Lexology Navigator: Franchising in Russia3 December 2018
Business climate and recent developments
What is the extent of franchise business in your jurisdiction, including any particular franchise-heavy sectors and notable recent developments?
Franchise business in Russia is growing at an average annual rate of 10% to 15%. The most popular and franchise-heavy sectors are:
- restaurants and cafes;
- hotels and leisure;
- shops and retail;
- medical services and clinics; and
- information technology and online services.
The legal climate surrounding franchising has been improved with the implementation of new law amendments and juridical tools that bring the Russian legal system in line with international practice. The local legal system supports favourable investment opportunities for both domestic and foreign market participants.
Are there any franchising-specific laws in your jurisdiction? What other legal regimes apply?
Franchising is specifically regulated by Chapter 54 of Part II of the Civil Code. Further, the general provisions of the Civil Code – especially those that govern general aspects of contract law and obligations (Part I), intellectual property and licensing (Part IV) and real estate and property law (Parts I and II) – may apply to franchising. Franchise relationships may also be affected by local laws regarding:
- commercial law and competition;
- consumer and data protection;
- labour and employment;
- advertising and promotion; and
- tax and currency control.
Other rules and regulations may also apply.
Is there a legal definition of ‘franchise’?
According to Article 1027(1) of the Civil Code, under a franchise agreement, the rights holder grants the user, for consideration and for a definite or indefinite period, a right to use a set of IP rights, including trademarks and other IP rights, to operate its business – in particular, trade names and secrets of production (know-how).
The key element of every franchise agreement is a protected (ie, registered) trademark. Without this, the contract may not be treated or interpreted as a franchise agreement.
Are there any specific regulatory implications for foreign franchisors seeking to expand into your jurisdiction?
Generally, there are no regulatory implications or legal restrictions on foreign franchisors seeking to expand into Russia. There is no imperative to establish a local business entity as a pre-condition for doing franchise business in Russia. International companies are free to offer and sell franchises directly or indirectly to local business entities.
When entering the Russian market through franchising, foreign companies should comply with the relevant national laws and regulations governing franchise-related deals and general civil law principles.
Certain areas of investment are of strategic importance and the government is seeking to secure the state defence and national security in these areas. Hence, a special licence or permission from the government must be obtained before investing in certain industries or transacting with particular assets (eg, encryption, weaponry, space and aviation). Restrictions may apply with regard to corporate ownership and control (eg, media and telecoms).
Are any regulatory reforms envisaged or underway that affect franchises?
The Civil Code was drafted in 1992 and had been amended multiple times. The main regulatory and local civil law reform was accomplished between 2014 and 2015. Discussions for improving the national legal and business climate – including related to franchising issues – are expected in the future.
Which models and company forms are commonly used for franchises in your jurisdiction? Are there any restrictions or requirements as to which models and forms may be used?
Typically, franchisors prefer to build relationships using the direct franchising model. In certain instances, franchisors engage master franchisees (sub-franchisors) to operate in Russia through third-party sub-franchisees. Other models relating to franchising, including the sale of development rights, are sometimes implemented.
The principal rule of franchising in Russia is that the parties to a contract must be commercial entities. Non-commercial companies or government agencies may not set up franchise relations. Therefore, limited liability companies will regularly represent franchisors or franchisees. In exceptional cases, joint-stock companies are used in complex franchise operations (eg, joint venture franchising).
Are there any national or regional franchising associations? If so, is membership mandatory and what operational codes and guidelines apply?
A few national franchise associations operate in Russia. While membership is not mandatory, it may, to a certain extent, be commercially advisable.
Established in 1997, the Russian Franchise Association (RFA) is a local non-profit public organisation which helps its members to promote franchising activities in Russia. Although the RFA has no regulatory power, it may provide useful practical advice and guidelines on doing business through franchising. More information about the RFA is available at www.rusfranch.ru/en.
Common features and contractual requirements
What are the common elements of franchise agreements in your jurisdiction? Do any requirements or restrictions on contractual provisions apply?
Franchise agreements may contain various terms and conditions depending on the transaction structure and the parties’ negotiations.
