1.

LICENSING

i). Introduction

Licensing is a term that has various meanings, it varies with the field of topic it is used in. For
instance, in political science the term denotes absolute freedom i.e. rights without any
restriction. Similarly it can also denote delegated power, to a person to exercise such power
unrestrictedly in polity and other fields. So the general idea that we may perceive of the term
licensing is that it is the freedom or power to exercise certain set of rights without any kind of
restriction.

Definition

In defining the term licensing in respect of international trade and finance we need to
understand this from the viewpoint of different international experts.

A licensing agreement is an agreement wherein the licensor gives something of value to the
licensee in exchange for certain performance and payments. Usually what is transferred from one
party to the other is some form of industrial or commercial expertise, such as:

A patent covering a product or process

The right to the use of a trademark or brand name

Copyright

Manufacturing know-how on products or processes (that is not the subject of a patent)

Technical advice and assistance including (occasionally) the supply of components,

materials, etc. which may be required in the manufacturing process

Marketing advice and assistance

Payment for the expertise involved can take any or a combination of the following forms:

An initial payment, payable as soon as the licensing agreement is signed, either for knowhow or for the initial transfer of machinery, components or designs

An annual minimum payment

An annual percentage fee based either on sales or on profits

A mutual exchange of knowledge and/or patents, i.e. cross-licensing.1

The essence of licensing (which is also the basis of franchising) is the owner retaining
ownership of its IP while granting others the right to use it. The terms can vary considerably.
Having said that, some licensing can look a lot like franchising. For example, in the 1850s the
inventor of the sewing machine, Isaac Singer, sold licences to entrepreneurs to sell his machines
in different parts of the USA. He also offered training in the use of the machines. In this case, the
IP licensed was a patent, brand name and know how. Strictly, this was licensing, but it is so
similar to what we think of franchising today that some people even consider Singer the father of
franchising.
A clearer case of licensing is a car wash that has developed a successful process for getting its
customers to opt for hot wax and other optional extras. It might license that process to other car
wash businesses in return for royalties. These might be payments each month to use its way of
promoting the wax, so that more customers buy it. In this example, the IP being licensed is
know how.
Another example of licensing is a software licence, such as for Microsoft Office. The software is
licensed to you you do not own anything more than the right to use it. The software is licensed
subject to strict terms and conditions.2
Examples
Some examples of licensing are:

Pharmaceutical firms engage in cross-licensing practices in which they exchange

scientific knowledge about producing products and distribution rights.

Service firms in retailing, fast food, car rentals, television programming, and animation
rely on licensing and franchising agreements.

7-Eleven is the world's largest chain of convenience stores, with about 26,000 stores in 18
countries. While the parent firm in Japan owns most of the stores, several thousand in
Canada, Mexico, and the U.S. operate via licensing or franchising agreements.3

1See http://www.exporthelp.co.za/modules/8_export_plan/distribution/licensing_franchising.html.
2See http://azrights.com/media/news-and-media/blog/business-2/2014/12/licensing-and-franchisingwhat-is-the-difference-and-does-it-matter.
3See Dana, Licensing and Franchising.

Examples of licenses include a company using the design of a popular character, e.g. Mickey
Mouse, on their products. Another example would be a clothing manufacturer like Life is
Good licensing its designs and brand in a certain country to a local company. It can also apply to
the use of software, e.g. a company using Microsoft Office on itscomputers.4

ii). Advantages of licensing

There are numerous advantages in entering into a licensing agreement with a foreign national:

Licensing requires very little capital outlay (making it an accessible channel even to
small companies) and it should provide a high rate of return on the capital invested

It provides access to markets which might otherwise be closed because of high rates of
duty, import quotas or other restrictions, or because of excessive transportation costs

Should the licensing arrangement prove to be a failure, it will not result in heavy financial
losses

The exporter does not face the risk of having assets nationalised or expropriated

The exporter gains access to the licensee's local marketing and distribution organisations,
and existing clientele, thus avoiding many of the problems associated with setting up a
wholly- owned manufacturing subsidiary

Many governments favour licensing over direct foreign investment because licensing
brings technology into the country without the disadvantages associated with direct
investment

Because of the limited capital requirements, licensing enables new products to be sold
worldwide before competition develops5

iii). Disadvantages of licensing

Licensing, however, does have some disadvantages:

During the period that the licensing agreement is in force, the firm may transfer sufficient
expertise to the licensee to enable the latter to set himself up as a competitor, not only in
the original market but perhaps also in neighbouring markets or even in the domestic
market

