What is franchising?
The definition for franchising given by the International Franchise Association (IFA) states that a franchise is “A contractual relationship between the franchisor and the franchisee in which the franchisor offers or is required to maintain a continuing interest in the franchisee’s business in areas such as know-how and training; the franchisee operates under a common trade name, format, or procedure owned or controlled by the franchisor; and the franchisee has made or will make a substantial capital investment in his business from his own resources.” So, basically, Franchising means where the business owner of a company gives a license to another individual to carry out their own business under the title or brand name of that company. A franchise consists of two parties that are “franchisor” and “franchisee”. A franchisor is the owner of a business that provides its brand, trade name, product, service or any other form of intellectual property laws along with the value chain. whereas, franchisee is a person who receives the right to use franchisor’s business in exchange for a royalty and an initial fee. The franchise aims to profit both the franchisor and the franchisee. A business that is seen in different cities and known because of their brand sign and colors is the same all around the places where the franchise operates. For example, the quality and taste of domino’s pizza is the same no matter from where you buy it. Some other examples of a franchise are KFC, McDonald’s, Pizza Hut, Subway, etc. It is important for anyone deciding to start a business by becoming a franchisee to keep in mind that for franchising the franchisee is legally bound to a franchise agreement with the franchisor for a specified period of time.
What is a Franchise Agreement?
A franchise agreement is the base of a franchise. A franchise Agreement is a legally binding contract between two parties that are franchisor and the franchisee. It binds both the parties to carry out legal obligations for each other. The contract includes details of the franchisor’s expectations from the franchisee that how the business must be operated. It is an agreement where the franchisor consents to grant the company’s name or system to the franchisee.
Essential elements of Franchise Agreement
- Details of both the Franchisor and Franchisee – The franchise Agreement should include all the details and information of both the parties entering into the agreement.
- Business operations – The franchise agreement should consist of information regarding the roles and responsibilities of the franchisee and how the franchisor expects the franchisee to run their business. The information should include details of the goods or services franchised, proper maintenance of accounts and other registers, standards of operations, and inspection of the said unit at regular intervals etc.
- Monetary Details to Be Included– Franchise Fee – Every franchise has its own fee structure. These fees include the original franchise fee, regular franchise fees, royalty fees, and other fees. Late fees and interest are also included in the agreement. Any mandatory expenses should also be covered under the agreement. For example, the franchisee may be responsible for travel expenditures, training, and other costs.
- Royalty – This is a fixed percentage that the franchisee has to pay to the franchisor on a monthly basis for the benefit to use his brand’s name. Also, mention the specific format in which it needs to be paid, the mode of payment, details of the concerned bank account, and the intervals of making payment (monthly, quarterly or annual payment).
- Location of the franchise’s operation – The Franchise agreement should clearly mention the location and the territory under which the said franchisee can conduct its business operation. This is an important step as the franchisor may franchise its business to several franchises in different locations.
- Duration of franchisee – The agreement should include the duration for which the franchise is lent or licensed to the franchisee. Also, it is important to mention that the franchise agreement is subject to renewal or termination post this period.
- Training support – The Franchisor provides training assistance to each Franchisee. It ensures that franchise businesses run smoothly and to make sure that uniformity is maintained among all franchised businesses.
- Intellectual Property Rights – The franchise agreement should include the way and the method in which the said franchisee can use the Copyright, Trademark, and Trade Secrets of the franchisor. It is important to note that this clause specifies the Intellectual Property Rights that the franchisee gets to use, manufacture, sell, and distribute the goods or services in the name of the franchisor and use the Copyrighted creation of the franchisor.
- Renewal clause – Agreement must mention whether the franchisor wants to renew the agreement after the completion of the tenure of a franchise or terminate it. It should also state the terms and conditions for the renewal.
- Termination Clauses – It includes the terms that mention detailed provisions related to the termination of the franchise agreement along with the grounds on which such a franchise may be declared canceled by the franchisor during the period of the agreement. It is done where either party fails to perform as per the terms mentioned in the agreement. It also clearly mentions penalties in cases where a franchise agreement is terminated.
- Resale of the franchise – The terms and conditions stated in the agreement must also specify whether any rights regarding the reselling the franchise is given to the franchisee or not.
- Non-Disclosure/ Confidentiality– A franchisee is aware of various trade secrets during the franchise agreement, including proprietary formulas and recipes and how the franchisor conducts the business. This information should not be disclosed and kept private ,the franchisor always states the confidentiality terms, deeds, and restraints in the franchise agreement.
- Advertising– This clause of the agreement gives the responsibility to the franchisee to market, advertise and other activities for the promotion.
- Applicable laws – the Franchise Agreement must also prescribe the laws applicable over both the franchisor and franchisee together with the legal action that can be taken by either of the parties in the case of an infringement. Some franchisor’s also include an arbitration clause. This will make it necessary that an arbitrator will review the case before it goes to court in the case of any legal event.
- Long Term Duration – The franchise agreement will state the duration of the contract. Franchise agreements are long term agreements. An average term is 10 years and some are 20 years.
