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People Also Read This: Franchise Terms And Conditions In India

The following sections, in the order shown below, must be included in every document:

1. The franchisor and any parents, predecessors, and affiliates
2. Business experience
3. Litigation
4. Bankruptcy
5. Initial fees
6. Other fees
7. Estimated initial investment
8. Restrictions on sources of products and services
9. Franchisee’s obligations
10. Financing
11. Franchisor’s assistance, advertising, computer systems, and training
12. Territory 
13. Trademarks
14. Patents, copyrights, and proprietary information
15. Obligation to participate in the actual operation of the franchise business
16. Restrictions on what the franchisee may sell
17. Renewal, termination, transfer, and dispute resolution
18. Public figures
19. Financial performance representations
20. Outlets and franchisee information
21. Financial statements
22. Contracts
23. Receipts

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Why Do We Need FDD?

The FDD is a Federal Trade Commission requirement (FTC). The FTC requires that a Franchise Disclosure Document (FDD) be supplied to potential franchisees no later than 14 days before any formal contract is signed to ensure that they have all of the information required to make an informed judgment.

The 14-day timeframe begins when a formal receipt is signed. The receipt merely acknowledges that one might have received the FDD and does not imply any obligation on the other's behalf.

The FDD does not require government approval. However, in other states, the FDD must be registered and meet certain approval requirements. Some of which are California, Hawaii, Illinois, Maryland, New York etc. Other states do not need the franchisor to register the FDD, but they demand the franchisor file the FDD with the state to sell franchises there. Some of these are Connecticut, Florida, North Carolina, South Carolina, Texas etc.

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Importance of FDD in India

The FDD protects both parties. It thoroughly discusses all financial concerns so that the franchisee is not surprised by any unexpected fees later. Since franchises have diverse approaches, franchisees need to know exactly what to expect before signing a contract. The contract can protect the franchisor from risks and liability if the investment fails and eventually be able to collect any amounts owed to them.

Since February 2020, 34 jurisdictions have enacted some type of franchise-specific legislation or regulation requiring the issuance of a disclosure document to a potential franchisee even before the franchise is purchased. A franchisor is not subject to any pre-contract disclosure requirements or any statutory responsibility to offer any information to a potential franchisee under Indian law. In India, there is a general rule that parties owe each other a duty of good faith and fair dealing, which might require pre-sale disclosure. This makes franchising in India a dangerous business, thus a franchisee should conduct comprehensive due diligence on the franchise and be doubly sure before signing a franchise agreement.

Is Review of FDD Important?

Owning a franchise is a significant investment. One should examine the Franchise Disclosure Document (FDD) from beginning to end. Because a franchise normally involves a ten-year commitment, one should take their time and put in the necessary effort.

Because the franchise disclosure document cannot be modified, some people do not want to hire a lawyer to prepare and review it. However, it is equally critical to retain the services of a lawyer because: a franchise lawyer understands what might go wrong and where to check for warning signs. A skilled lawyer can advise you on how to protect yourself and when to walk away in rare circumstances. Years of experience can be brought to the table by a franchise lawyer. He or she will explain how a franchisee operates and provide you with important advice on how to acquire a franchise.

The purpose of the FDD is to provide information that can be used in real-time interactions. While reading the long document, the nuances may be overlooked, particularly when determining how to buy a franchise. The FDD allows potential franchisees to evaluate and determine whether or not to purchase the franchise.

In other words, it can be said that Business format franchising is a distribution network that operates under a shared trademark wherein the franchisor gives the franchisees the right to do business under his name for a specified period in exchange of money.

Characteristics of a Business Format Franchise

Characteristics of a business format franchise are:

• The Concept:
  • The franchise concept is an established business with a certain degree of success, a proven reputation and an established and recognized brand name.
• The training:
  • As part of the business format, the franchisor promises paid training on program performance before opening a business, and assists with opening a business. The franchisor must make his brand and business success in the long-term and it is incumbent on him to offer ongoing training that will keep pace with the expansion of the franchise and its future success.
• Support in operations:
  • Whether at the technical, operational or management level, franchisors should provide ongoing guidance on where the business is headed, what research and development needs to be done to keep it high and always improve management efficiency.
• Assistance in Marketing:
  • The success of many franchise brands results from marketing innovation that ensures that the spread of merchants is supported by effective advertising and promotion. In many cases the funds raised by shareholders go to national advertising campaigns to benefit both the brand and the individual franchises.