Licensing provides limited returns on the investment of managerial and engineering time
- royalties and fees normally constitute less than seven per cent of turnover

4See http://www.diffen.com/difference/Franchising_vs_Licensing.
5See http://www.exporthelp.co.za/modules/8_export_plan/distribution/licensing_franchising.html

Governments can impose restrictions either on the remittance of royalties or on the

supply of components

It is often difficult to control the quality of the product which, in most cases, is sold under
the licensor's brand name

Although the contract should specify the responsibilities of each party, misunderstandings
and conflicts can arise during the implementation stage. Areas of conflict might include;
the marketing efforts of the licensee, the interpretation of exclusivity and the extent of the
licensee's territorial coverage6

2. FRANCHISING

Franchising is associated with the term franchise which has become a common term after the
advent of globalisation. Franchise in lay-man language is a multinational corporation (in most of
the cases) that sets up its branch in foreign countries to extend its presence abroad, as well as it
can do so in host country. Pepsi-co, Coca Cola, Microsoft, Google, Apple, Samsung, General
Motors Corporation, FC Barcelona etc.

i). Introduction7
The concept of franchising has been existent for several centuries now. Franchising has its
antecedents in feudalism and in licenses granted by kings in the middle ages.8 The guild system
that was introduced in the London in the twelfth century is one example.9 While franchising as a
concept, has still not developed into an industry in India, it is a growing phenomenon of business

6Ibid.
7Legal issues in Franchising- An Indian Perspective, Aashith Shah and Vaibhav Parikh.
8

W. Blackstaone, Commentaries on the laws of England 37-38 (1766) as quoted in Robert W.

Emerson, Franchising and the Collective Rights of Franchisees (1990) 43 Vand. L. Rev. 1503 at
p. 1507.See Martin Mendleson, The Guide to Franchising 1993 (5th. Edn,) at p. 19.

organisation and sales or services distribution10 world over, especially in the United States11 and
United Kingdom.12
The origins of franchising can be traced back to the middle ages, but it is generally recognised
that the early 20th century saw the first real Business Format Franchise. This was developed by
the Singer Sewing Machine Company in the United States, which set up a service and
maintenance system for its machines. General Motors was also involved in franchising later in
the 20th century, laying the foundations for a franchised motor dealership network, a system
which still predominates motor vehicle retailing to this day.
One of the most successful early franchises was the soft drinks bottling industry, where CocaCola, Pepsi and 7-Up initiated the use of franchising as an economic method of expansion for the
sales and distribution of their brands. As the idea of franchising gathered further converts in the
United States, so the number of franchisors grew: oil companies franchised their petrol filling
stations and wholesalers franchised their retail grocery stores.13
Franchising is a way to scale a business once it is successful and proven. It involves finding
franchisees with the skills necessary to operate branches of the same business. McDonalds is
one of the best known examples of a business that has grown through franchising. (By contrast,
Starbucks has grown by opening its own branches).
You can franchise almost any type of business. Under a franchise, the owner (franchisor) retains
control of the brand and licenses (that is, grants permissions to) the franchisee to use its
successful business model and brand. In exchange, the franchisee puts up the initial capital for
the business, helps to promote the brand and pays a licence fee. The franchisor supports its
franchisees by providing training, know how, marketing and other resources and skills.
Licensing of intellectual property (IP) is at the heart of a franchise contract. So, in fact, a
franchise includes licensing. Typically, this will cover know how and other confidential
information, trademarks, logos and designs, and copyright materials. For some businesses there
may be patents, too.
10Robert W. Emerson, Franchising and the Collective Rights of Franchisees (1990) 43 Vand. L. Rev.
1503 at p. 1506.
11David Gurnick, Case History of the American Business Franchise (1999) 24 Okla. City U.L. Rev.
37.
12 Franchising accounts for approximately one third of UK retail sales in applicable sectors. North

Americanorigin franchise systems operate in the UK, with more than 4,200 franchised units
employing 35,000 staff, generating a turnover of $1.6 billion. See
http://www.fdsfranchise.com/how-franchising-works.htm.

