Walking on Eggshells in India

Tips for franchisors considering a move into the Indian market.

By Safir Anand and Twinky Rampal

Stalwarts in the industry peg the size of the franchise sector in India at an estimated US$47 billion-$48 billion. A simple road trip on a major highway in the country shows the presence of popular restaurants that, up until sometime ago, could only be accessed internationally. The demand in consumption of such foreign brands is not just a reflection of the urban economy but a large part of this demand is being led by the population in Tier-2 and Tier-3 cities despite the differences in consumer profile. It is no surprise that India, in recent times, has seen a boom in the number of foreign players.

New Opportunities

This “urbanization” is exposing the population at increasing rates to newer business models, product categories and brands in India, leading to greater brand consciousness. Instead of buying a meal from an unfamiliar roadside restaurant, the consumer now can choose a popular international eatery in the same vicinity. This change has resulted in a better ambience, better service, better quality of food and newer experiences for the consumer. The ability to consume a “brand” is a big driving force since it creates an aspiration for the consumer, and once met, validates inclusivity with the rest of the progressive world.

This trend is not limited to the food and beverage industry and is identifiable within a majority of the sectors. One of the big reasons for this is the energy and high demand of the new-age Indian entrepreneur. Indian entrepreneurs no longer compete in just their own country but are lunging for a chunk of the foreign pie, which once was out of reach. And the government is taking appropriate steps to ensure that foreign brands find it easier to develop a footing in India.

The Income Tax Appellate Tribunal gave relief to foreign franchisors in 2018 when it ruled that Domino’s Pizza is a U.S. company and cannot be subjected to Indian taxes. The controversy arose when the tax officer alleged that the Permanent Establishment rule required that Domino’s Pizza be taxed at 40 percent instead of the 10 percent typically required on royalties through the Double Tax Avoidance Agreement between India and the U.S. The Tribunal held that Jubilant Foodworks (master franchisee of Domino's) cannot be considered a permanent establishment for Domino’s Pizza in India.

For a typical franchisor looking to enter the Indian market, the most relevant company structure is either a private limited company or a limited liability partnership (LLP). Both types of entities have independent corporate existence, are well-governed by a regulatory regime, are amenable to foreign investment, subject to relevant foreign exchange control norms and offer protection from unlimited liability. While there are other business structures such as sole proprietorship concerns and partnership firms, these options are not available for foreign franchisors as foreign investment is not permitted in these entities.

Regulations

A franchise arrangement can be regulated and governed through various applicable statutory enactments prevailing in India, including the Indian Contract Act, 1872; Competition Act, 2002; Consumer Protection Act, 1986; Trade Marks Act, 1999; Copyright Act, 1957; Patents Act, 1970; Design Act, 2000; Specific Relief Act, 1963; Foreign Exchange Management Act, 1999 and other FDI policies and regulations issued by the Reserve Bank of India. Industry-specific and state legislation could apply, depending on the relevant industry/sector, and the transaction can thus be largely guided by the arrangement between the franchisor and the Indian franchisee. This allows excessive freedom to both the parties to create a set of matrices that appeases the diversity of the Indian consumer.

A franchisor investing in India is set to gain largely in this arrangement since the investment commitment is limited, the responsibility of scoping for and assuming charge of the local region is on the franchisee and local permits and approvals are obtained by the franchisee.

Regional Knowledge

There are many factors which go into establishing successful franchise stories in India, and intimate knowledge of the local region by the franchisee is one. While it is possible to have a non-exclusive relationship with your franchisee, exclusivity brings certain perks. Domino’s first came to India in 1996 through a master franchisee, Jubilant Foodworks, and their relationship continues to date.

Coordinating with a single source optimizes efficiency, consistency and, in turn, the execution. Jubilant has exclusive rights for India, Nepal, Bangladesh and Sri Lanka, and Domino’s has carved out a large consumer base from an earlier pizza-skeptical community in this region. Statistics suggest that as of Dec. 31, 2018, Jubilant is a market leader in the pizza segment with a network of 1,200 restaurants across 271 cities in India.

Conversely, a large, well-known QSR currently is in a dispute due to “non-payment of royalties” with one of its franchisees responsible for the Northern and Eastern part of the country. The dispute has been ongoing since 2017 and the matter is subjudice. Until the issue is resolved, the QSR’s revenues and brand value in India are suffering not only from royalty shortfall but also from aggressive competitors.

After this QSR terminated the arrangement, it also wrote to the franchisee’s suppliers not to provide packaging and food products, a move being strongly contested by the franchisee. Thus, rigorous due diligence, stronger negotiations and the rights that the franchisor can exercise in case of an anomaly must be assiduously addressed while preparing and signing contracts.

Communication is Critical

A clear communication and set of guidelines with the franchisee is vital to avoid issues in the future. For example, the franchisor, to safeguard its interests in an alien country, can ask the franchisee to not compete with the franchisor’s business during the course of their relationship. The courts have upheld this agreement, although great care has to be taken to ensure that such covenants are not excessively unreasonable. In Esso Petroleum, the court stipulated, “…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...” This was supported by the Supreme Court in India in favor of the Coca-Cola Company.

Choose Partners Wisely

Among other factors, picking the right franchisee is critical to the success of any franchise arrangement since the franchisee is obligated to perform the requisite set of expectations on a day-to-day basis which reflects directly on the franchisor’s reputation. In India, it is not mandatory to make disclosures in the early stages and, hence, the franchisor has greater control over the process of dissemination of information.

Some of the issues that can trigger long term problems are best addressed in negotiations and captured in agreements. The risk can be mitigated by having a clearly defined agreement which at least covers the following issues in a crisp and concise manner:

- Issues regarding territory
- Dissemination of confidential information and know-how
- Best practice guidelines for use of intellectual property of the franchisor by the franchisee during and after the term of the agreement
- Restrictive covenants
- Timelines for royalty and consequences on breach
- Responsibility for hiring and labor-related legal and regulatory issues
- Renewal of the agreement
- Right of first refusal for the purchase of business of the franchisee
- Guaranties, indemnities and warranties
- Expansion plans
- Dispute resolution clauses

It may also benefit the franchisor to become a member of a leading local franchise association or group. Such associations usually have a network effect and could help in keeping the activities of respective parties in check. In some cases, these associations offer mediations between the parties and offer constant exposure to industry practices, knowledge, updates, government measures and other beneficial resources.

Safir Anand is a Senior Partner with Anand and Anand, and Twinky Rampal is a Partner. Find out more about the firm here.