As regards the most common elements, franchise agreements will typically address the following essentials applicable to Russia-targeted deals:
- parties (ie, corporate names and addresses);
- subject matter (ie, registration numbers of franchised trademarks and descriptions of other franchised IP rights such as copyrights and know-how);
- franchised products (ie, goods or services for which the franchised trademarks are protected and licensed);
- scope of franchised rights (ie, permitted manners of IP use and distribution of franchised goods or services, as well as the sphere of commercial activities);
- franchisee duties and covenants (eg, compliance with standards or manuals, product quality assurance and non-compete obligations, confidentiality and non-disclosure covenants, site selection and approval);
- consideration (eg, franchise entrance fees, lump sums and royalties);
- type of franchise (eg, sole, exclusive or non-exclusive);
- term (ie, term of protection of franchised IP rights or certain specific period);
- territory (ie, the whole of Russia or specific regions);
- sub-franchising (eg, permitted or prohibited, how many and to whom);
- franchise renewal (ie, possible or not, franchisee’s right of first refusal);
- termination (eg, mutual or unilateral, for cause or convenience);
- post-termination (ie, franchisee obligations and liabilities following termination);
- miscellaneous (eg, franchise amendments, governing law, jurisdiction or arbitration); and
- signatures (ie, names and titles of signees).
Are parties to a franchise agreement subject to an implied or explicit duty of good faith?
Parties to a franchise agreement are subject to an implied duty of good faith. Good faith and fair dealing are the fundamental principles of the national civil law, as set out by Articles 1(3) and 10(5) of the Civil Code. These principles are usually supported and enforced by local courts in all disputes involving domestic contracts and cross-border transactions, including in terms of franchising.
Are franchise agreements subject to any formal or documentary requirements, including registration?
Franchise agreements must be made in writing and prepared or translated into Russian. In practice, bilingual versions are drafted in the context of cross-border deals. If the franchise agreement is produced and executed in a foreign language (eg, English), a certified Russian translation may be prepared and attached to the original contract.
Further, the underlying franchise or licence grants which are targeted at Russia, including those governed by applicable foreign law, must be registered with the Federal Service for Intellectual Property (Rospatent). A franchise or licence grant which is not registered with Rospatent will be regarded as invalid and unenforceable against third parties.
The types of documentation that may be submitted to Rospatent for recordal purposes are as follows:
- the original franchise agreement;
- a notarised excerpt from the original franchise agreement; or
- the so-called ‘notification’ (ie, the statement of franchise).
If the parties do not wish to disclose the original contract along with agreed financial terms or other sensitive data, the best option would be to make, sign and file an excerpt from the franchise agreement or submit the notification. Before filing, it is essential to ensure that the document filed to Rospatent contains all of the essential elements (ie, mandatory clauses and points) as required by Russian law and applicable registration regulations.
What due diligence should both parties undertake before entering into a franchising agreement?
Normally, parties undertake the following types of due diligence before entering into a franchise agreement:
- corporate and commercial;
- banking and finance;
- intellectual property and real estate; and
- dispute resolution and litigation.
In certain instances, specific categories of due diligence may be conducted or required before starting a franchise deal, such as tax, insurance and employment.
Are franchisors subject to pre-contractual disclosure requirements? If so, do any exemptions apply? What remedies are available to franchisees in the event of breach of these requirements?
Pre-contractual disclosure is not mandatory under Russian law. The law states that the franchisor alone must provide technical and commercial documentation – along with any other necessary information for the franchisee to be able to develop the franchise operations – and instruct the franchisee and its employees on any aspects associated with the contracted franchising activities.
Disclosure obligations may be established by the parties on the basis of the doctrine of culpa in contrahendo at the negotiation stage of a prospective deal. When negotiating the franchise grant, parties may corroborate their contractual negotiations using a special form of agreement available under Russian law that is enforceable under Article 434(1) of the Civil Code.
The format of disclosure is not prescribed by Russian law or published by any governmental agency. Therefore, the parties to a contract may use and be guided by the documentation normally used in the context of international franchise practice.
Choice of law
May the parties freely choose the governing law of the franchise agreement?
There is no legal requirement for a franchise agreement, or part of the same, to be governed by the Russian law. Under the basic principles of the international private law, the contracting parties may choose the relevant governing law when entering into a deal (or afterwards). Hence, the franchise agreement may be governed by any applicable law – Russian or foreign.