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Business Format Franchise Agreement

A business format franchise agreement has the following clauses:

• Description of the business which is being franchised.
• Territory or area in which the franchise is given. Typically, one franchise per area is provided.
• Determination of prices: Franchisor’s typically determine the prices for the products sold through the franchise.
• An estimate of costs, names of suppliers etc. are also included in a business format franchise agreement.
• Exit provisions.
• Tenure: Typically, the parties want a long tenure ranging between 5-15 years to realise their costs.

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Advantages and Disadvantages of Business Format Franchise

Advantages:

Marketing:

One of the franchisor's primary responsibilities is using the best efforts to advertise and promote its brand name. Therefore, the franchise business is often better advertised and branded than a traditional business. Also, in the case of a franchise business, as advertising or sales costs are shared by all franchisees, the total sales costs are lower in the franchise model.

Lower operating cost:

In some models, the franchisor would negotiate price and group purchases on behalf of the franchises. This will help reduce the operating costs of the franchisee business. In addition, as the business owner is aware of the local market conditions, the franchisor can save by conducting costly research on local markets, business processes, etc.,

Ease in expansion:

For standard business models, developers will need large sums of money or bank loans to grow their business. However, in the franchise model, the franchisee provides large amounts of money and the franchisor provides product information and technical knowledge to grow faster with the minimum amount of money required.

Low risk for the franchisee:

As the franchisor makes every effort to market the product, the franchisee poses a small risk. Moreover, in the franchise model, as the business model is also proven, the business risk for the business owner is reduced.

Easy access to capital:

With many well-established franchise business models with a proven name, it is easy for a franchise owner to get a bank loan to start a franchise business.

Business Knowledge:

Many businesses do not have sufficient business, legal, or real estate knowledge and investment experience in all the provinces and cities of India. However, in this format, franchisors have the ability to work with franchises to recognize information about local market conditions.

Training and technical knowledge:

In the franchise business, the franchisor provides the franchisee with training and technical knowledge. Therefore, it prevents the possibility of costly mistakes due to the lack of training on the franchisee side.

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Disadvantages:

Franchisee Independence:

In a franchisee model, although the franchisee owns a business, the franchisee owner cannot act independently. The franchisor manages the franchisees and it is necessary to submit various reports to the franchisor.

Lock-in period/Commitment:

Franchisees are usually made to commit to a franchisor a closing period until they are legally obliged to conduct business regardless of profit or loss. During the locking period, the lender will not change the business model or change the franchisor.

Negative publicity:

If a retail business gets a bad name because of the actions of a franchisor or another trader, the entire product will suffer. This could result in the loss of sales or customers of the business owner who was not involved in the transaction.

It can be said that although the Business Format Franchise brings with it a lot of advantages for both the parties that enter into the Contract, it also poses certain challenges that serve as disadvantages for both the parties. Therefore, the advantages and disadvantages of the franchise format should be taken into due consideration for a particular business model.

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These benefits accruing to a franchisee are as follows:

• Minimal Industry experience is required to buy a franchise - Purchasing a franchise permits one to work in a profession in which they may or may not have prior experience, but might be interested in. Franchisors provide franchisees with substantial support and training in order to educate and help them comprehend their company’s business strategy.
• Brand Name, Recognition and associated benefits - Arguably, one of the most important advantages which a franchisee has is with respect to the brand name and recognition of the franchisors company. Most entrepreneurs and small-scale businessmen often find it extremely arduous or difficult to develop their brand name and get recognition in the market. This major hurdle is avoided to a large extent when the franchisee who in most cases is a small businessman utilizes the developed brand name of the franchisors company.
• Business Assistance, Support and established track record of Franchisor – Another major point which acts as an advantage for the franchisee is the assistance, support provided by the franchisor and the established track record of the franchisor’s company. Franchisees typically sign a contract with an experienced team, ideally with an established brand with established methods and resources to support and guide the franchisee in designing, opening, advertising, and operating a franchise.
• Lower Risk - The factor of risk is present in every business enterprise. This is true whether a business owner is starting their own company or buying a franchise. However, the risk is considerably lower when opening a franchise. The network developed by the franchisor is one of the reasons franchisees are exposed to lower risks than independent business owners.
• Economies of Scale - Through economies of scale, franchise systems can provide purchasing efficiencies. The franchisor or trusted suppliers will provide some or all of the required products to the franchisee. Bulk discounts are frequently available to franchisees. A franchisee has access to network of the franchises on a large scale and therefore, has the ability to acquire items in bulk at a reduced cost.

