise Agreements

WHAT IS A FRANCHISE?

Legally speaking, the Black's Law Dictionary defines a Franchise as a license from the owner of a trademark or trade name permitting another to sell a product or service under that name or mark.[1] The Indian law has not specifically defined it per se.

Simply put, (as per Google), franchising is based on a marketing concept which can be adopted by an organization as a strategy for business expansion.

Gone are the days when we’d have to go to California for a happy meal or to Mumbai for Theobroma brownies or to Connaught Place to relish Kake Da Dhaba’s butter chicken or fly to Virginia to walk into an Apple Store or be in Minnesota to work out at 3 am at Anytime Fitness, and these are very few examples of how our Local makes us feel Global, which has been possible due to a little thing called ‘Franchising’.

WHAT IS A FRANCHISE AGREEMENT?

A legal contract between the Franchisor and Franchisee to open and operate a Franchise unit. As per the British Franchise Association and Federal Trade Commission of the US, following characteristics of a Franchise Agreement have been established:

• A franchise arrangement is based upon a contractual relationship.
• The franchisor should have developed a business system or format, which is identified with a brand name.
• The franchisee makes a substantial initial capital investment and normally owns the business operation.
• The franchisor normally trains the franchisee to ensure that it is equipped to effectively comply with the business system.
• Once the franchisee’s business commences, the franchisor continually supports the franchisee in certain aspects of the business operation.
• The franchisor also regularly supervises the franchisee’s business operations in order to protect the franchisor’s goodwill and brand name.
• Some form of consideration is paid by the franchisee to the franchisor for the rights licensed and the services rendered.

KINDS OF FRANCHISE AGREEMENT*:

1.    On the basis of Format:

1.1.Product/Distribution: The product comes from the Franchisor while the Franchisee gets the distribution rights either on exclusive/semi-exclusive or non-exclusive basis. With a product franchise, the product itself is the only aspect of the business distributed per the franchisor’s terms. The consumer experience can vary a lot from one business to the next, as the distributor (franchisee) maintains control over most aspects of their business, and the franchisor does not offer any assistance in terms of sales processes, employee training, etc. This is often used for larger products. Some famous brands using this concept are coca cola and Ford Company.

1.2.Manufacturing/production/processing:A manufacturing franchise is a manufacturing company that produces the raw or finished product that a franchisor ultimately sells. Sometimes, these operations are also called “suppliers” or “partners.” Manufacturing franchises must pay the franchisor a fee in for the license to produce the raw materials or finished product with the company’s trademarked name. Coca Cola is an example of a company that partners with manufacturing franchises to manufacture the syrup that goes into their soft drinks. The syrup is then sold to a bottling company that adds water and carbonation, and then bottles and distributes the drinks.

1.3.Business Format: This is the most common type of Franchise Agreement. The franchisee not only sells a certain product, but also produces and delivers the product or service in accordance with the franchisor’s proprietary ingredients and/or practices, and with the franchisor’s assistance. Some famous examples are Subway, McDonald’s, Nike, Mariott Hotels.

2.    On the basis of Control:

2.1.Direct: The purest form of franchising where the Franchisor enters into individual franchise agreements with each territory or outlet.

2.2.Master: A master franchise agreement is an agreement executed by and between a franchisor and a master franchisee, whereby the franchisor grants the master franchisee rights to the franchise and licence to: (i) exploit and use intellectual property rights, including without limitation, the trademarks, manuals and ‘know-how’ (franchise system) to develop, establish and operate franchise units in a specific territory; and (ii) grant sub-franchises and sublicense the trademarks and the franchise system to operate franchise units in such territory. Furthermore, the franchisor provides to the master franchisee technical assistance in connection with the franchised business, and the master franchisee, in turn, provides such technical assistance to its sub-franchisees. It can be non-exclusive or exclusive, usually the latter.

2.3.International: Where the franchisor grants the franchisee (based in another country), in exchange for direct or indirect financial compensation, the right to exploit a package of industrial or intellectual property rights relating mainly to know-how and commercial symbols, and to receive continuing commercial or technical assistance for the duration of the contract.

BOILER PLATE/ STANDARD CLAUSES:

1. Franchisor & Franchisee Details: Details and legal authority of the person entering into franchise agreement on behalf of the franchisor and franchisee are entered in detail at the beginning of the franchise agreement. In most cases, franchise agreement is executed between two companies or legal entities. In such a case, a Director or Officer of the duly authorised by a Board Resolution signs on behalf of the franchisor and franchisee.
2. Definitions: The important terms used throughout the Agreement will be interpreted as per the definition clause.
3. Franchise Fee & Consideration: Terms of franchise fee, deposit, royalties, advertising fees and other charges are discussed at length in a separate section. The mode of payment and due dates for payment of franchise fee and other consideration are also discussed at length. It is important to ensure that the terms of franchisee fee mentioned in the agreement are as per the understanding between the franchisor and franchisee, prior to signing the agreement.
4.  Business Operations: The biggest benefit of a franchise is that the franchisor would help with the operation of the franchise unit based on their past experience and expertise. Hence, all franchise agreements contain detailed information about the level of support provided by the franchisor and responsibilities of the franchisee. Some of the major areas covered in a franchise agreement with respect to franchise operation are:

• Details of goods or services that can be offered by the franchisee.
• Requirement to exclusively purchase products or services from franchisor, if any.
• Requirement to operate the franchisee unit as per the standards of operations fixed by the franchisor.
• Requirement to maintain accounts and other details as per the franchisor’s instructions.
• Right of franchisor to inspect the unit at regular intervals.
• Requirement for franchisor to abide by applicable laws and maintain the required licenses or business registrations.

