Why Termination Is Where Franchise Arbitration Gets Tested

Introduction : Most franchisors and franchisees never think about dispute resolution terms in their franchise contracts : as long as both sides are satisfied with the ongoing payments of royalties for the use of the franchisor’s trademark and observe all standards, renewals are signed, audits are made, and everything goes smoothly. Nevertheless, when the moment comes that one party wants to terminate the agreement as soon as possible while the other wants to prolong it as long as possible, one has to revisit the arbitration clause which often lays forgotten until the very end. This article aims to provide an insight into disputes that emerge when a franchise contract is terminated or when both sides want to terminate it. Among the issues to be discussed are the grounds for dispute between franchisors and franchisees, the battle for injunctive relief, the obligations that have to be fulfilled even after termination, the types of evidence examined by arbitral tribunals, and what past disputes can say about the issues to be considered when drafting a franchise contract.

How Arbitration Actually Handles These Disputes

Franchise disputes in India are, with a few important exceptions, generally arbitrable. The Supreme Court's four-part test in Vidya Drolia v Durga Trading Corporation ("SC test") requires that a dispute falling outside the purview of Section 2(3) of the Arbitration and Conciliation Act, 1996, be one that: (i) contains some right in rem or binds any third party with erga omnes effect; (ii) involves an inalienable sovereign function; (iii) is specifically prohibited by a statute that creates a different forum exclusively for such disputes; or (iv) (iv) the subject matter of the dispute is expressly or by necessary implication made non-arbitrable by a mandatory statutory framework. Since a dispute between franchisor and franchisee on termination of the franchise agreement is purely contractual, in personam dispute between commercial entities, it does not fall outside the scope of arbitrability as per SC test. Franchise agreements routinely contain arbitration clauses as an integral part of the bargain.

Hence the question of enforceability of such arbitration clauses rarely comes up before tribunals. Procedural regularities play a more important role than many believe. The Supreme Court recently observed ("Section 21 issue") that arbitration proceedings are deemed to have begun only upon actual service of notice referring the dispute to arbitration under Section 21 of the Arbitration and Conciliation Act, 1996 ("Arbitration Act"). It follows that limitation issues as well as those concerning the date from which protection of a party's rights in the interim is to be considered are to be calculated from the date of service of the notice of arbitration, not the date when a party threatened the other or approached the court on the issue of appointment of arbitrator. Counsel failing to consider this nuance on a routine basis routinely lose months of their limitation period.

It is a settled position of Indian arbitration law that the arbitration clause survives termination of the contract that contains it. Even when the franchisor and franchisee in the course of litigation agree that all rights and obligations of the parties, including the arbitration clause itself, have come to an end on termination, the Indian courts, including the National Company Law Tribunal ("NCLT") and the Supreme Court, have repeatedly observed that termination of a contract containing an arbitration clause is itself an arbitrable dispute. This is so since the arbitration agreement is severable from the main contract, but continues to exist independently. Thus, the dispute regarding the interpretation and scope of the arbitration clause continues to be an arbitrable dispute even after termination of the main contract.

The Grounds That Actually Get Litigated

There are a handful of termination dispute fact patterns that dominate the landscape of franchise agreement disputes. This is not unusual, given that franchise agreements typically contain a set of standard termination rights for the franchisor and a set of standard remedies for the franchisee.

The most common ground for termination by the franchisor is the failure by the franchisee to pay royalties and other sums due, which is the easiest type of default to prove provided that the franchisor maintains accounts payable records correctly and pursues its contractual right to cure the default. The breach of brand and franchisor standards, by contrast, is a ground for termination that is often difficult to prove due to its subjective nature; the level of proof required in this category is directly tied to the quality of audit and inspection evidence presented by the franchisor to the tribunal.

Unauthorised transfer of the franchisee business or change of control of the franchisee, in turn, is a breach of the express agreement of the parties. It is more often than not decided on the basis of whether the franchisor acted inconsistently with its duty to perform in good faith when denying consent to the transfer or change of control. Similarly, breach of confidentiality or non-compete clauses during the term of the franchise agreement are increasingly litigated as franchisees move into similar verticals, adopting some but not all of the franchisor's brands, while continuing to retain a presence in their previous verticals.