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Disadvantages of a Franchisee

• Initial Investments and Costs incurred – Initial investments can vary greatly depending on the type of business. In addition to the initial investment, some franchisors may charge rent if you buy an existing store, handle marketing expenditures, pay management fees, recruitment fees, service fees, royalties, and so on. It can be a hefty investment, which might be a disadvantage for individuals just starting their entrepreneurial careers.
• Hampered Creativity and Restrictive regulations - Franchisees that want to explore, alter, or add to their company’s business strategy or brand face creative limits because franchises already have a predetermined brand. Because of the preset business model, there are also limitations on where the franchisee may operate, what products he/she can sell, and whose suppliers the franchisee can utilize.
• Financial Information is shared with Franchisor - A lack of privacy is another downside of franchising. The franchise agreement will almost certainly state that the franchisor has complete control over the franchise’s finances. Franchisees may view the absence of financial privacy as a drawback of owning a franchise.
• Limited Control and potential for conflict – Owing to the restrictive regulations and hampered creativity along being constantly supervised by the franchisor, a franchisee has limited control over his/her franchise. This may lead to a potential situation of conflict which is not preferred by most franchisors.

People Also Read This: Franchise Terms And Conditions In India

Hence, a franchise agreement has both benefits and disadvantages for a franchisee. It is best to get legal help before deciding to become a franchisee or sign a franchise agreement.

India does not have a separate law governing the franchise operations. Still, the now repealed Finance Act, 1999 offers a rough idea of the concept of franchise which runs along the same lines as defined by IFA. The International Franchise Association describes a franchise as a system in which a ‘franchisor’ specifies the items and services that the ‘franchisee’ will sell while also providing an operating system, a brand, and support. A franchisee is on the receiving side of the scale, since the franchisor offers permission to operate business under their brand. A franchise agreement is a contract between the franchisor and the franchisee which highlights the terms and conditions that will typically govern the relationship between the contracting parties. Also, noteworthy information to stress upon is that the franchise agreements in India must confirm to the provisions of the Indian Contract Act, 1872. One important distinction to keep in mind is that the relationship between the two parties is that of two independent contractors and not that of a partnership or joint venture or an employment contract.

What Happens When A Franchisor Terminates Franchise Agreement?

Franchise agreement termination and non-renewal are two alternative ways for the franchisor to achieve the same result. The franchisor terminates the agreement before the end of the contract term in a termination, whereas the franchisor refuses to renew the agreement after the end of its term in a non-renewal. The end consequence is the same for the franchisee: you lose your business.

There are a variety of reasons for cancelling a franchise agreement, some of the reasons for cancelling a franchise include:

• Default in payment of franchise fee.
• Default in payment of royalty payments.
• Intellectual property infringement issues.
• Loss of market or loss of potential opportunities in a specific market.

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Typically, the franchisor has an upper hand in controlling the provisions and their implications in a franchise agreement.  There are also cases of wrongful termination of the agreement which happens when the franchisor terminates the franchisee without the legal right to do so. This includes the termination in bad faith, in violation of the terms of the agreement, against the state law, false allegation of material default. At times, some hidden motives may be there, such as the desire of the franchisor to take over the lucrative business territory for him, consolidate multiple franchise locations under a single franchisee, or simply transfer the said franchise to a favored successor. In such a case scenario, a franchisee can approach the court and hire a competent franchise lawyer to fight for his rights.

Expiration of Franchise Agreement

The franchise agreement expires when the term or period of the agreement ends without any breach or any action/conflict between the contracting parties. Even after the expiration, the franchisee still owes some obligations to the franchise, for instance no right to continue the use of trademark upon expiration. The franchisor now reserves the right to purchase the franchised units' assets or allot it to a third party. The franchisee must be asked to return all the confidential information obtained during the agreement term and should not open a competing business within the same location. Moreover, the franchisee must pay the due royalties, advertising fees, or any other miscellaneous dues. Nonetheless the franchisee can very well negotiate the use of some rights post expiration for a specific period.