13

An essential element of a franchise (and one of the features that distinguishes it from a straight
licence) relates to the formalities involved in setting up a franchise, and the degree of control the
franchisor retains.
A franchise agreement will usually give the franchisor the ability to control how the business is
run. For example, if a customer visits a branch of McDonalds while on a trip abroad, expecting
the familiar service they are used to at home, it is important that they should not be disappointed.
Any unpleasant surprises due to changes in the business format could damage McDonalds brand
generally, not just that particular outlet. For that reason, McDonalds franchise agreement
contains strict quality control provisions.14

ii). Definition

a). Meaning15
The Indian law does not define franchising. However, simplistically put, franchising is a form
of businessorganization in which a firm which already has a successful product or service (the
franchisor) enters into a continuing contractual relationship with other businesses (franchisees)
operating under the franchisor's trade name and usually with the franchisor's guidance, in
exchange for a fee.The Blacks Law Dictionary defines a franchise as a license from the owner of
a trademark or trade name permitting another to sell a product or service under that name or
mark.16
In a normal franchise agreement, there are at least two parties involved:

the franchisor, who lends his trademark or trade name (or other intellectual property
rights) and the business system; and
the franchisee, who pays a royalty and often an initial fee for the right to do business
under the franchisors name and business system.17

b). Characteristic Features18

14See http://azrights.com/media/news-and-media/blog/business-2/2014/12/licensing-and-franchisingwhat-is-the-difference-and-does-it-matter.
15Legal issues in Franchising- An Indian Perspective, Aashith Shah and Vaibhav Parikh.
16Blacks Law Dictionary, (6th Ed.) Centennial Edition (1891-1991) at p. 658.
17See http://www.franchise.org/resourcectr/faq/q1.asp.
18Legal issues in Franchising- An Indian Perspective, Aashith Shah and Vaibhav Parikh.

By drawing from the definitions ascribed to franchising by the British Franchise

Association,19the International Franchising Association20 and the Federal Trade Commission of
the United States21, the following characteristic traits of franchising emerge:22

A franchise arrangement is based upon a contractual relationship.

The franchisor should have developed a business system or format, which is identified
with a brand name.
The franchisee makes a substantial initial capital investment and normally owns the
business operation.
The franchisor normally trains the franchisee to ensure that it is equipped to effectively
comply with the business system.
Once the franchisees business commences, the franchisor continually supports the
franchisee in certain aspects of the business operation.
The franchisor also regularly supervises the franchisees business operations in order to
protect the franchisors goodwill and brand name.
Some form of consideration is paid by the franchisee to the franchisor for the rights
licensed and the services rendered.

There are two parties involved in franchising, they are Franchisor and Franchisee. Franchisor
provides vital assets, has economies of scale, a wealth of intellectual property, and know-how
about its own industry. Franchisee performs local functions in foreign markets, such as
marketing and distribution that the franchisor usually cannot perform. He has entrepreneurial
drive, deep knowledge about the local market and how to run a business there.23

iii). Types of Franchising

Franchising arrangements are broadly classified into three types:

19See http://www.british-franchise.org/whatis.html.
20See http://www.franchise.org/resourcectr/faq/faq.asp.
21See http://www.prenhall.com/divisions/bp/app/berman3/cw/retail_resources/FTCfranrule.html.
22See Martin Mendleson, The Guide to Franchising 1993 (5th. Edn,) at p. 11.
23See Dana, Licensing and Franchising.

a). Product Franchising:

This is the earliest type of franchising. Under this, dealers were given the right to distribute
goods for a manufacturer. For this right, the dealer pays a fee for the right to sell the trademarked
goods of the producer. Product franchising was used, perhaps for the first time, by the Singer
Corporation during the 1800s to distribute its sewing machines. This practice subsequently
became popular in the petroleum and automobile industries also.
b). Manufacturing Franchising:
Under this arrangement, the franchisor (manufacturer) gives the dealer (bottler) the exclusive
right to produce and distribute the product in a particular area. This type of franchising is
commonly used in the soft-drink industry.
c). Business-format Franchising:
This is recent type of franchising and is the most popular one at present. This is the type that
most people today mean when they use the term franchising. In the United States, this form
accounts for nearly three-fourth of all franchised outlets. Business-format franchising is an
arrangement under which the franchisor offers a wide range of services to the franchisee,
including marketing, advertising, strategic planning, training, production of operations manuals
and standards and quality control guidance.24
Some authors have classified franchising into yet other three types as follows:
a). Trade-name Franchising:
When franchisee purchases the right to use the franchisors trade name without actually
distributing the specific trade mark products exclusively using the name of the franchisor, this is
called trade-name franchising.
24See http://www.yourarticlelibrary.com/business/franchising-types-advantages-and-disadvantages.

