LEGAL ISSUES WITH THE FRANCHISED BUSINESSES

LEGAL ISSUES WITH THE FRANCHISED BUSINESSES

 

This article discusses the most common legal issues faced by Franchised Businesses in India.

Author - Charmie Africawala
A.  Introduction to Franchise Business

A franchise business is one that is owned by an individual or group of owners (“Franchisee”) and offers a good or service that is branded by a company (“Franchisor”). This company offers support in all areas of the business in exchange for a fixed fees as royalty fees for using the brand name of this company as well as payments based on sales or profits. The term “franchised business” is not defined by Indian law. However, to put it briefly, franchising is a way to distribute goods or services by delegating every day operational functions. Under a franchise business a license granted by the proprietor of a trademark or trade name to another person allowing them to market goods or services under that name or mark.

B. Parties to a Franchise Business

In a franchise business following parties are involved:

  1. the franchisor: who entrusts the company system and his trade name, trademark, or other intellectual property.
  2. the franchisee: who purchases the right to use the franchisor’s brand and company system by paying a royalty and frequently an upfront fee.
  3. landlord: the owner of the land in case the franchise business in operated through leased premises
  4. third party supplier/vendors/distributors: supplier/vendor/distributors for the products or service used in the franchise business for sake of uniformity.
C.  Legal Issues with the Franchise Business

Even if the idea of franchise business looks intriguing and straightforward, there are a number of issues that must be resolved before starting a sound franchising business. Although there is no explicit legislation governing franchising in India, the practice of franchised business in the nation is impacted by many other company laws and industry-specific laws.

It would be necessary to comprehend how these various rules might impact an Indian franchise business and what problems might result from them.  A few examples are enumerated below.

  1. Enforceability of Franchise Agreements in accordance with Indian Contract Act, 1872
  2. Relationship between Franchisor and Franchisee
  3. Law related to Intellectual Property Rights affecting Franchise Business
  4. Consumer Protection and Product Liability
  5. Competition law and Unfair Trade Practices
  6. Property Law
  7. Taxation
  8. Labour Law

 

We would hereby procced with understanding how Doctrine of Privity and Doctrine of Frustration under the Indian Contract Act, 1872 (“Act”) shall affect Franchised Businesses in India.

D. Doctrine of Privity

Doctrine of Privity in the Act prevents non-contractual parties from exercising any rights in a contract and confers obligations and rights on parties to a contract. It could be easily understood by the saying that “a stranger to a contract cannot sue”.

The tenant of a landlord, for instance, cannot sue the prior owner of the property under the doctrine of privity for failing to make repairs that were promised in the property sales contract between the seller and the buyer since the occupant was not “in privity” with the original seller. Privity is designed to prevent third parties from taking any legal action resulting from a contract.

In general, privity of contract has three effects:

  1. If a third party is not a party to the contract, he cannot benefit from it.
  2. A third person who is not a party to a contract is not subject to that contract’s obligations.
  3. If a third party is not a party to the contract, he cannot enforce it.

Privity, however, has proven to be troublesome, leading to the acceptance of several exceptions.

  • Beneficiary
  • Provision for maintenance or marriage
  • Conduct, Acknowledgement, or Admission
  • Family Settlement
  • Estoppels
  • Agency

 

Doctrine of Privity and its effects on Franchise Business

Though the doctrine of privity has been of a great importance in common law, it has some negative effects in the franchised businesses. This is because, as mentioned above, in the franchised business the most common arrangement entered between various parties are as below:

  1. Franchise Agreements: between franchisor and franchisee
  2. Lease Agreement: between the landlord and franchisor/franchisee (as the case may be)
  3. Vendor / Supplier Agreement: between the Vendor/ Supplier and franchisor/franchisee (as the case may be)

As in the world of franchise, each of the parties are interdependent and interrelated with each other though not through any direct contractual obligations but if any loss/breach is caused due to non fulfilment of any of the stipulated condition in any of the above mentioned agreement, then the loss is incurred by the party who is not the party to the agreement and due to the doctrine of privity the aggrieved third party has no stand for suing the breaching party to the agreement. Thus, making this to be an obstacle in the franchise business.

