India does not have a specific statute dealing with franchise matters. The Finance Act, defined the term franchise, which has now been repealed, owing to the introduction of the Goods and Services Tax. The Finance Act had defined a franchise, in the context of service tax, to mean an agreement by which the franchisee is granted the representational right to sell or manufacture goods or to provide service or undertake any process identified with a franchisor, with respect to any trademark, service mark, trade name, logo, etc. A franchisor was defined as any person who enters into a franchise with a franchisee and the term ‘franchisee’ is construed accordingly. These definitions are not mentioned in the law relating to the Goods and Services Tax.
However, the Indian Contract Act 1872, the Specific Relief Act 1963 and other acts which apply to all commercial arrangements, are relevant to franchise agreements and the same are discussed in detail below.
- Contract Act
Fundamentally, every franchising relationship is a contractual relationship and therefore, the Indian Contract Act, 1872 (“Contract Act”) would be applicable to all franchising arrangements.
Under the Contract Act, a “contract” is an agreement enforceable by law. The following elements are required to constitute a contract:
(a) an agreement, i.e. an offer and an acceptance of the offer;
(b) lawful consideration for the agreement;
(c)lawful object and purpose of the agreement;
(d) free consent of the parties to the agreement; and
(e) capacity of the parties to enter into an agreement.
Every franchising agreement would have to necessarily meet the above five criteria in order to be legally enforceable.
2. Specific Relief Act
The Specific Relief Act 1963 set outs the remedies available for enforcement of contracts. Until recently, specific performance of a contract was a discretionary remedy that was awarded if the court was satisfied that damages would not be adequate for breach of a contract. However, pursuant to the amendments made by the Specific Relief Amendment Act 2018, courts are now bound to award specific performance except in certain cases. Additionally, under the substituted performance regime introduced by the Specific Relief Amendment Act 2018, the aggrieved party can engage a third party or an agent to perform the contract and recover expenses and costs actually incurred by it in seeking this substituted performance from the defaulting party. Further, if the substituted performance remedy is exercised, the aggrieved party cannot seek specific performance but can seek damages for breach of contract.
3. Protection of Intellectual Property Rights
The most important aspect of a franchising agreement is the licensing of the Intellectual Property Rights such as trademarks, tradenames, goodwill, exclusive manufacturing or selling rights. Thus, to protect these IPRs, the franchise agreements often contain provisions which allows the usage of several trademarks by the franchisee where competing with only other franchisees is allowed & not within the franchise.
The Trademark Act provides for the protection of franchise by means of registration of trademark in India due to its territorial nature. It also provides remedies for infringement by third parties such as injunction, damages, lost profits or destruction of the infringing products under the labels & trademark.
The know-how, confidential information, design & copyright of the franchisor are also protected under the relevant set of laws existing in India under the Design Act, 2000 & Copyright Act, 1957 respectively. The franchisor for more effective protection may opt for adequate clauses in the franchise agreement which provides for express obligations on the franchisee in relation to the technical know-how & trademarks.
4. Consumer Protection and Product Liability
The Consumer Protection Act was initiated in 1986 to provide recourse for consumers who receive defective goods or experience unsatisfactory service. Under these laws consumers are encouraged to file complaints and could file an action against a franchisor, a franchisee or both depending on the nature of the franchise agreement.
5. The Competition Act
The Competition Act has been enacted with the aim to promote free trade & to end protectionism where it prohibits anti-competitive agreements and abuse of dominant position. Franchise Agreements can be covered under the vertical agreements. The Competition Act, 2002 per se does not provide for franchise agreements but can be covered under the vertical agreements which prohibit vertical restraints such as tie-in arrangements, exclusive supply and distribution agreements, and resale price maintenance that are likely to cause Adverse Appreciable Effect on Competition (AAEC) under Section 3(4) of the Act.
The franchisors who are also the manufacturers in the garb of vertical restraints often foreclose the market for entry of potential rivals by raising the cost of distribution. Due to this, competition reduces substantially at both levels i.e intra-brand (due to resale price mechanism, competition between distributors are eliminated) & inter-brand (prices of products rise due to selective distribution by manufacturer and the same is also adopted by the rivals in the market).
The Competition Act defines Resale Price Maintenance (RPM) as an arrangement where the manufacturer dictates the resale price i.e. the retail transaction price. In certain circumstances the franchisor demands that his goods cannot be sold below a particular price by the franchisee. This impedes competition in the market. The CCI expanded the ambit of RPM to include instances where manufacturer determines the distribution margin, rebates, discounts etc. or where uses threats, penalties or delayed deliveries for fixing prices charged by the retailer.
The franchise agreement may also amount to restrictive trade where the agreement clearly specifies that the franchisee cannot employ third parties for distribution of the product. It amounts to restrictive trade practice where the agreement was stipulated that sub-serving dealers shall be appointed only on prior approval of the manufacturer.
Normally payments under franchise agreements attract direct and indirect taxes in India. Income tax will be payable by a franchisee on the income earned from franchise operations. If the franchisee is providing a service to consumers (for example, a restaurant), Goods and Services Tax will be payable by the entity providing the services.
a. Franchisor tax liabilities
A franchisor may be liable to pay income tax in India if it is resident in India for tax purposes. If the franchisor is based outside India, the franchise agreement should be structured carefully to ensure that the franchisor is not considered to have a permanent establishment in India.
b. Franchisee tax liabilities
Subject to the FEMA provisions, a franchisee can make royalty payments to an international franchisor from India. However, the franchisee will be obliged to withhold tax on payments towards royalties and technical services made to the franchisor under the franchise agreement. This is subject to double-taxation avoidance agreements (DTAA), or treaties, and for treaty countries the effective withholding tax liability may be reduced. India has in force DTAAs with approximately 120 countries.
7. Labour laws
It is unlikely that the franchisee would be treated as an employee of the franchisor under Indian employment laws, as often the franchisee would be a corporate entity rather than an individual. It would be advisable to incorporate clear drafting in the franchising agreement demarcating responsibilities with respect to franchisee employees, and their salary and benefits. Until recently, there was a plethora of employment laws in India covering aspects such as wages, payment of benefits, gratuities and leave. Parliament has recently enacted legislation that would replace several employment laws, including the Code on Wages 2019, the Industrial Relations Code 2020, the Occupational Health Safety and Working Conditions Code 2020 and the Code on Social Security 2020. These Codes have not come into effect as yet and delegated legislation under the Codes is in the process of being drafted. Companies formed in India are bound by these laws and, depending on individual states, additional regulations may also apply.
8. Dispute resolution:
Since litigants may face backlogs and delays in the Indian court system, it is usual for commercial contracts to provide for disputes to be settled by arbitration in India or outside India. The Arbitration and Conciliation Act 1996 (the Arbitration Act) is the Indian legislation relating to arbitration. The Arbitration Act is divided into several parts. Part I of the Arbitration Act deals with various stages of arbitration proceedings such as initiation and conduct of arbitration and enforcement, and challenge of arbitral awards. Part II of the Arbitration Act deals with enforcement of foreign arbitral awards. However, the franchise agreement shall govern how disputes arising may be resolved.
Author: Kavya Velagala, Associate.
Disclaimer: The content of this article is intended to provide a general guide to the subject matter and that the same shall not be treated as legal advice. For any queries, the author can be reached at firstname.lastname@example.org.