Overview (June 2012) - International Law Office

Introduction
No pre-franchise disclosure requirements
Minimum content of franchise agreement
Registration
Franchisor liability
Restrictions on termination rights
First refusal rights
Policing trademarks
Resale price maintenance, non-compete provisions and refusal to deal
No registration deadlines
Exclusive licence not equivalent to exclusive use
Choice of law

Introduction

Since 2008 Russian franchise law has been based on the same standard franchise concept used in most other countries: a franchisor licenses a set of rights to a franchisee, including the right to conduct business under the franchisor's trademark or service mark. The franchise agreement is often territorially exclusive and covers other IP rights, such as trade secrets. Nonetheless, Russian franchise law differs from that of other countries in several significant respects. Notwithstanding these differences, a potential franchisor should not be deterred by the unique provisions on franchising, as the number of successful franchises operating in Russia has been increasing rapidly in recent years.

No pre-franchise disclosure requirements

Unlike some other countries, Russia has no disclosure requirements for a franchisor in respect of potential franchisees, and has no equivalent to the US franchise disclosure document.

Minimum content of franchise agreement

Although the parties to a franchise agreement that will be effective in Russia are generally free to enter into whatever contractual arrangements they wish, a few statutory requirements apply. All franchise agreements - termed 'commercial concessions' - must include not only a trademark licence, but also the optional right to use at least one other IP right, such as a patent, a trade secret, copyrighted material or a trade name (this last being considered intellectual property under Russian law). In addition, each franchise agreement must include specific provisions regarding remuneration and must either indicate the term of the agreement or state that the agreement is to run indefinitely. In the latter case, the franchise agreement will be valid for as long as the trademark in question has a valid registration. An agreement that is neither for a specific term nor for an undefined term is automatically considered to be for a term of five years. The main difference between a franchise agreement and a mere trademark licence is that the franchise agreement grants a number of exclusive IP rights, whereas a licence agreement grants only one. A franchisee can use the goodwill and commercial experience of the franchisor within the framework established by the franchise agreement.

Registration

One area in which Russian franchise law differs from many other countries' systems is its strict registration requirements. Before any franchise agreement can take effect, it must be registered with Rospatent, the Russian patent and trademark office. Although registration is largely a formality, Rospatent carefully reviews each franchise agreement and will reject agreements that do not meet the straightforward - but strict - substantive requirements. In particular, the franchisor's trademark must be valid in Russia, based on either a Russian trademark registration or a World Intellectual Property Organisation trademark registration with Russia as a designated registrant country. Franchise and sub-franchise agreements, as well as any amendments thereto or terminations thereof, must all be registered. Unless the franchise agreement specifically states otherwise, the franchisor (whether Russian or foreign), rather than the franchisee, is responsible for submitting the signed franchise agreement to Rospatent for registration.

Franchisor liability

Under Russian law, certain rights, duties and liabilities apply irrespective of whether they are included in, or excluded from, the franchise agreement. These include:

• the joint and several liability of both franchisor and franchisee for third-party claims brought against the franchisee with respect to products manufactured by the franchisee; and
• the secondary liability of the franchisor for claims made against an insolvent franchisee in respect to products provided or services rendered by the franchisee.

Although such mandatory joint and several liability may appear to be a deterrent to foreign companies that are considering franchise operations in Russia, in reality their effect is minor. To date, no Russian court has ever held a franchisor liable for a product or service sold by a franchisee.

Restrictions on termination rights

Recent changes to Russian franchise law have relaxed the restrictions regarding franchise termination. First, the parties themselves may contractually agree that either may withdraw from the franchise agreement before its expiry at 30 days' notice and on payment of a specified sum. Second, the franchisor may terminate the franchise agreement if the franchisee breaches the agreement by failing to meet quality standards, deviating from instructions regarding intellectual property or failing to make timely payment of money when due. The franchisee must be given an opportunity to cure the breach, but if the same breach recurs within one year, the franchisor may withdraw from the agreement.

First refusal rights

Another change pertains to first refusal rights. The old law was overprotective of franchisees. Under the old law, when a franchise term ended, a franchisor was legally obligated to offer the existing franchisee a renewal term under the exact same conditions and for the same length of time as an original franchise agreement. The only alternative was to abandon the territory for three years. The franchisor could restrict the territory to a single location, but this was still a huge problem.