Absent a choice of law provision stated in the franchise agreement, the law of the country where the franchisee has been authorised to use the franchised system and the licensed set of IP rights will apply. Further, where such use has been permitted on the territories of several jurisdictions including Russia, the law of the country where the franchisor is located or has its principal place of business will govern the parties’ relationship.
In any event, pursuant to Article 1211(9) of the Civil Code, the law of the country that is more bound up with the contract may apply in the event that the nature, or terms and conditions of the contract, or circumstances surrounding the transaction, clearly evidence such a fact.
What fees are typically charged under a franchise agreement?
No typical fees are charged under franchise agreements. Every contract has its own fee amount calculations and formulas, payment orders and details, as well as applicable terms and conditions which depend on the franchised business and the parties’ negotiations.
Do franchisees have a right of renewal?
The franchisee has a right of first refusal under Russian law. If the franchisee has performed its contractual obligations in a timely and proper manner, it has a pre-emptive right to re-conclude the franchise agreement for a new term with the franchisor. When re-making the franchise relationship, parties are free to amend or modify the terms and conditions of the underlying contract.
On what grounds may a franchisor refuse to renew?
If the franchisor refuses to enter into the franchise agreement for a new period with the former franchisee, and within a year concludes a new franchise agreement granting the same rights to the other (third) party and under the same terms and conditions, the former franchisee is entitled (at its option) to claim in court the transfer of franchise in its favour and reimbursement of damages, or simply the reimbursement of damages. However, if the franchisor does not grant the same franchise to a third party by making a new franchise agreement within a year, or sells different franchise rights to a third party, or offers franchise agreement to a third party under non-similar (other) terms and conditions, the franchisee’s right of renewal will not arise. The franchisor may refuse to renew the franchise agreement with the franchisee if the latter has failed to perform its obligations in compliance with the terms and conditions of the underlying contract.
How are renewals of franchise agreements usually effected? Do any formal or substantive requirements apply?
Franchise renewals may be governed by amendment or supplemental agreements and are subject to mandatory registration with Rospatent. Contract extension filing must be made before the initial period ends. Failure to file for franchise renewal on time will result in the automatic termination of franchise rights, and the parties will need to revive the relationship by entering into a new franchise agreement.
On what grounds may a franchisor terminate a franchise agreement? Are any remedies available to franchisees in this regard?
Under Russian law, a franchisor may terminate a contract at any time if the franchise agreement has been concluded for an indefinite term. In such a case, six months’ written notice is required, unless the contract indicates a longer term for the advance termination notice. If the contract provides for a specific validity period, the franchisor must be guided by the terms of the franchise agreement.
Either party to the contract concluded for a definite or indefinite term, including the franchisor, may terminate the franchise agreement by sending written notice to the other party within 30 days. This option is available only if the contract provides for the release of certain monetary compensation.
The franchisor may terminate the franchise agreement if the franchisee produces goods of inferior quality or the quality of its services does not correspond to what has been set out in the contract. The franchisor may also repudiate from the franchise agreement if the franchisee does not follow the franchisor’s instructions and guidance aimed at compliance with the contractual provisions relating to the terms and conditions on the use of the franchised set of IP rights. The franchisor may cancel the franchise agreement if the franchisee fails to settle the franchise fees on the terms and conditions set out in the contract. Termination or repudiation by the franchisor is available if the franchisee fails to remedy the breach within a reasonable term, or has committed another breach within a year of receipt of the written notice from the franchisor.
Further, if the franchisee becomes insolvent (bankrupt) the franchise agreement must be dissolved.
The earlier termination of franchise agreement is subject to mandatory registration with Rospatent. Absent registration, the earlier termination will not be effective and enforceable against third parties.
Ongoing franchisor/franchisee relationship
What mechanisms (formal and informal) are commonly used by franchisors to ensure franchisee compliance with the operational terms and standards of the agreement?
Franchise agreements usually contain trademark control (use) provisions, quality control clauses, system and standards compliance conditions, as well as confidential information non-disclosure duties. The franchisor reserves the right to check for compliance with these provisions. Failure to abide by the contractual obligations will give the franchisor the right to terminate the franchise agreement and claim the associated damages or penalties. Further, the contract may provide for technical or operation suspension (eg, deactivation of software access), at least for the period of a breach. Non-compliance with post-termination operational terms and standards may lead to IP infringement actions that may be brought by franchisors.
Amendment of operational terms
Can the franchisor unilaterally change operational terms and standards during the course of the agreement?
