India recently staged the largest free democratic election in world history, bringing to power the National Democratic Alliance, led by the Bharatiya Janata Par ty, and with it a fresh sense of optimism about India’s economic future. The new (and strongly pro-business) prime minister, Narendra Modi, campaigned to revive India’s economy, create millions of new jobs, tame persistently high inflation, improve trade ties between India and the United States and, over time, lift restrictions on US expor ts in a broad range of industries. India is home to many globally recognized companies – including in the pharmaceuticals, steel, information technology and space technology industries – and has become an impor tant voice on the international stage.1 And, as a result of India’s diverse, skilled and low-cost workforce, its notable economic growth2 effor ts to invest in infrastructure3 and legal and economic reforms to ease foreign direct investment (FDI) in single brand and multi-brand retail, there has been an increase in the number of crossborder transactions in which foreign franchisors have sought to establish their brands in India. It should be no surprise to foreign franchisors that franchising in India is expected to continue growing at a rapid pace. But, despite public optimism stemming from the election results, there remain a number of legal, political, business and cultural barriers that foreign franchisors must consider before investing in India. In this ar ticle, we discuss the business climate in India, India’s current market for franchising, and some of the applicable laws that govern the relationships between an international franchisor and an India franchisee. We also take a quick look at other concerns that international franchisors may face when trying to establish their brands in India.
INDIA’S GROWTH STORY India is the four th largest and one of the fastest growing economies in the world. Some notable numbers: ■■ With 1.2 billion people as of 2014, India is the second most populous country in the world. As of July 2014, India’s population is estimated to be approximately 1.24 billion (second only to China).4 ■■ In 2013-2014, the GDP real growth rate was estimated to be 4.7 percent, and it is projected to rise to over 6 percent in 2014-2015, 6.6 percent in 2015-2016 and 7.1 percent in 2016-2017.5 ■■ By 2015, the India economy is expected to be worth US$2.4 trillion (INR 129 trillion) and, in addition to the recent government reforms (including the raised FDI ceilings for the retail, airline, telecoms, financial and defense sectors), there is expected to be fur ther growth that could potentially make India the world’s fifth-fastest growing economy by 2015.6 This impressive rate of growth will inevitably lead to increased oppor tunities for foreign investors aiming to tap into the India domestic market. FRANCHISING IS BECOMING INCREASINGLY POPULAR IN INDIA The franchise business in India is becoming increasingly popular among domestic and international players across many sectors. Consequently, some of the major industries credit successful franchising in India for their rapid economic growth internationally. According to KPMG India, the key industries with the highest prospects of successfully franchising in India are: (i) retail; (ii) food and beverages; (iii) health, beauty and wellness; (iv) consumer services; and (v) education and training.7 As a business model, franchising is becoming especially widespread in India’s metropolitan areas. It has gained a firm foothold since the government star ted loosening financial regulations in the early 1990s to encourage a free-market economy. Notably, in 2009, the India government lifted the restriction on foreign franchisors’ ability to charge royalty rates above cer tain levels (stated another way, royalty rates considered by foreign franchisors to be “market”) without needing specific governmental approval.8 Now, foreign franchisors may charge a lump-sum fee and royalty for the transfer of technology and use of a trademark or brand without any maximum limit through the automatic route. Today India is home to more than 3,000 brands which adopt the franchising model: ■■ Bata, one of the leading footwear companies, was among the first franchisors in India - other pioneers of franchising in India were NIIT, Apollo Hospitals and Titan Watches. ■■ According to published repor ts, global franchise companies in India include Arby’s International, Armani Junior, Auntie Anne’s, Barista Lavazza, Baskin Robbins, Booster Juice, California Pizza Kitchen, ChemDry, Chile’s, Cinnabon, The Coffee Bean, Domino’s, Dunkin Donuts, Hard Rock Café, Johnny Rockets, KFC, Krispy Kreme Donuts, McDonald’s, Pinkberry, Pollo Tropical, Pizza Hut, Quiznos, Sbarro, ServiceMaster Clean, Spring Air, Starbucks, Subway, TGI Friday’s, Wimpy’s, Yogen Fruz, YogurBerry and Yum Brands. ■■ According to published repor ts, other brands may also enter the India market at some point in the near future, as among them Applebee’s, Armani Junior, BannaStrow’s Crepes and Coffee, BG Cleaning Systems, Carl’s Jr., Carvel Ice Cream, Denny’s, Di Bella Coffee, Lipsy, Luxeyard, Mad Over Donuts, Marc Cain, Moe’s Southwest Grill, Muffin Break, Panaria, Rober to Cavalli, Schlotzsky’s Deli, Spring Air, Triangle, Wendy’s, Winkwor th, Willy Winkies, and Yoforia. KPMG India estimates that by 2017 the franchising industry in India will have quadrupled over its 2012 levels and by that date will contribute to almost 4 percent of India’s GDP (growing from a current estimated contribution of 1.4 percent of GDP).9 In 2014, the Franchising Association of India estimated that the market potential of India’s franchise industry would be wor th US$50.4 billion by 2017 (with retail being wor th US$10.6 billion and food and beverages wor th US$1.2 billion).10 In turn, this growth is expected to create job oppor tunities, including both direct and indirect, for an additional 11 million people by 2017.11 The individual growth and potential of these industries are driving the growth of the overall franchise sector within India.