This could be explained with the help of example, a franchise business is operated in a Franchise owned and Company operated model (FOCO). In this situation the agreement is entered upon with the vendors/ suppliers (as informed by the franchisor) by the franchisee as the business will be owned by franchisee. In this case even if the franchise agreement is terminated between franchisor and franchisee, the agreement with the vendor and supplier does not get effected, therefore making this a loss for franchisor.

The same is the case with Lease Agreement. If a lease agreement is entered by the franchisee and the landlord for operation of the franchised business then the franchisor has no rights on the property in case the franchisee breaches the Franchise Agreement.

Thus, it could be inferred that the long-standing principle of Privity of Contract had resulted in a great deal of unfairness and difficulty for non-contracting parties in a franchised business. Judges, academics, and law reform organizations have all criticized the Privity rule’s existence, and in some states, the rule has been formally abrogated. There is no theological, rational, or economic basis why the laws should invalidate a contract that the parties expressly intended to be for the advantage of a third party.

E. Doctrine of Frustration

The theory of impracticability and impossibility is referred to as Doctrine of Frustration under the Indian Contract Act, 1872. On the axiom Lex non cogit ad Impossibilia, the doctrine of frustration is established. It translates to “The Impossible cannot be compelled by law.” A key tenet of any agreement between two parties is that the execution of the agreement depends on the continuous existence of a particular person or thing, and that any later inability (due to the person or object dying) shall excuse the fulfilment of the agreement. All contracts automatically include this clause.

Frustration refers to a situation in which external factors beyond the control of the involved parties make it impossible for the contract to be fulfilled. It covers both:

  1. Failure to fulfil a contractual duty and
  2. Failure to achieve a secondary objective for which the agreement was executed for.

Justice Fazal Ali of the Supreme Court of India discussed the validity of frustration in India in the case of Ganga Saran v. Ram Charan. The Supreme Court made the observation that  the doctrine of frustration is an aspect or part of the law of contract which restricts fulfillment of obligations due to supernatural causation impossibility or illegality of the act consented to be done and thus comes within the ambit of Section 56 of the Act.

As a result, it has been noted that the idea of frustration has historically held a prominent place in a number of judicial systems. The legislation governing this topic is unquestionably currently evolving. However, there are some documented justifications for when the Doctrine of Frustration can be used. As follows:

  1. Eradication/Lack of the subject matter of contract
  2. Destruction of a thing required for the fulfilment of the contract but not the subject matter
  3. When the performance approach is rendered impossible
  4. Force Majeure situations like export/import bans, wars, strikes, natural calamities etc
  5. Change in situation

Doctrine of Frustration and its effects on Franchise business

The Doctrine of Frustration will have an impact on the franchised business in the same way it would in any other sector. The theory of frustration comes into play when a contract becomes impossible to perform after it has been made due to events beyond the parties’ control or when a change in circumstances renders the contract impossible to perform. A party may attempt to claim that a contract has been frustrated if it is confronted with an external circumstance or incident that could make fulfilling its obligations under the agreement difficult, cumbersome, or even impossible. The agreement includes a clause that prohibits the parties from carrying out their commitments due to a force majeure situation. This clause releases one or both parties from their contractual duties in the event that performance is prohibited by an unforeseen occurrence or circumstance. Typical force majeure situations can include a terrorist attack, a fire, a flood, or civil upheaval. The doctrine of contract frustration, which refers to force majeure, is found in common law. According to this idea, a contract will be rendered useless if its primary goal is achieved. The doctrine of frustration will be used if contracts between parties lack force majeure clauses and an event occurs that makes it impossible for the contract to be performed.

From the above it is evident that the franchised businesses in India suffer from a lack of single legislation governing them and thus, would require analysis of multiple legal perspectives to avoid any roadblocks.

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