Franchising in India
Preeti Mehta -
India is one the world’s largest and the fastest-growing emerging markets, and franchising has become a successful business model for many local companies.
Globalisation and market liberalisation has fuelled brand awareness among the Indian masses making the importation of foreign brands to Indian shores an attractive business opportunity for local businessmen. Foreign brands such as McDonald's and Pizza Hut have studied India's tastes and needs and customised their products and menus to suit local preferences.
Many foreign companies consider franchising to be a convenient method of entry into the geographically vast and culturally diverse Indian market, which offers a very favourable franchising environment.
Legal aspects
Compared to other parts of the world, the franchise sector in India is at a nascent stage and the general feeling at the moment is that there is no need for franchise-specific legislation. As a consequence, franchising in India is governed by a number of statutes, rules and regulations, some of which are discussed below.
The Contract Act
The contractual relationship between the franchisor and the franchisee is governed by the Indian Contract Act, 1872 (the Contract Act). There is no specific requirement under Indian law as regards a particular language; however, English is customarily accepted as the standard language.
Under the Contract Act, a "contract" is an agreement enforceable by law. A franchise agreement would be enforceable under Indian law since it would meet the criteria of a valid contract. However, care needs to be taken to ensure that the agreement does not contain any provisions that render the contract void or voidable.
Restraint of trade
Section 27 of the Contract Act deserves specific mention. As per said section, agreements in restraint of trade are void. The Monopolies and Restrictive Trade Practices Act, 1969 (MRTP Act) also regulates agreements that relate to restrictive trade practices; however, in the context of the Contract Act, it is imperative to understand the implications of a restrictive provision in a franchise agreement.
While deciding on the issue of restraint of trade in the landmark case of Gujarat Bottling Company Limited v Coca Cola Company (AIR (1995) Supreme Court 237), the Supreme Court of India held that:
"There is a growing trend to regulate distribution of goods and services through franchise agreements providing for grant of franchise by the franchisor on certain terms and conditions to the franchisee. Such agreements often incorporate a condition that the franchisee shall not deal with competing goods. Such a condition restricting the right of the franchisee to deal with competing goods is for facilitating the distribution of the goods of the franchisor and it cannot be regarded as in restraint of trade."
Accordingly, covenants in a franchise agreement restraining the franchisee from carrying out competing business or limiting it to a given territory would normally be regarded as reasonable restraints and would be enforceable against a franchisee.
Consumer protection and product liability
The Consumer Protection Act, 1986 seeks to provide remedies to consumers in case of defective products or deficiency in services and holding the manufacturers and service providers liable.
Despite the fact that under a franchise goods would be manufactured and likewise services provided by the franchisee, it is quite likely that the consumers could file an action against both the franchisor and the franchisee, since the goods are sold and the services are rendered under the brand name of the franchisor.
While consumers may seek remedy against both, it is common for the franchise agreement to provide that all product liabilities and responsibilities for consumer claims lie with the franchisee.
Monopolies and restrictive practices law and competition law
The Monopolies & Restrictive Trade Practices Act, 1969 (MRTP Act) prohibits the imposition of restrictions in respect of sources of supply and pricing of products. It must be ensured that the terms of the franchise agreement are not construed as monopolistic or restrictive. If found to be otherwise the MRTP Commission could grant an injunction preventing such trade practices and may also award compensation to the complainant for any losses or damages suffered.
Restrictive trade practices
The MRTP Act orders the registration of agreements considered to contain restrictive trade practices. Those that are relevant in the context of a franchise include: exclusive supply provisions; exclusivity in product dealing; restrictions on methods used; and resale price-fixing conditions.
Irrespective of whether the agreement has been registered or not, the MRTP Commission has the right to investigate if it is of the opinion that the agreement is prejudicial to the public interest.
Some of the decisions of the MRTP Commission, which are relevant to franchising include:
• Director General (Investigations and Registration) v Sri Sarvarayay Sugars Limited, where the respondent company engaged in the manufacturing, bottling and sale of beverages under various brand names and required the dealer to keep for sale only the respondent company's products and was therefore prevented from selling similar products from competitors. The MRTP Commission held that the respondent was not in any manner guilty of adoption of or indulgence in restrictive trade practices under the MRTP Act.
• Mohan Meakins Limited and others, where Mohan Meakins had entered into franchise agreements with bottlers for the manufacture, bottling and selling of soft drinks, which required the bottlers to purchase raw materials from Mohan Meakins. Upon being challenged as restrictive, the MRTP Commission held that reasonable restrictions on the franchisees to protect the quality of the products would be in the public interest and are justified.
Competition law
Following the globalisation and liberalisation of India's economy, competition law has shifted its focus from curbing monopolies to promoting healthy competition. Accordingly, the Competition Act, 2002 (the Competition Act) replaces the MRTP Act. Though some of its provisions have yet not been made effective, the provisions with respect to anti-competitive agreements and abuse of dominant position have recently entered into force.