INDIA ADDRESSES FRANCHISING VIA A NUMBER OF KEY LAWS India has no franchise law – there is no requirement to register franchise offerings or to provide franchise disclosure documents, and no specific laws restricting franchise terminations, transfers or other aspects of franchise relationships. Despite this, there are a number of laws that may be implicated by cross-border franchising into India (including laws addressing competition, exchange control regulations, consumer protection, intellectual proper ty, labor, permanent establishment, proper ty and taxation). Below are some of the key laws that may impact a franchising operation in India:12 1. The Indian Contract Act, 1982. Depending on the choice of law (or other) provision in the franchise agreement, this act may govern the agreement between the foreign franchisor and Indian franchisee. It provides the requirements for all aspects of the franchise agreement (e.g., offer, acceptance, consideration, validity, breach and termination). 2. The Trademarks Act, 1999; The Designs Act, 2000; The Patents Act, 1970, The Copyright Act, 1957. These laws govern trademarks, patents, registered designs and technical assistance required for franchising agreements. As a trademark license typically is the cornerstone of a franchise relationship, it is impor tant to note that – in India, the above statutes provide for protection of trademarks through registration, the ability to bring infringement actions against third par ties to seek injunctions, damages and an accounting of profits. Criminal sanctions are also available, at least in theory. 3. The Competition Act, 2002. The Competition Act prohibits arrangements related to production, supply, distribution, storage, acquisition or control of goods or provision of services that cause or are likely to cause an “appreciable adverse effect” on competition within India. Under the Competition Act, tie-in arrangements, exclusive supply and distribution agreements and resale price maintenance would be regarded as being anticompetitive if such agreements cause an appreciable adverse effect on competition in India. 4. The Foreign Exchange Management Act, 1999. This act, along with its rules and regulations, governs payments in foreign currency. A cross-border franchise arrangement would normally involve such payments (e.g., franchise fees, royalties for use of trademarks and system, training expenses, adver tisement contributions, etc.) which can be remitted to the foreign franchisor without any approvals. As discussed above, the India government has lifted a number of the prior restrictions on foreign franchisors’ ability to charge cer tain fees without needing governmental approval. Guarantees in favor of a foreign franchisor may also require approval of the Reserve Bank of India. 5. Income Tax Act, 1961. This act governs the tax aspects of any franchising arrangement in India and generally provides that a foreign franchisor’s income in the form of royalties or franchise fees would be treated and taxed as business income subject to a tax deduction at the applicable rates. Of course, this would be subject to any tax treaty between India and the relevant country (including withholding tax provisions related to the franchisee’s royalty payments to the foreign franchisor). 6. The Consumer Protection Act, 1986. This set of laws provides remedies to consumers in the event of product defects and service deficiencies. Under these laws, because goods and services may be provided by a franchisee, it is possible that consumers could file an action against both the franchisor and the franchisee. In fact, these laws can encourage India consumers to file complaints for any defects and deficiencies in the goods or services supplied by either the franchisee or franchisor – which, may result in consumers having claims against franchisors and franchisees. The par ty that has more control over the business is used to determine which par ty would be appropriate par ty to bring a suit against. 7. The Arbitration and Conciliation Act, 1996. This act governs the India law of arbitration (and as a result of case law, the evolving landscape of the enforceability of arbitration awards in which the seat of arbitration is outside of India). Par t I of the act addresses domestic arbitration and awards and Par t II of the act addresses international arbitration and awards. Following the India supreme cour t’s decision in Bharat Aluminium Co vs. Kaiser Aluminium Technical Service Inc. decision (BALCO), Par t I of the act does not apply to foreign seated arbitrations, thereby dissuading par ties from approaching India cour ts for interim relief. While arbitration in India continues to evolve, for the time being it does seem clear (as a result of BALCO) that India cour ts cannot set aside arbitral awards made, or otherwise intervene in arbitrations seated, outside India (and therefore, the India cour ts will give effect to par ty autonomy and choice of an arbitration seat).
