Termination of a franchise agreement and its consequences in India (Lisa Sen)
Wednesday, September 6, 2017
Termination of a franchise agreement before the expiration of the term can be a major upheaval for both the franchisor and franchisee. It lays waste the investment made by the franchisee and can affect the brand’s image when one member is made to leave the franchise network due to some negative circumstances.
Termination clauses in franchise agreements provide a long list of grounds under which the franchisor can make the franchisee to shut down their franchise business and de-brand. The justification is to protect the Franchisor’s intellectual property, know-how and reputation which also has impact on the franchise network.
Franchisees, on the other hand, usually have very limited grounds to terminate, such as, insolvency of the Franchisor or breach of warranty provided in relation to their intellectual property rights. This is despite the fact that the franchisee makes the investment to grow the Franchisor’s brand in the territory.
In addition, International Development Agreements or Master Franchise Agreements, entered into between foreign franchisors and Indian developers or, master franchisees, have clauses whereby the developer or master franchisee is required to waive its right to legal action against the Franchisor.
Termination provisions are not always difficult to enforce in situations where facts cannot be disputed or challenged. For instance when the franchisee is facing financial difficulties or insolvency and co-operates with the franchisor to bring an end to its obligations.
There are also situations where the franchisee/developer may have been convicted of a criminal offence, including violation of anti-bribery or money laundering laws or franchisor’s intellectual property rights; or abandons the business, and cannot effectively challenge the right of the Franchisor to terminate to protect its reputation.
More complex situations arisewhen franchisors seek to terminate for “material” or “substantial” or “persistent” breach on the part of the franchisee. A number of situations fall into this category including non-payment of dues to the franchisor, accounting discrepancies, standard of goods and services being provided to the customer or method of running the business which does not conform to the Manual. The level of importance of such items vary from sector to sector.
For the food and beverage sector food safety, hygiene standards and customer complaints about food poisoning take priority above other issues as these risks damaging the brand. In the retail sector, accounting and payment for supplies arise more frequently. Most good agreements would define or list what constitutes “breach” or “serious breach” but many do not, and leave open room for interpretation.
Most franchisors try to avoid termination and give the franchisee opportunity to remedy the breach within a reasonable time, if the breach is capable of being remedied. The franchisee then has to do their best to remedy the breach or seek any justifiable extensions. If the franchisee fails, the franchisor can exercise their right to terminate the agreement with immediate effect.
Foreign franchisors are often surprised when sending a termination notice to an Indian developer or master franchisee result in legal action with the Indian developer or master franchisee challenging the right of the franchisor in respect of termination and its interpretation of breach.
This can be partly due to the perception among Indian developers and master franchisees that they are making the investment and taking on the risk for growth of the foreign brand whether or not it is known in India, and franchisors should not have unequal rights in their favour.
The other reason is Section 28 of the Contract Act, which renders any provision void that restricts a party from enforcing his legal right or limits the time within which the contract may be enforced. Section 28 provides that “Every Agreement
(a)by which any party thereto is restricted absolutely from enforcing his right under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, or
(b) which extinguishes the right of any party thereto, or discharges any party thereto from any liability, under or in respect of any contract on the expiry of a specified period, so as to restrict any party from enforcing his rights, is void to that extent.”
The exception provided under section 28 is in respect of arbitrations.
Franchisors: Take Note
Despite the fact that Franchise Agreements include termination clauses and waivers, franchisors should be aware that there is not adequate protection against being sued by a franchisee who wishes to resist termination in India. Even if there are arbitration clauses, or no provision for action in a court of law in India, a franchisee can make allegations that the franchisor is being unjust in terminating the agreement and laying waste all the investment and efforts the developer or franchisee has put in.
Court process in India can take a long time, and even if in the end the developer or franchisee may lose the case, the expense and stress involved in going through the process can be significant for the franchisor. When there is a dispute regarding termination, sometimes the franchisee carries on the business using the franchisor’s trade mark, logo and know-how without necessarily paying the dues. Franchisors, especially foreign franchisors, have to initiate injunction suits to protect their intellectual property rights. Not all franchisees or developers are like that, some are very reputable companies taking on number of brands.
Other issues that can arise on termination include what would happen to the premises and the business. Some agreements allow the franchisor to take over the business on termination. In India, a foreign franchisor would need to check whether it is allowed for a foreign company to take over an Indian business in the particular sector. The process can invite a myriad of regulatory issues. Often it is easier to either shut the business down or allow another local party to enter into a franchise agreement in respect of the territory.
Exceptions Can Be Made
Termination upon the expiry of the agreement is usually a natural end to the franchisor franchisee relationship, unless the franchisee carries on a competing business using the franchisor’s know-how immediately after the termination of the franchise agreement.
Enforcement of post term non-compete provisions are also not easy in India especially against former employees. Courts in some states in India are more aware of intellectual property rights and considerate about the need for international and domestic brands to protect their know-how. The exceptions found in Section 27 of the Indian Contract Act can help a judge to justify imposing reasonable restrictions on a franchisee.
Section 27 of the Indian Contract Act states “Every agreement by which anyone is restrained from exercising a lawful profession or trade or business of any kind, is to that extent void.
Exception: One who sells goodwill of a business with a buyer to refrain from carrying on a similar business, within specified local limits so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein provided such limits appear to the Court reasonable, regard being to the nature of the business.”
It is important for a franchisor to invest time in finding a reputable franchisee. This can help in avoiding early termination and a number of problems post termination. In any event, there can be a number of practical obstacles in relation to termination despite having a comprehensive franchise agreement.