5. Advertising and Brand Promotion: Franchisors typically spend significant resources for promotion of brand. Hence, the responsibility of the franchisor with respect to promotional expenditure for franchisee and requirement of the franchisee to contribute to brand building activities is mentioned clearly in the franchise agreement.

6. Training, Supervision and Support: Franchisors provide the necessary training, supervision and support to franchisee units for a certain amount of time or on a regular basis. The responsibility of the franchisor with respect to training, supervision and support are mentioned in detail along with the requirement for franchisee to support the franchisor in conducting such activities.

7. Confidentiality: Neither party is at liberty to disclose the other party’s confidential information except under certain circumstances and this clause survives the termination of the agreement.

8. Use of Trademark & Intellectual Property: One of the most important elements in a franchise agreement is the right to use of trademarks of the franchisor. The franchisor must have registered the trademark and have an exclusive right to use. The franchisor in the agreement must state the word or marks or symbols for which trademark has been registered or applied. Most franchise agreements also have clauses that require the franchisee to notify the franchisor in case of trademark infringement and/or avoid damage of trademark during usage. Finally, ownership of the trademark is clearly mentioned in a franchisee agreement with provisions prohibiting usage of trademark by franchisee post termination of the franchise agreement.

9. Term of Agreement: Franchise agreement must clearly state the terms of the franchise agreement, length of agreement, provision for renewal and the effect of termination of the franchise agreement.

10. Transfer or Assignment of Franchise: Most franchise agreements explicitly require the franchisee to obtain the approval of the franchisor for transfer or assignment of interest in the franchise unit. In addition, there can also be clauses providing the franchisor with rights of first refusal to take over the franchise in case the franchisee wants to transfer ownership.

11. Termination of Franchise Agreement: Franchise agreements contain detailed provisions for termination of franchise agreement in case of failure of either party in the agreement to perform as per the terms of agreement. Further, termination clause must also contain penalties or fines applicable for early termination and the liabilities of the parties after termination of franchise agreement.

12. Waiver: Any failure or delay by either party to enforce their rights provided in the agreement not to be construed as a waiver thereof.

13. Notice: The mode of serving notice and the Format.

14. Force Majeure: The effect of natural disasters or any other occurrence beyond the control and perception of human (now it has become a norm to add pandemics, government orders and other unprecedented and unforeseeable circumstances preventing either the Franchisor or the franchisee from fulfilling their contractual obligations).

15. Limitation of Liability: The parties will not be held liable for any consequential, direct or indirect, incidental damage or loss arising out of this agreement.

16. Governing Law and Dispute Resolution: In case of franchise agreement between an Indian entity and foreign entity, the parties to the franchise agreement can designate the law of a foreign country as the governing law and submit to exclusive or non-exclusive jurisdiction of a foreign court, provided such foreign court has inherent jurisdiction over the dispute. It is however best to agree on alternate dispute resolution mechanisms like arbitration, conciliation or mediation, in case of dispute to ensure speedy and cost effective resolution of any dispute.

17. Severability: If any provision in the Agreement becomes illegal, invalid or unenforceable by law in force, such provision may be severed rendering the remainder of the agreement valid and legally enforceable

18. Entire Agreement: The superseding effect of this agreement over all the previous discussions or commitments and understanding. Any amendment to be made must be by a written agreement signed by both parties.

CONCLUSION

It is imperative to be flexible and accommodating while drafting the clauses which are specific to the parties and surrounding circumstances at the time. Every connected legal issue pertaining to contracts, tax, IPR, property law, E-commerce, territoriality, corporate and securities, customs, weights and measures, competition law, insurance, labour law, banking and finance, foreign exchange must be given equal and urgent attention. The priorities and requirements change if you’re drafting from the vantage point of a Franchisor or Franchisee and hence the draft MUST be made and proofread as well as negotiated by your Attorney.

PS- CORONIAL TIMES NEWS FLASH 2020

Here’s an interesting blog that talks about the most profitable franchise businesses in India to invest in- https://topfranchise.com/articles/10-most-profitable-franchise-businesses-in-india/

[1] Black’s Law Dictionary, (6th Ed.) Centennial Edition (1891-1991) at p. 658.

*This is not an exhaustive list.