KEEP TRACK OF INDIA’S FDI POLICY In addition to the laws mentioned above, it is impor tant to note that any proposed investment in India would be subject to the FDI Policy, which is released semi-annually by the Depar tment for Industrial Policy and Promotion (which, among other things, determines the permissible levels for foreign investment in India and in which sectors investment is permitted). In previous years, India’s FDI Policy prohibited foreign investment in multi-brand retailing and allowed only up to 51 percent FDI in single-brand retailing. Over the past couple of years, however, the India government has passed FDI Policy reforms designed to encourage foreign investment. Now, the FDI policy allows for up to 100 percent FDI in single-brand retail13 and up to 51 percent FDI in multi-brand retail.14 Fur ther, the government has taken steps to remove barriers to FDI in a range of sectors, including (a) 100 percent FDI in aviation, telecoms, asset reconstruction companies and courier services; (b) 74 percent FDI in credit information companies; and (c) 49 percent FDI in power exchanges, stock and commodity exchanges and depositories.15 These FDI reforms are notable for franchising because, as a result of liberalizing foreign investment in India (across various sectors), international franchise brands will have greater flexibility in adopting business models that would allow for expansion to India. BEFORE ENTERING THE INDIAN MARKET, ADDRESS ANY ISSUES OF CONCERN Despite the storied growth and positive growth numbers mentioned above, franchisors should take special care to understand all regulatory, legal, political and business ramifications of entering the India market, including: ■■ Since 2012, India has experienced a notable slowdown in economic growth. While there are reasons to be optimistic (e.g., the recent election results and new economic policies), there is no way to predict future economic growth. Prime Minister Modi faces several constraints – namely, that the BJP only controls the lower house of parliament (the Lok Sabha), but lacks a majority in the upper house (the Rajya Sabha). The absence of a majority in the Rajya Sabha poses a threat to the BJP’s legislative agenda. Additionally, India is increasingly governed through its states rather than by the central government in New Delhi. ■■ India’s legal system is incredibly slow and there are staggering delays associated with India court proceedings – thus, the path to a non-appealable final resolution may be prohibitively long.16 Among the 185 economies covered by the World Bank’s 2013 Doing Business survey, India ranks as #184 in terms of countries in which it is easiest to enforce a contract.17 Fur ther, cour ts at the lower level may not have the experience to handle complex commercial matters for which foreign franchisors may seek resolution, and such proceedings are not confidential. Also, India’s legal system is filled with archaic laws no longer applicable to today’s marketplace (as India does not employ sunset clauses that require the expiration of cer tain laws after a fixed period of time). ■■ While FDI restrictions have been relieved in various sectors, India still needs to address its great infrastructure shortfalls (such as shor tages of utilities, poor roads and bridges), pervasive state control in business activities (for instance, the number of permits and licenses that may be required to do business can be overwhelming and overly burdensome for a foreign franchisor), and unequal access to quality education (areas beyond metropolitan places must continue to develop to sustain growth and a qualified workforce). ■■ Excessive government bureaucracy and corruption persist at various levels and have proved to be difficult to curb. ■■ While the India government continues to reform the FDI Policy, more progress is sought from the business community. ■■ India has a diverse consumer base and workforce. But because it is not really “one” market, there are often cultural, linguistic and socio-economic issues that may make it difficult to establish a uniform business model suitable for the entire country.
MAKE SURE TO THOROUGHLY EVALUATE THE FRANCHISING OPPORTUNITY IN INDIA Despite the concerns noted above, franchising in India should experience a bright future under the new, pro-business government. Over the years, India has become an attractive destination for business investments due to the rapid growth of consumerism, globalization and liberalization. India enjoys a positive economy, large consumer market and loosening government restrictions. The window of oppor tunity in India is open. But foreign franchisors should make sure to conduct a thorough investigation and evaluation of business oppor tunities (taking into account the many legal, political, business and cultural barriers that may exist) before committing long-term to franchising in India. Fur ther, and in addition to working with domestic counsel, consultation with India counsel may be invaluable. To find appropriate counsel in India, please contact the authors, who will help to guide you.