b). Product Distribution Franchising:

Such franchising involves a system in which a franchisor gives license to the franchisee to sell
the specific products under the trademark and brand name of the franchisor. This type of
franchising is commonly used to market automobiles (such as Chevrolet), soft-drinks (such as
Coca-Cola) and appliances. It is worth mentioning that these two types of franchising give
franchisees some sort of franchisors identity.
c). Pure Franchising:
When franchisor sells the complete business format and system of his/her product to the
franchisee, it is called pure franchising. In other words, this type of franchising provides the
franchisee with a complete business format including license for a trade name, the product or
service to be marketed, the physical plant, methods of operation, a marketing strategy plan, a
quality control process, and so on. Such type of franchising is common among fast-food
restaurants (such as McDonalds) hotels, educational institutions (such as Delhi Public School,
(DPS), and many others.
Franchising is an old concept in use for long time in the business world. Some trace out the
history of franchising dating back to the mid-nineteenth century when Isaac Singer decided to
improve the distribution of his sewing machines, i.e., Singer. Nowadays, franchising has
become a common business format especially in the businesses with a good track record of
profitability and businesses which are easily duplicated.25

25See http://www.yourarticlelibrary.com/business/franchising-types-advantages-and-disadvantages.

iv). Advantages of Franchising26

Franchising arrangement is a symbiotic one for the franchisor and the franchisee, nonetheless
franchising is particularly beneficial for the franchisee.
Following are, for example, the distinct advantages that franchising provides to the franchisee:
(i) Franchising makes the task of getting started easier because the franchisee gets a business
format- already market tested and found to work. Hence, buying a franchise is so far safer than
trying to start a business.
(ii) It reduces chances for failure. Here, what is significant to mention is that fewer than 10 per
cent of all franchise fail. In dramatic contrast with this is the fact that two out of every five
entrepreneurs who start on their own fail within three years, and eight out of every ten fail within
ten years.
(iii) A well-established franchise brings with it the very important advantage of recognition.
Many new businesses experience lean months, or years, after start-up. Obviously, the longer the
period the business must experience it, the greater the chances of failure. With the well-tested
franchise, this period of agony may reduce to only weeks, or perhaps just days.
(iv) Franchising may increase the franchisees purchasing power also. Because, being part of a
large and that too proprietor organization means paying less for a variety of things such as
supplies equipment, inventory, services, insurance, and so on. It also can mean getting better
service from suppliers because of the importance of the organisation (franchisor) of you
(franchisee) is part.
(v) One gets the benefit of the franchisors research and development in improving the product.
26Ibid.

(vi) The franchisee has the protected or privileged rights to franchise within a given area.
(vii) As compared with other forms of new business, the prospects of obtaining loan facilities
from the banks and financial institutions in case of franchising are also improved.

v). Disadvantages of Franchising27

In-spite of above benefits, franchising is not an unmixed blessing. There are some
disadvantages as well associated with a franchise arrangement.
The main ones are listed as follows:
(i) Unlike entrepreneurs who start their own business, the franchisees find no room or scope for
enjoying their creativity especially in case of pure franchising. They have to work as per the
business-format given by the franchisor. One classic example of regimentation in franchising can
be found in the McDonalds restaurant business-format.
A McDonalds franchise is given very little operational latitude; indeed, the operations manual
attends to such minor details as when to boil the bearings on the potato slicer. The purpose of
these restrictions is not to frustrate the franchisees, but to ensure that each outlet is rim in a
uniform, correct manner.
(ii) A number of restrictions are also imposed upon the franchisees. Restrictions may relate to
remain confined to product line or a particular geographical location only.
(iii) Franchisees usually do not have the right to sell their businesses to the highest bidder or to
leave it to a member of their family without approval from the franchisor.

27Ibid.

(iv) Though the franchisee can build up goodwill for his or her business by his or her efforts,
goodwill still remains the property of the franchisor.
(v) The franchisee may become subject to fail with the failure of the franchisor.
(vi) Another disadvantage franchisees face is that franchisors generally reserve the option to buy
back an outlet upon termination of the contract. Many franchisees become vulnerable to this
option. As such, they operate under the constant fear of, non-renewal of the franchise
arrangement.

vi). Legal Issues in Franchising28

Fundamentally, every franchising relationship is a contractual relationship and therefore, the