Operational terms and standards usually form the integral part of underlying franchise agreements, which may be amended or modified on the basis of the agreement of the parties during the contracted term. Unilateral changes to the contractual provisions, including those relating to operational compliance or standards, are permitted only if explicitly allowed by contract. Otherwise, the franchisor may be restricted from performance of unilateral operational changes during the course of the franchise agreement.
Do any specific laws affect the ongoing franchisor/franchisee relationship after they enter into the franchise agreement?
The ongoing franchise relationship may be regulated and affected by the local laws on:
- franchising and IP licensing;
- intellectual property and information technology;
- real estate and property law;
- competition and commercial law;
- labour and employment;
- consumer law and data protection;
- advertising and promotion; and
- tax and currency control.
Other related Russian laws and regulations may also apply.
Do any ongoing disclosure requirements apply during the course of the agreement?
Ongoing disclosure is not required under Russian law. Therefore, a franchisor does not need to provide disclosure updates to a franchisee during the course of a franchise agreement. However, the franchisor must render ongoing technical and consultative assistance to the franchisee, unless otherwise provided for in the contract.
Transfer and sale
What rules and procedures apply to the transfer and sale of a franchise business?
Generally, the franchisee may be prohibited by the franchisor from transferring its rights, obligations and franchise under contract to a third party. However, the franchisor may restrict transfers by the franchisee of ownership interests in a franchisee’s entity to a third party only if the franchisor has acquired corporate control over the franchisee’s business.
So-called ‘step-in’ rights and ‘conditional assignments’ are also available and may be implemented through additional formalities and recordals. Other guarantees and protection against franchise transfers or sales are also available.
What competition laws apply to franchises, with particular regard to:
(a) Non-competes and other restrictive covenants?
The franchise agreement may contain non-compete and other restrictive covenants. These may be imposed on the franchisee as allowed under Russian law. The franchisor may elect for the following covenants to be incorporated into the contract:
- the franchisee’s covenant not to compete with the franchisor in the franchised territory in relation to the franchised business and franchised set of IP rights;
- the franchisee’s refusal to accept analogous rights under franchise agreements from actual and potential competitors of the franchisor;
- the franchisee’s covenant to distribute and sell the manufactured or purchased goods, perform works or provide services by using the franchised rights and applying the prices fixed by the franchisor;
- the franchisee’s covenant to refrain from distributing analogous goods, performing analogous work and providing analogous services using the trademarks or trade names of other franchisors;
- the franchisee’s covenant to sell goods, perform works or provide services exclusively within the boundaries of a certain territory; and
- the franchisee’s covenant to obtain approval from the franchisor for the location and exterior or interior design of the commercial premises used for the implementation of the franchised rights under the contract.
The above restrictive covenants are permitted under Russian law and may be enforced if not complied with, especially during the course of the franchise agreement.
(b) Exclusive geographical areas?
Exclusive geographical areas are permitted and enforceable under franchise agreements.
The franchised territory (eg, the region, city or street) may be specified in the underlying contract. If it is unspecified, the franchise will be regarded as granted and registered for all of Russia. If the contract specifies certain boundaries or areas, the franchise will be valid in such contracted boundaries and areas.
A franchise may be sole, exclusive or non-exclusive:
- If the granted franchise is sole, the franchisor loses its right to use the franchised set of IP rights in the franchised territory on its own and loses the right to offer and sell the same franchise to third parties in the franchised territory.
- If the granted franchise is exclusive, the franchisor may reserve the right to use the franchised set of IP rights in the franchised territory on its own. However, it loses the right to offer and sell the same franchise to third parties in the franchised territory.
- If the granted franchise is non-exclusive, the franchisor is free to franchise the already franchised set of IP rights to others in the franchised territory and can use the franchised set of IP rights in the franchised territory on its own.
(c) Price fixing and mandatory product purchases?
Under Article 1033(1) of the Civil Code, franchisees may be obliged by contract to sell the franchised goods purchased from, and under prices fixed by, franchisors. While clearly allowed by virtue of law, price fixing (including minimum resale prices) and product tying may be considered anti-competitive and deemed invalid by the Federal Anti-monopoly Service or other interested parties, subject to relevant market conditions and the parties’ economic status.
(d) Online trading?