- Non-Competes – Franchise agreements often contain restrictive covenants limiting what franchisees can do. For example, after the termination one cannot be permitted to operate a similar business during the agreement duration. Agreements also contain non-competes after termination. For example, a provision could prohibit from operating a competing business within 5 miles of former location for a period of three years after termination.
- Arbitration – Franchise agreements generally contain an arbitration clause so that if in future any dispute arises then parties should go for arbitration. Instead of filing a lawsuit, parties might have to go before an arbitration body. The franchisor sometimes reserves the right to file a lawsuit to obtain an injunction under some conditions such as to stop the franchisee from disclosing confidential information about the franchise system. The agreement will contain the jurisdiction for filing any lawsuit. The choice of jurisdiction will be of franchisor.
- Records and Audits – it is the responsibility of the franchisee to maintain accurate records and provide regular financial and operations reports. As royalty payments are a percentage of gross sales, reporting accurate sales numbers is equally important. The franchisor has the right to request additional information including tax returns and to audit records. Also Franchisees can be charged an audit fee.
- Physical Premises and Renovations – If the business is a restaurant or retail place where consumers visit franchisees will have obligations to maintain the premises in good condition by its own expense. The franchisor has the right to inspect the premises to make sure they are well maintained. Franchisees may be required to renovate once every 5 to 10 years or sooner if needed. Renovation may contain considerable expense, including replacing furniture or fixtures to meet the franchisor’s standards.
- Negotiating – franchisees generally want to know if they can negotiate the franchising agreement. Then the answer is yes one should always try to negotiate. but, always be ready for the franchisor to refuse. Because of the nature of a franchise system, the franchisor tries to keep all requirements consistent. A franchise agreement is a contract created by one party with greater bargaining power using standard form provisions. Franchisees can sometimes negotiate minor details such as an installment schedule for the initial franchise fee.
- Review with a Lawyer – It is important for anyone to get a franchise lawyer to review the franchise agreement. An experienced franchise professional can explain major provisions of the franchise agreement. A franchise lawyer may also point out some unwanted hard or unjust provisions that are not common in the industry. An experienced lawyer will understand what are the essential clauses for in the Franchise Disclosure Document and can identify warnings. Also, the attorney knows the common law and state laws that protect franchisees. Suggested key points before signing the agreement can save one from making a big mistake.
Types Of Franchise Agreement In India
- Single Unit Franchise Agreement – This type of agreement is the most common form of franchising. According to this agreement the franchisor gives the right and responsibilities to establish and operate one franchise to the franchisee. Also, the franchisees need to invest capital on their own and also apply their management skills for the growth of their business.
- Multi-Unit Franchise Agreement – In this type of agreement the franchisor gives the right and the responsibilities to establish and operate more than one franchised unit to the franchisee. Also, the multi-unit franchisee should have both the financial and decision making skills in order to expand multiple units itself.
- Master Franchise Agreement – In this type of agreement franchisor gives the right for a specific region, country, so, granting the master franchisee to offer a full range of products and services of the franchisor.
Different Laws Governing The Concept Of Franchising
In India, franchise agreements are controlled by various relevant laws enactments that are as follows: –
The Indian Contract Act, 1872
The Competition Act, 2002
The Income Tax Act, 1961 The Consumer Protection Act, 1986
The Arbitration and Conciliation, 1996
The Foreign Exchange Management Act, 1999
The Copyright Act 1957,
The Patent Act, 1970,
The Trademarks Act, 1999,
The Design Act, 2000
The Specific Relief Act of 1963,
The Transfer of Property Act of 1882,
The Indian Stamp Act of 1899,
The Information Technology Act of 2000
Benefits of a Franchise Agreement
- As franchise Agreements are valid legal documents, it binds the franchisor and the franchisee in a relationship where both have to comply with the specific provisions.
- As both the franchisor and the franchisee get monetary and other benefits out of the relationship, there is little chance of dispute or breach of agreements.
- The terms and conditions in the franchise agreement are mutually decided this results in a healthy business relationship between both of the parties.
- A franchise agreement allows the franchisor to define guidelines for the maintenance of quality related to different sides of the trade before boarding the franchisee and binding them in a franchise contract.
- The penalties for mismanagement or violation of the business branding are defined in the agreement to protect the brand name at all times.
- Franchise Agreements must comply with the provision of the Indian Contract Act, 1872. Also, franchises may include the disclosure requirements as a part of the contract.
Advantages of franchisor’s
- franchising is a great way to expand a business without suffering additional costs on expansion.
- This also helps in building a brand name, increasing goodwill and reaching out to more customers.
Advantages of franchisee’s
- A franchisee gets advantage to start a business on a ready-made brand name of the franchisor. As a result, the franchise can get more success and less risks of failure. Which is not guaranteed in case of starting up his own startup business.
- Franchisees will get to know business techniques and trade secrets of brands
The franchise agreement is a legal document with rights and obligations which are binding on both the parties into contract. It provides investors (franchisees) with the product, brand name, recognition and a support system by the owner of the company (franchisor).There are terms and clauses that are essential to make the franchise agreement a strong document. It is important to explain all the terms and elements of a franchise agreement. If important details are not seen then it can affect the franchised business badly. That is why the advice of experienced professionals and legal experts is a necessity. Both parties should review franchise agreements properly with the help of a lawyer before signing.