Indian Contract Act, 1872 (Contract Act) would be applicable to all franchising arrangements.
Under the Contract Act, a contract is an agreement enforceable by law.29 The following
elements are required to constitute a contract:
(a) an agreement, i.e. an offer and an acceptance of the offer;30
(b) lawful consideration for the agreement;31
(c) lawful object and purpose of the agreement;32
(d) free consent of the parties to the agreement;33 and
(e) capacity of the parties to enter into an agreement.34
28Legal issues in Franchising- An Indian Perspective, Aashith Shah and Vaibhav Parikh.
29Section 2(h) of the Indian Contract Act, 1872 (Contract Act).
30Section 2(a) and 2(b), Contract Act.
31Section 23, 24 and 25, Contract Act.
32Section 23 and 24, Contract Act.
33Section 14, Contract Act.
34Section 11, Contract Act.

Every franchising agreement would have to necessarily meet the above five criteria in order to be
legally enforceable. For example, if the franchising agreement is entered into for distributing
arms and weapons in India, the same may not be for a lawful object and hence invalid.
While the Contract Act does not stipulate that a contract has to be in writing, it is advisable to
have a formal and written franchising agreement to precisely lay down the rights and obligations
of the franchisor and the franchisee. This would assist in resolving any future deadlocks and
disputes.
Another issue that could arise is of competing with the franchisors business during the term of
the franchising relationship. In the landmark case of Gujarat Bottling Co. Ltd. and others v. Coca
Cola Co. and others,35 the Coca Cola Co. had imposed a restriction on Gujarat Bottling Co. Ltd
from entering into an agreement with any other beverage manufacturing company during the
term of their contract.
When the case came up before the Supreme Court as being in restraint of trade,36 the Court held
the following:
There is a growing trend to regulate distribution of goods and services through franchise
agreements providing for grant of franchise by the franchiser 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 franchiser and it cannot be
regarded as in restraint of trade.
The Court therefore held that a negative agreement restraining the franchisee from
manufacturing, bottling, selling, dealing or otherwise being concerned with the products or
beverages of any other brands or trade marks/trade names during the subsistence of a franchise
agreement including the period of the period of one years' notice, is not violative of Section 27 of
the Contract Act.
However, the Court did not address the issue of a negative covenant post-termination of the
agreement. This is an issue that the parties must bear in mind while formulating the contract.

35(1995) 5 SCC 545.

36Section 27, Contract Act: Agreement in restraint of trade, void

Every agreement by which

anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that
extent void.
Exception 1: Saving of agreement not to carry on business of which good will is sold - One who
sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar
business, within specified local limits, so long as the buyer, or any person deriving title to the
goodwill from him, carries on a like business therein, provided that such limits appear to the court
reasonable, regard being had to the nature of the business.

In a 2008 case, Otto Dental Supply, Inc. v. Kerr Corp.,37 another disguised franchise vs. a license
was at issue. The company claimed it sold just a license, not a franchise and the franchise laws
simply didn't apply. It made a motion for summary judgment to have the case thrown out of
court.
The federal Eastern District Court ruled against the company and ordered the case forward. It
said whether or not the license was really a franchise was up to a jury to decide. Jurors are like
most of us, and apply common sense to the simple defining elements of a franchise. They are not
swayed by semantic arguments like "licensing arises under contract law, not franchise law and
therefore franchise law doesn't apply." Another very expensive franchise vs. license learning
lesson.
Enforcement actions by regulatory agencies can also be very expensive learning lessons. In
Current Technology Concepts Inc. v. Irie Enterprises Inc., the Minnesota Supreme Court
concluded a licensing arrangement was a franchise and held the franchise company liable for
damages in the amount of $1.3 million for violating the Minnesota Franchise Law. Hearing "after
the fact" that the arrangement was an accidental, illegal franchise and you're liable for $1.3
million was the last thing that company ever wanted to hear.

3. BASIC DIFFERENCES BETWEEN FRANCHISING AND LICENSING 38-

Franchising

Governed by

Securities lawContract law

RegistrationRequiredNot required

Territorial RightsOffered to franchiseeNot offered;

Support and trainingProvided by franchisorNot provided

372008 WL 410630.
38See http://www.diffen.com/difference/Franchising_vs_Licensing.

Licensing

Royalty paymentsYes

No

Use of trademark/logoLogo and trademark retained byCan be licensed

franchisorand used by franchisee

ExamplesMc Donalds, Subway, 7-11, Dunkin

Microsoft Office

Donuts

ControlFranchisor exercise control over franchisee

have control over
licensee

4. CONCLUSION

Licensor does not