Under Russian law, it is possible to oblige a franchisee to sell goods or provide services exclusively within a contracted territory. However, the relevant clause set out in the franchise agreement which obliges the franchisee to sell goods or provide services, whether online or offline, solely to the customers located or residing in the franchised territory will be null and void pursuant to Article 1033(2) of the Civil Code. Therefore, as long as the franchisee restricts its franchising activities to its own (contracted) territory, it must sell goods or provide services to different customers, including those not necessarily located or resided in the franchised territory.
There is no maximum permitted period within which the franchise agreement may be effective. The franchise agreement may be concluded within a definite or indefinite period. If the franchise agreement is made for a definite period, the contract may provide for a specific period (eg, five years) within which the franchise will stay valid or clearly state that it remains effective during the period of protection of the franchised set of IP rights that has been licensed under the franchise agreement. If the term of the franchise agreement is not defined by contract, the franchise will be regarded as granted and registered for five consecutive years.
How can franchisors protect their intellectual property (eg, trademarks and copyright)?
Trademark registration is an essential first element for every franchise transaction targeted at Russia. A trademark may not be granted for use within the scope of a franchise unless it is properly protected (ie, registered) in Russia. Therefore, a foreign trademark, mark-in-use or pending trademark application cannot be licensed by way of a franchise agreement.
Trademarks may be protected on a national or international basis. National marks must be filed and registered with the Federal Service for Intellectual Property (Rospatent). As Russia is a signatory to the Madrid Agreement and the Madrid Protocol, international trademark registrations, which designate Russia, are also protected.
The duration of the national trademark registration procedure is approximately one year. The examination procedure includes formal and substantive examination. In the course of substantive examination, Rospatent runs absolute and relative grounds tests to allow or refuse trademark registration.
Any words, pictures, three-dimensional configurations and other marks may be registered as trademarks. The registration of non-traditional marks (eg, sounds, colours and smells) is permitted.
To be registered, a mark must be new and distinctive. Distinctiveness may be inherent or acquired. A trademark can acquire distinctive character through intensive and actual use in commerce.
Generally, use of the mark need not be claimed before registration. Further, proof of use need not be submitted before the trademark application is filed. However, the owner must start using the trademark within three years of registration. If the mark is unused during any three-year period following trademark registration, any interested person may apply for cancellation of the trademark protection on the grounds of non-use.
Registered trademarks are listed on the Trademark Register and are valid for 10 years. Trademark registrations can be renewed for 10-year periods an unlimited number of times.
Often, franchisees will be granted access to certain business standards, operations manuals and proprietary software. As a result, copyright vested in such contracted works of authorship may be included along with trademarks in the content of the underlying franchise agreement.
Copyright subsists in scientific, literary and artistic works fixed in any tangible medium of expression, regardless of benefit, purpose or method of expression. To be copyrightable, a work of authorship must satisfy two fundamental criteria:
- it must represent a result of creative input; and
- it must be fixed in a tangible medium of expression (eg, on paper or a CD-ROM).
Generally, the following examples of works of authorship can obtain copyright protection in Russia:
- literary works;
- dramatic works;
- musical works;
- choreographic works and pantomimes;
- audio-visual works;
- sculptural, graphic and design works;
- photographic works;
- architectural works;
- pictorial works;
- computer programs; and
Essentially, copyright vests in a work of authorship from the moment of its creation. No registration or compliance with any other formalities is required to acquire, exercise, transact, franchise, protect or enforce copyright in Russia. However, a unique national system of registration is available for software. The software registration may give an irrebuttable presumption of copyright ownership and protection.
The standard duration of copyright protection, which applies to all works of authorship, is the lifetime of the author plus 70 years after her or his death.
Must IP licences be registered?
As with franchising, mandatory registration of IP licences involving the grant of use of registrable intellectual property (eg, patents, industrial designs, trademarks and service marks) is a legal requirement. Therefore, if the subject matter of the IP licence agreement is a trademark or patent, the licence will be subject to compulsory registration with Rospatent.
A registered IP licence (with respect to the registered intellectual property) is a condition for the validity and enforceability of the licence grant against third parties. Therefore, a non-registered IP licence (with respect to the registered intellectual property) will be invalid and unenforceable against third parties.
How can franchisors protect their know-how and trade secrets?
