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Jan, 01 2007

Disputes in a franchise, its likely causes

THERE are essentially two types of disputes in relation to a franchise, one between the franchisor and franchisee, and the other between the franchise and a third party.

Franchisor-franchisee disputes
In a franchisor-franchisee relationship which is like a marriage, it is in the interest of each party to have the other's welfare in mind to avoid failure of the business. Therefore, at the negotiation stage it is more pragmatic for parties not to be one-sided or impose onerous terms and conditions which cannot be practically fulfilled by the other side. It is also necessary in relation to international franchises to check that the commercial, financial and other terms imposed are legal and practical in the country or territory where the franchise rights are being granted, otherwise the contract may even become voidable, or void if it is against public policy. It is also advisable to take precautions from the start and franchisors and franchisees to conduct due diligence on each other, particularly in relation to financial matters, background, reputation and any litigation they may be involved in. If parties enter into the contract without checking for themselves then it is difficult to obtain a remedy for misrepresentation under the Contract Act if the facts could have been easily checked by ordinary diligence. The court would then look at the parties as prudent businessmen who ought to have taken the necessary precautions. Remedies are available if one party is proved fraudulent.
Litigation is the worst for any franchise not only in respect of the particular franchisor-franchisee relations but also for the reputation of the entire brand. It gives bad publicity to the brand and discourages other franchisees from considering taking on the franchise. In case there is a dispute, there should be provisions in the agreement for recourse to various means of alternate dispute mechanism especially discussion, mediation, conciliation and at most arbitration.
To avoid disputes, it is always good if there is great interest on the part of the franchisor to act as mentor and provide support for the franchisee's success. On the part of the franchisee it is also important to take keen interest and work hard to make the outlet succeed, understanding that each outlet is an independent business. Further, each franchisee must ensure that the outlet is identical in its appearance and standard of goods or services are at par as compared to others in the franchise network. A system for regular communication between the franchisor and franchisee can stem many disputes.
The most common causes of disputes include:
* Non-payment of dues by franchisee
* Non compliance of franchisee with accounting requirements
* Failure of franchisee to maintain standards required by the franchisor
* Breach of the franchisee of non-compete provisions
* Breach of the territorial restrictions
* Lack of support by the franchisor and disinterest in the franchisee's progress
* Imposition of very onerous financial terms by the franchisor
* Imposition of fresh onerous terms by the franchisor on the franchisee prior to renewal of the franchise
* Restrictive trade practices imposed by the franchisor like price fixing or tie in arrangements etc…

Franchise and Third Parties
A franchise may face disputes with third parties in situations like:
* Infringement of intellectual property rights associated with the franchise by a third party**
* Complaint made by a consumer regarding unsatisfactory quality of product or service provided by the franchise
* Complaint made against the franchise for violation of competition laws
Unlike in the previous case, disputes with third party would usually end up in court or a tribunal and the franchisor and franchisee would have to defend their common cause.
In relation to the protection of trade or service marks, it is best for the franchisor to register his mark at the Trade Mark Registry as the proprietor and register the franchisee as the licensed user. By doing that they will have protection against infringement from third parties and can obtain remedy through court more easily in terms of injunctions, damages and delivery up of labels. Remedies under Trade Marks Act 1999 are available for registered marks and for unregistered marks under passing off action. The burden of proof is higher in cases of unregistered marks and more difficult to obtain injunctions. A franchisor and franchisee also have remedies through criminal law under Sections 78, 79 and 482 of the Indian Penal Code. A magistrate's court can pass an Order directing the Inspector of Police to enquire into violation of a trade mark and carry out searches and seizure of all incriminating materials and submit a report to the court for it to pursue its case.
A consumer can make a complaint against the franchise for its product or service to the Consumer Forum under consumer protection act or product liability laws. The goods may be defective or the service substandard or the price excessive compared to the product given. In India, the franchisor and the franchisee would have to defend themselves against the complainant's allegations under the Consumer Protection Act 1986 (as amended in 1991, 1993, and 2002)
A franchise network may find that a complaint has been made against it for anti-competitive behavior or abuse of dominant position especially if it has grown in size to hundreds of outlets and allegations are made against it under the competition laws. The Competition Act 2002 is not yet fully in force and parts of the Monopolies and Restrictive Practices Act is still in operation.
Section 3 of the new Competition Act defines anti-competitive agreements which are prohibited. It provides that "No enterprise or association of enterprises or person or association of persons shall enter into any agreement in respect of production, supply, distribution, storage, acquisition or control of goods or provision of services, which causes or is likely to cause an appreciable adverse effect on competition within India."
Section 3(3) lists the practices that are deemed anti-competitive. "Any agreement entered into between enterprises or association of enterprises or persons or associations of persons or between any person and enterprise or practice carried on, or decision taken by, any association of enterprises or association of persons, including cartels, engaged in identical or similar trade of goods or provisions of services, which
(a) directly or indirectly determines purchase or sale prices,
(b) limits or controls production, supply, market, technical development, investment or provision of services;
(c) shares the market or source of production or provision of services by way of allocation of geographical area of market or type of goods or services, or number of customers in the market or any other similar way,
(d) directly or indirectly results in bid rigging or collusive bidding, shall be presumed to have an appreciable adverse effect on competition.
Provided nothing contained in this sub-section shall apply to any agreement entered into by way of joint ventures if such agreement increases efficiency in production, supply, distribution, storage, acquisition or control of goods or provision of services."
To conclude, in relation to franchisor- franchisee relationship it is best to have as comprehensive an agreement as possible between the parties and a clear understanding of all the responsibilities and obligations involved to avoid disputes, and these obligations must be practical and enforceable in the territory of operation. All precautions must be taken to ensure that a suitable partner has been chosen and due diligence done. The franchise should also conduct itself in such a manner so as to avoid falling foul of the competition laws.
The author is a barrister & advocate specialising in the field of franchising. She is also a consultant with Field, Fisher, Waterhouse, a U.K. Solicitor's firm specialised in franchising and licensing. Contact:

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