Indian tribunals, when interpreting Indian laws, routinely adopt a commercial reading of the terms of commercial agreements, including franchise agreements. Thus, even though a franchise agreement may provide absolute termination rights to a franchisor upon notice, a tribunal considering such a dispute will apply an objective test when assessing the legitimacy of termination. The provision granting unconditional termination rights to the franchisor will not save it from damages claims in cases when such a termination right was exercised by the franchisor in bad faith by the franchisor. This may be so when such a termination right was exercised by the franchisor to remedy a technical default, when, in fact, the franchisor had waived its right to terminate or the franchise agreement contained a cure period which the franchisor failed to observe.

Injunction Risk: The Battle Before the Merits

By far, the most litigated dispute in the context of termination of franchise agreements is the dispute over injunctive relief, which typically takes place before the tribunal is constituted.

Indian courts have held that a commercial contract, unless otherwise specified, is a determinable contract that can be terminated by either party with or without notice by one party to the other. As such, a contract of franchise, unless otherwise provided for, is a determinable contract. Therefore, under Sections 14(d) and 41(e) of the Specific Relief Act, 1963, specific performance is not available in respect of determinable contracts, and consequently, Section 9 of the Arbitration Act cannot ordinarily be used to obtain specific performance or relief that would effectively compel continuation of a determinable franchise relationship. However, courts may grant carefully framed interim protection to preserve the subject matter of arbitration, including protection against post-termination misuse of intellectual property or enforcement of an independently framed negative covenant. This is exactly the finding recently reached by a Gujarat High Court bench in respect of application under Section 9 of the Arbitration Act filed by a franchisee seeking to put the franchisor in possession of the franchise premises or alternatively to prevent the franchisor from going into business at those premises.

However, there is a single exception carved out by Section 42 of the Specific Relief Act, which provides that a negative covenant, that is, a stipulation of the contract containing an agreement not to do something, is specifically enforceable. A negative covenant is a term of a contract which prohibits a party from performing certain acts. The term "negative covenant" is to be broadly interpreted to include undertakings not to sue. It has recently been applied by Delhi High Court to prohibit a counterparty from exercising any rights under a contract to assign or sub franchise an exclusive commercial agency agreement in the course of arbitration proceedings. It should be noted that Section 42 makes a negative covenant specifically enforceable even if an obligation to perform a positive act is not specifically enforceable, as is the case with franchise agreements. Consequently, the application for injunctive relief in a dispute over termination of a franchise agreement will succeed only if the application contains sufficient evidence showing that the relief sought is covered by the exception carved out in Section 42 of the Specific Relief Act, 1963.

Post Termination Obligations That Actually Get Enforced

A dispute over termination of a franchise agreement is only the beginning of the dispute; the obligations which survive termination of the franchise agreement are routinely the ones that end up before courts and tribunals in due course. De-branding, that is, the obligation of franchisees to cease to use any trademarks, signs, manuals or other materials provided or approved by the franchisor at the time of opening of the outlet, is one of the most common default claims that arise after termination and are litigated. It is of paramount importance for the franchisor to ensure that this obligation is fulfilled following the termination of franchise agreement which often fails to happen because the staff, landlords, and customers remain unaware of the change.

A particularly prominent example of such a dispute is the public dispute between McDonald's India and its erstwhile North and East India franchisee which ended in protracted litigation in both company law courts and arbitration awards, with the commercial relationship between the parties being terminated only after years of litigation. Although the dispute is of exceptional size, it is illustrative of a much more common scenario of disputes over brand use following termination. It is a fairly common sight to see a dispute in arbitration over termination of a franchise agreement turn into a dispute over continued brand use within a short time after the termination.

While de-branding is a common post termination dispute that arises on termination of a franchise agreement, non compete obligations of franchisees on termination are much more difficult to litigate and enforce. Indian courts have historically scrutinised restraints of trade closely under Section 27 of the Indian Contract Act, particularly in the context of post-termination restrictions, while recognising the need to protect legitimate interests such as confidential information, know-how and proprietary processes. Other obligations that routinely survive termination include rights of franchisor to buy back inventory, return of manuals and customer data, final accounts, and reconciliation of all payments between the parties. It goes without saying that all of these issues, when litigated, greatly prolong the dispute resolution process as well as its cost.

The Evidence That Actually Decides These Cases

Arbitration tribunals sitting on franchise termination disputes routinely face the situation when the dispute between franchisor and franchisee has arisen in circumstances not contemplated by the arbitration agreement, that is, when neither party anticipated the dispute when the agreement was concluded. In such cases, the evidence to which the tribunal turns to in order to determine the dispute is limited. The evidence that routinely carries the most weight with tribunals hearing disputes over termination of franchise agreements is evidence of notices and correspondence concerning curing of defaults sent to the franchisee by the franchisor.