Many franchise agreements incorporate know-how licences as the transfer of proprietary and confidential information is often regarded as the most valuable intangible asset of every franchise business.
Any piece of confidential information, including from the technical/scientific or professional/commercial side, may be protected as know-how.
Know-how is not subject to registration or deposit. Nevertheless, the owner of confidential information must undertake certain reasonable measures to maintain the confidentiality of the relevant data. If such measures are not implemented, know-how protection will not be afforded to the confidential information.
A proper legal way to acquire know-how protection is to set up a so-called ‘trade secrets regime’ as it is set out in Russian law. In brief, owners of confidential information must:
- properly identify and list the confidential information;
- limit access to the confidential information by establishing an appropriate procedure for dealings with the same;
- affix the notice ‘trade secret’ and the owner’s details to the medium in which the confidential information is stored; and
- follow up with the other required steps
If one of these steps is ignored or omitted by the owner of the confidential information, the trade secrets regime will not be considered as having been introduced. At the same time, there are other practical reasonable measures which can be undertaken for the purposes of achievement of know-how protection.
Know-how will be protected for as long as it is kept secret by its owner. When the confidentiality is lost, the exclusive rights lapse immediately.
What are the consequences of a franchisee’s breach of the franchisor’s IP, know-how or trade secret rights and what remedies are available to the franchisor in this regard?
Local IP enforcement is well developed and efficient in Russia:
- Enforcement court actions can be brought by respective IP owners and their registered (exclusive) licensees.
- Infringement of IP rights may primarily be prosecuted through administrative, civil or criminal proceedings depending on the nature of infringement and corresponding facts.
- A special quasi-judicial procedure based on unfair competition is available (eg, bad faith acquisition and use of IP rights, trade dress imitation).
- Cease and desist letters have become a mandatory pre-judicial remedy for companies that wish to sue infringers in court and claim damages or compensation.
Laws and considerations
What real estate laws and considerations should franchisors bear in mind where:
(a) The franchisor owns the premises on which the franchisee operates?
Legally, there are two main types of right on the basis of which real estate, including commercial premises, may be held under Russian law:
- an ownership right (ie, the right to possess, use and dispose of real estate); and
- a lease right (ie, the right to possess and use real estate in accordance with the terms agreed with the owner or lessor).
Further, a number of real estate encumbrances grant their beneficiaries a limited right to use certain real estate, including mortgages, trust management, easements or servitudes.
Owners of buildings enjoy the exclusive right to purchase the underlying publicly owned land. The transfer of title to the real estate normally causes the automatic transfer of rights to the land plot under the subject real estate object, even if it is leased. Lease agreements may be concluded in respect of future properties and stay valid in case of change of ownership.
In the context of commercial real estate, no restrictions apply to foreign business entities holding a real estate interest or being the sub-lessors in real estate transactions. However, the following general restrictions may apply to foreign companies, including franchisors:
- They may not own land or plots located alongside the national borders; however, they may lease land or plots located alongside the national borders.
- They may not own agricultural land plots (this restriction applies to Russian companies in which over 50% of the equity capital belongs to foreigners); however, they may lease agricultural land plots.
- They may not enter into transactions which establish control over businesses of strategic importance (eg, aerospace, military and nuclear) without the prior permission or license from the government.
Transfers of real estate ownership are subject to registration in the Unified State Register of Real Estate. Long-term leases (ie, one year or more) also require registration and are effective and enforceable against third parties as of the registration date.
If a franchisor owns premises and leases the same to the franchisee, it must ensure that the respective (separable) improvements made following the renovation made by the franchisee will become the franchisor’s property upon expiration or termination of the lease agreement.
(b) The franchisor sub-leases the premises to the franchisee?
If the franchisor sub-leases premises to the franchisee, it can pass all related costs to the latter. This may be implemented by way of the assignment of debt.
If the franchisor wishes to prevent the franchisee from occupying the premises after the franchise agreement has been expired or terminated, the franchisor as the lessee can reserve the right to terminate the sub-lease agreement. Otherwise, the parties can agree that, in this event, the sub-lease agreement will be terminated automatically.
(c) The franchisee leases the premises from a third-party landlord?