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Renewal Process of the Franchise Agreement

One of the crucial provisions mentioned in the franchise agreement is the clause of renewal which provides the option to either renew the agreement beyond the initial contract (typically 5-15 years) or disband it altogether before its expiration date. If the franchisor has a steady flow of royalties and if the franchisee has a profitable franchise and can maintain their goodwill, then there is no reason to prevent a renewal of the franchise agreement. But that’s not the case always, many a times things go south ways. Indian laws in particular do not mandate a franchisor to be registered with any regulatory body or national franchise association before entering into a franchise agreement. But, the Indian Trademark Act, 1999 does come into play when concerned with registering a mark. The provision of renewal is mentioned in the agreement as a separate clause. Usually, it contains a time period prior to the expiration within which the franchisee must convey his desire to renew the agreement. The renewal process differs from country to country, at some places franchisors offers continuing, unlimited renewals called evergreen agreements while others allow renewal just once. Many a times, the term of the renewed agreement is shortened than the original one, sometimes it remains the same. The 5+5 rule works in many nations, in this the franchise agreement is followed for five years and then renewed for another five years. One thing to note here is that the terms and conditions of the agreement are redefined and a ‘new agreement’ is drawn out.

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Disadvantages of Selling a Franchise

Some significant disadvantages of a franchise for a franchisor are:

• Lack of control over business processes after franchising the business.
• There is always a risk that the franchisee may violate applicable laws and regulations.
• There is no guarantee that the brand would expand and generate a customer base.
• There are significant risks as to infringement of intellectual property and proprietary information.
• Training costs and liability for wrongs committed by the franchisee often pose risks.

People Also Read This: Franchise Terms And Conditions In India

With the advantage of enjoying the franchisor's brand name, there come the checks and balances that the franchisee must deal with regularly. To be assured that the franchise runs smoothly and makes profits; will try to oversee the entire financial system that the franchisee operates. Thus, this might be restrictive of the autonomy of the financial powers of the franchisee. Therefore, the whole notion that the franchisee is his' boss' is not entirely true since we can see that the franchisee does not always enjoy individual control when it comes to implementing creative ideas in the business and have to comply to the strict interpretations of the regulations and standards by the franchisors in the franchise agreement.

frequently asked questions

Advantages:

1. What are the advantages of selling a franchise?

   • Selling a franchise offers a ready-made business model with established brand recognition, which can lead to higher chances of success compared to starting a business from scratch.

2. How does selling a franchise reduce risk?

   • Franchising often comes with built-in support systems, including training, marketing assistance, and ongoing operational support, reducing the risks associated with running a business independently.

3. Can selling a franchise provide access to financing?

   • Yes, selling a franchise may provide easier access to financing from banks and lending institutions because of the proven track record and support systems associated with established franchise brands.

4. Are there economies of scale with selling a franchise?

   • Yes, selling a franchise often allows franchisees to benefit from economies of scale in purchasing supplies, equipment, and marketing materials due to the collective buying power of the franchise network.

5. How does brand recognition benefit franchisees?

   • Selling a franchise grants access to an established brand with existing customer loyalty, which can lead to faster customer acquisition and potentially higher revenues compared to independent businesses.

Disadvantages:

6. What are the disadvantages of selling a franchise?

   • Selling a franchise typically involves paying ongoing royalty fees and adhering to strict operational guidelines set by the franchisor, which can limit flexibility and autonomy.

7. Do franchisees face limitations on creativity and innovation?

   • Yes, franchise agreements often restrict franchisees from implementing their own ideas or making significant changes to the business model, which may hinder innovation and creativity.

8. Can selling a franchise lead to conflicts with the franchisor?

   • Yes, disagreements over issues such as territory rights, marketing strategies, or operational standards can sometimes lead to conflicts between franchisees and franchisors.

9. Are there risks associated with the franchisor's financial stability?

   • Yes, if the franchisor encounters financial difficulties or goes out of business, it could negatively impact franchisees, potentially leading to the loss of support services, brand reputation, or even closure of the franchise unit.

10. How does market saturation affect franchisees?

    • Market saturation can lead to increased competition among franchise units, potentially impacting profitability and growth opportunities for individual franchisees, especially in densely populated areas or in industries with high franchise penetration.