Under the new law, a franchisee has first refusal rights for only one year and the renewal terms do no have to be identical to the old terms, so that a franchisor is no longer locked in. One peculiarity of Russian law is that even though a franchisee, at renewal time, has first refusal rights for anything that a franchisor offers to some third party, if a franchisor were to conclude an agreement with a new franchisee in violation of this requirement, the current franchisee's remedies would depend on the term of the deal. If the terms are the same as in the expiring contract with the current franchisee, the current franchisee can block the deal by demanding that all rights and obligations be transferred to it and can demand damages. If the terms are different than those in the expiring contract, the current franchisee can still get damages but cannot block the deal.

This right of first refusal is presumably based on the argument that franchisees typically invest considerable time and effort in establishing their business, and that as long as they have performed their role as required during the initial term of the agreement, they should enjoy a measure of protection from abandonment by the franchisor. Nonetheless, franchisors which find such a requirement unduly restrictive can minimise its effects (eg, by defining the territory very narrowly).

Policing trademarks

Under Russian law, a trademark owner has the right, but not the obligation, to control the quality of the goods produced under licence. Thus, from a strictly legal standpoint, so-called 'naked' licences are permissible. Nonetheless, franchise arrangements that do not include some form of quality control for the purposes of brand protection are virtually unknown.

Change or expiry of trademark

If the franchisor's trade name or trademark is one of the IP rights included in the franchise agreement and the franchisor changes its trade name or trademark (or it expires through non-use), the franchisee may demand a reduction in franchise fees or terminate the agreement and claim damages.

Resale price maintenance, non-compete provisions and refusal to deal

Recent changes to Russian franchise law now allow franchisors to set fixed, minimum or maximum resale prices. Furthermore, the franchisor can bar the franchisee from:

• entering into a franchise agreement with any of the franchisor's actual or potential competitors; or
• selling similar goods or services under third-party brand names.

A franchisor may designate non-exclusive or exclusive territories for its franchisees and may prohibit them from targeting advertising to locations outside their territories. Russian franchise law does not permit a franchisor to impose passive territorial sale restrictions on its franchisees. Thus, as long as a franchisee restricts its operations to its own territory, it is free to sell to customers anywhere.

No registration deadlines

Notwithstanding the strict registration requirements, neither Russian law nor any procedural rule places a time limit on registration. A franchisor and a franchisee may commence franchise operations without registration and register the franchise agreement with retroactive effect, sometimes years later. This gap in the law should be viewed more as an 'excusable neglect' provision than an invitation to disregard the registration requirement. Even if the franchise agreement is governed by non-Russian law, deferring registration has a number of disadvantages:

• The franchisor has no legal right to licence fees before registration. If a dispute arises and the franchise agreement has not been registered, the franchisee may demand repayment, with interest, of all licence fees paid (although the franchisor may attempt to offset such a claim by demanding payment for use of intellectual property).
• If the franchisee has failed to pay franchise fees or has refused to pay them pending registration, by the time the agreement is registered some or all of the franchisor's claims for such fees may be time barred.
• If an international arbitration tribunal awards damages or another remedy to either party in respect of its unregistered franchise activities in Russia, a Russian court is likely to refuse to enforce the award.

Exclusive licence not equivalent to exclusive use

Russia's highest commercial court, the Supreme Arbitrazh Court, has ruled that even if a franchisor grants exclusivity to a franchisee within a defined territory, the exclusive licence by itself does not prevent the franchisor from setting up company-owned stores and competing with the franchisor in its own territory.

The court said that if the franchisee wants to prevent the franchisor from setting up competing company-owned stores, this restriction must be in the franchise agreement. This is not a change in the law, but it is the first time that the court has expressly pointed it out.

Choice of law

A non-Russian franchisor can specify a law other than Russian law to govern the overall agreement with a Russian franchisee. Nonetheless, Russian licensing law contains certain mandatory provisions that override contradictory provisions of a chosen foreign law. In order to be eligible for registration, a franchise agreement must comply fully with these mandatory provisions. There are no clear judicial guidelines on whether the Franchise Law itself should be considered mandatory law and should therefore be held to apply to an agreement that is stated to be governed by foreign law. Russian courts tend to be sceptical of agreements that are governed by foreign law, but many international franchise agreements with Russian franchisees require disputes to be submitted to arbitration before one of the major international tribunals. However, Russia is a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, and Russian courts consistently enforce international arbitral awards.

Notwithstanding these differences that remain in Russian franchise law, the net result of these changes has been a strongly increased interest in setting up franchise operations in Russia.

For further information on this topic please contact Natalya Babenkova at Noerr by telephone (+7 495 799 56 96), fax (+7 495 799 56 97) or email (natalya.babenkova@noerr.com).