If the franchisee leases the premises from a third-party lessor and is in breach of its duties, the franchisor may be the one to assume its rights and obligations. This may be implemented by way of an option agreement or conditional lease assignment under which a franchisor has the right to adopt the franchisee’s (lessee’s) position under the lease, or direct that a third party (as a replacement franchisee) may do so if the original lessee fails. However, if the franchisee (lessee) has been performing its lease obligations in a timely and proper manner, it will have a pre-emptive right to conclude a lease agreement for a new term (ie, right of first refusal) unless an agreement to the contrary has been made between the parties.
If the franchise agreement is expired or terminated, franchisors must ensure that the lease agreement concluded between the franchisee (lessee) and a third party (lessor) is also terminated. Usually, the parties agree on this provision in the lease agreement by making it conditional on the franchise agreement and may support this remedy via a separate trilateral agreement (also known as an ‘owner agreement’).
(d) The franchisee owns the premises?
Russian law provides the following legal options for franchisors wishing to acquire franchisee premises at the end of a franchise relationship:
- a real estate sale and purchase agreement;
- a preliminary real estate sale and purchase agreement; and
- an option agreement.
The transfer of real estate ownership vested in the franchisee’s premises must be registered in the Unified State Register of Real Estate.
Can franchisees or their employees be regarded as employees of the franchisor for liability purposes? If so, how can franchisors mitigate this risk?
The franchisor and the franchisee are separate business entities operating under the franchise agreement. Each has their own labour and employment obligations in relation to their respective employees, but not in relation to each other.
The terms and conditions of the franchise agreement are primarily governed by civil law (ie, the Civil Code), while the labour and employment relations of entities doing business in Russia are regulated by the Labour Code.
Under the Labour Code, employment relations between the employer and the employee may arise only under a labour agreement. Article 15 of the Labour Code stipulates that the conclusion of civil law agreements which de facto govern the relationship between the employer and the employee are not allowed.
Therefore, the franchisee or even the franchisee’s employees cannot be treated as the employees of the franchisor for liability or other purposes in Russia. However, in certain cases as cited by law, franchisors may bear subsidiary or even joint and several liability under product-related claims of third parties.
Tax and currency controls
What tax regimes apply to the franchisor/franchisee relationship?
No specific franchise tax exists in Russia. Usually, a foreign franchisor must take into account the rules applicable to the value added tax (VAT) and corporate income tax (CIT) on the contracted franchise fees, while the local franchisee, as the franchisor’s tax agent, is responsible for withholding obligations
Franchisor tax liabilities
Foreign franchisors must add 18% VAT on franchise fees payable by Russian franchisees under the franchise agreement.
The licensing of patents, industrial designs, know-how, computer programs, databases and mask works are exempt from VAT, while trademark and copyright licences will be taxed under the underlying franchise agreements.
Further, franchise fees payable to a foreign franchisor by a Russian franchisee are subject to 20% CIT, unless there is a special double tax treaty in place between Russia and the foreign state where the franchisor resides, as this would provide certain tax reliefs.
Franchisee tax liabilities
If the foreign franchisor does not have a permanent establishment or a representative office in Russia, the Russian franchisee acts as a tax agent for the foreign franchisor. Therefore, the Russian franchisee must withhold the corresponding VAT amount from corresponding franchise fees relating to trademark or copyright licence stipulated by the relevant franchise agreement and remit that amount to the state budget.
Further, the Russian franchisee, acting as a tax agent for the foreign franchisor, must withhold the corresponding CIT amount from the contracted franchise fees and remit this to the state budget, unless there is a special double tax treaty in place between Russia and the foreign state where the franchisor resides, as this would provide certain tax reliefs.
The franchisee may deduct the VAT amount, as well as the amount of franchise fees, when paying its own CIT to the government.
Parties should also observe local transfer-pricing rules. More specifically, the amount of contracted franchise fees should comply with the corresponding market price level to avoid additional taxes and penalties.
Do any currency controls apply with respect to foreign franchisors?
No legal restrictions on the repatriation of franchise fees to foreign franchisors apply.
As a rule, the Russian franchisee must register the international contract with a competent bank to remit the franchise fees to a foreign franchisor. The above rule applies only to the corresponding franchise operation for the contracted amount equal to Rb3 million or more (for import-related contracts) and Rb6 million or more (for export-related contracts).
The bank will register the international transaction agreement if the underlying franchise agreement is translated into Russian, and the contracted franchise is registered with Rospatent. Absent the franchise registration with Rospatent and the competent bank, franchise fees cannot be wired to the benefit of the foreign franchisor.