Such evidence is critical to any termination dispute, as the arbitral tribunal will always consider the issue of whether termination of the franchise agreement was justified by determining if either party attempted to cure the alleged default before termination. Audits, inspections, and mystery shopper evidence gathered by the franchisor prior to termination of the franchise agreement, which constitute contemporaneous evidence, carry greater weight with the tribunal than the documents produced by either party after the dispute arose between the franchisor and franchisee.

This is so as a matter of common sense, as termination notices are usually issued for defaults that become apparent to the franchisor at a particular point during the relationship. Financial reconciliation evidence, including point of sale reports and other similar documents, also plays a critical role in proving default as well as calculating damages upon award of compensation for breach. Finally, when a dispute arises in the course of arbitral proceedings regarding continued brand use after termination, evidence gathered contemporaneously with the dispute proves continued use is critical to the decision by the tribunal to grant an urgent injunction to stop such use of the franchisee.

Clause Design Advice for the Next Agreement

The disputes to which they relate are generally foreseeable which means that the clauses giving rise to them are amendable in advance.

• The cure period should be ascertainable by reference to a specific number of days, a particular manner of notice and an exact definition of cure, rather than the vague wording “reasonable opportunity”

• Post-termination restraints should be framed as independent negative covenants, segregated from the positive covenants in the remainder of the agreement so that a court faced with an urgent application for specific performance can grant injunctive relief in aid of arbitration under section 42 without first engaging in a detailed construction of the contract as a whole

• The arbitration clause should be self-contained, devoid of ambiguity as to the seat, the applicable institutional or ad-hoc rules or the language of arbitration, and should explicitly state that it survives termination or expiry of the agreement, thus precluding any argument that the tribunal’s jurisdiction ends with the contract

• Audit and inspection rights and a correlative obligation to preserve records should be included as stand-alone clauses rather than tucked away in the termination chapter because tribunals often find it hard to grant consequential remedies for de-branding without detailed evidence of the infringement and its effects on the business

• A liquidated damage remedy should be explicitly stated as the consequence of non-cure or of continued use of the franchisor’s brands after termination because tribunals may face greater difficulty in quantifying damages for brand depreciation on termination where the parties have not agreed upon a contractual mechanism for assessing such loss

• Consider inserting a specific saving clause permitting either party to apply directly to a court for interim relief despite the arbitration clause: Few courts are likely to grant such an application if the result would be a repudiation of the arbitration agreement.

Conclusion

The disputes in relation to termination of a franchise agreement are decided long before they are submitted to a tribunal because the party which files the better-informed and better-documented Section 9 application in the first week of arbitration can significantly influence the course of the subsequent proceedings. This is because many of the issues to be decided by the tribunal in relation to a franchise termination dispute are framed by the contents of the termination and dispute resolution clauses in the franchising agreement, which are in turn informed by the legal and commercial considerations set out in this article. In-situ counsel should always bear in mind that termination and dispute resolution clauses are the parts of the franchise agreement most likely to be invoked under pressure and should be drafted with that likelihood in mind.

Author: Shraddha Singh in case of any queries please contact/write back to us via email to content@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

References (Endnotes)

1. Arbitration and Conciliation Act, No. 26 of 1996, §§ 9, 21, India Code (1996).

2. Specific Relief Act, No. 47 of 1963, §§ 14(1)(c), 41(e), 42, India Code (1963).

3. Vidya Drolia v. Durga Trading Corp., (2021) 2 S.C.C. 1 (India).

4. Innovative Facility Solutions (P) Ltd. v. Affordable Infrastructure & Housing Projects (P) Ltd., 2024 SCC OnLine Del 7542 (India); Vijaya Minerals Pvt. Ltd. v. Bikash Chandra Deb, AIR 1996 Cal 314 (India).

5. Regenta Hotels Pvt. Ltd. v. Hotel Grand Centre Point, 2026 INSC 32 (India).

6. Raymond Ltd. v. Miltex Apparels, 2025 SCC OnLine Bom 333 (India).

7. Arvind Constructions Co. (P) Ltd. v. Kalinga Mining Corp., (2007) 6 S.C.C. 798 (India); Gujarat HC Section 9 franchise ruling (2022) (full citation unconfirmed).

8. Connaught Plaza Restaurants Pvt. Ltd. v. McDonald's India Pvt. Ltd. (no single reported citation; factual illustration only).