The Competition Act prohibits any arrangements with respect to production, supply, distribution, storage, acquisition or control of goods or provision of services that cause or are likely to cause an appreciable adverse effect on competition within India. For the purpose of the said Act the following arrangements are presumed to have an appreciable adverse effect on competition:
• directly or indirectly determines purchase or sale prices;
• limits or controls production, supply, markets, technical development, investment or provision of services;
• shares the market or source of production or provision of services by way of allocation of geographical areas of the market, or type of goods or services, or number of customers in the market or in any other similar way; and
• directly or indirectly results in bid rigging or collusive bidding.
Under the Competition Act, tie-in arrangements, exclusive supply and distribution agreements and resale price maintenance would be regarded as being anti-competitive if such agreements cause an appreciable adverse effect on competition in India. Since, these concepts are similar to the provisions of the MRTP Act, the implications under the Competition Act ought to be considered by taking into account the judicial decisions made under the MRTP Act.
Intellectual property rights
Trademark protection
The Trademarks Act, 1999 prescribes the procedure for registration of trademarks and service marks. Validity of registration is for a period of 10 years from the date of application and subject to renewal at the expiry of validity.
There are three courses of action that can be initiated against trademark infringement:
• an injunction under statute;
• an infringement or a passing off action, depending on whether the trademark is registered or not; and
• criminal action for an offence of falsifying a trademark.
Trans-border reputation of trademarks
Several decisions of the Indian courts have recognised the reputation and protected the trademarks of foreign companies where their products or services have an international reputation even though they have no actual business in India. In the case of Calvin Klein Inc (CK), the trademark "CALVIN KLEIN" was used for clothing and was registered internationally, but not in India. Despite this, the court issued an injunction against an Indian company using CK's trademark. Hence, it would be possible for a foreign franchisor to legally protect its trademarks in India on the basis of its trans-border reputation; however, it would be prudent to register the trademarks in India.
Foreign exchange regulations
The Foreign Exchange Management Act, 1999 and the relevant rules and regulations govern payments in foreign exchange. Franchise arrangements would normally include payments such as a franchise fee, royalty for use of trademarks and the system, training expenses, advertisement contributions, etc, which can be remitted to the foreign franchisor without any approvals provided the appropriate nomenclature is used to denote such payments.
Single brand retailing
In 2006, the government allowed up to 51 per cent of foreign direct investment in "single brand product retailing" subject to prior approval of the Foreign Investment and Promotion Board (FIPB) and certain prescribed conditions, such as, the products should be sold under the same brand internationally.
In view of the above regulatory regime, the use of a franchise as a business model has gained tremendous momentum, resulting in foreign franchisors such as Mothercare and Next entering the market. It should be noted, however, that other central and state legislation, such as labour laws and property laws should also be considered.
Franchising in various sectors in India
Food and beverages
Some of the well-known brands in this sector that have received an overwhelming response in India include Baskin Robbins, Subway, McDonald's, TGI Friday's, Taco Bell, Pizza Hut, Dominos Pizza, Ruby Tuesdays, Barista, Costa, Wetzel Pretzel, Papa John's and KFC.
A study has revealed that more than one third of new food outlets are operated through the franchise system. The rapid development of mall culture has also encouraged the growth of food and beverage franchises. Fine dining restaurants, quick service restaurants, cafes and juice bars are among the leading franchised food segments in India.
Beauty and health care Fitness clubs such as VLCC and Talwalkers have established chains while hair and beauty salons offering domestic branded products including Shanaz Hussein, Biotique and Habibs, and international brands, for example, L'Oreal and Tony & Guy, have marked their presence through the franchise model.
A rise in the standard of living in India has increased demand for quality health services and has resulted in health-care service providers, spas, beauty salons and clinics opening new businesses in the cities through franchises. Apollo Hospitals has set up large chain of state-of-the-art health-care clinics in India and abroad, offering comprehensive health-care services.
Education
The increased acceptance of the importance of education by the Indian population and the proven success of education franchising in India has led to a boom in the amount of business owners wanting to expand their education brands using the franchise route. According to a recent survey, India is one of the largest markets for education in the world in terms of the number of students, offering vast franchising opportunities. Currently, out of the 1,200 franchises in the country, 32 per cent are in the education sector. Professional and vocational courses in the fields of aviation, hospitality, retail, financial services and insurance capture almost a third of the total share of education provided through franchises, followed by training in the IT sector. Franchising in the pre-school sector has grown particularly in the past decade.
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For an emerging market such as India, franchising has the effect of creating cross-border economic relationships and helps foreign franchisors establish themselves and cater for a diverse population in the fastest way.
It is evident that foreign franchisors have realised the unparalleled potential for franchising in India, and there is no doubt that franchising as a business concept has a very bright future in this country.