Russian currency control law does not prohibit the use of a foreign currency (eg, US dollars) in the context of international franchising.
What issues are typically the subject of disputes arising in the franchisor/franchisee relationship?
Typically, the following issues represent the subject matter of disputes in the franchise relationship in Russia:
- trademark use and infringement;
- contract validity and termination;
- franchisees’ non-compete obligations; and
- franchisees’ non-performance of financial obligations.
Compared with other jurisdictions, Russia may be desirable in terms of timing, costs, remedies and enforcement proceedings associated with dispute resolution and litigation. For example, it may take about six months for an IP infringement claim or contractual breach matter to reach a first-instance decision, and then another four months to accomplish the enforcement procedure, if the case has not been appealed.
Remedies can include preliminary and permanent injunctive relief, as well as monetary relief, including statutory damages. Cases may be settled at any stage of the civil procedure. Settlement agreements will be approved by the competent courts if the agreed provisions do not affect the rights and legitimate interests of third parties. Attorneys’ fees may be capped by the clients’ respective lawyers and are recoverable from the losing party. If the case at issue is being settled, the parties are free to allocate the attorneys’ fees in whatever proportions they wish.
The general limitation period for the case to be brought to trial is three years. The same period applies for the commencement of the enforcement procedure, when the court decision becomes effective.
Which venues are empowered to hear franchising disputes in your jurisdiction? What considerations should be borne in mind when choosing a venue?
Basically, the Russian court system has two branches of courts: commercial courts (also known as ‘arbitrazh’ courts) and courts of general jurisdiction (also known as ‘common’ or ‘state’ courts).
Commercial courts examine cases involving business entities and individual entrepreneurs. Common courts consider cases where at least one of the parties is a private (physical) person. Since franchise relationships are established between business entities, the related disputes are heard by commercial courts.
The commercial court system has four instances:
- first-instance courts;
- appellate courts;
- cassation courts; and
- the Supreme Court.
The Intellectual Property Court operates as a first-instance court and a court of cassation. This specialised court is empowered to hear IP-related conflicts, as well as unfair competition claims. Franchising disputes may also fall under the jurisdiction of this court at the cassation stage (ie, third level).
To initiate an action and start litigation, a statement of claims must be filed with the competent court. Claims must be supported by the evidence of breach of the contract or infringement at issue. Under common procedure law, the residence or location of the defendant establishes the jurisdiction for a dispute.
Alternative dispute resolution
Is alternative dispute resolution (ADR) commonly used for franchising disputes in your jurisdiction? What considerations should be borne in mind when opting for ADR?
ADR is commonly used in cross-border franchise deals.
Instead of bringing franchise disputes to litigation in front of local courts, local franchisees and foreign franchisors can contractually agree on arbitration. If no arbitration clause is included in the underlying contract, the franchise conflicting relationship may not be submitted to the arbitration institution.
Mediation is also available as an efficient ADR method. However, franchising conflicts are rarely mediated in Russia.
Foreign judgments and awards
What regulations and procedures apply to the recognition of foreign judgments and arbitral awards where international franchising networks are concerned?
Russia is a signatory to many multilateral and bilateral international treaties for recognition and enforcement of foreign judgements, including the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (the New York Convention). Therefore, an arbitral award received from another jurisdiction that is a signatory to the New York Convention may be enforceable in Russia.
Further, a court judgment obtained from another jurisdiction may be enforceable in Russia, provided that recognition and enforcement of the foreign court judgment is stipulated by both the relevant international treaty to which Russia is a party and federal law. Russia is a signatory to many multilateral and bilateral international treaties for recognition and enforcement of foreign judgments.
Absent the relevant international treaty, a Russian court may recognise and enforce a foreign judgment on the basis of the international principle of reciprocity and comity (comitas gentium). Although not in the sphere of franchising, in at least a couple of successful cases, along with the landmark court orders, foreign judgments have been recognised and enforced in Russia on the basis of comitas gentium.
The Russian Civil (Commercial) Procedure Code provides for certain formal and mandatory requirements for recognition and enforcement of foreign judgments, as well as arbitral awards. These include the following criteria:
- effectiveness of the court judgment or arbitral award under the law of the jurisdiction in the territory on which it has been issued;
- compliance with the statutory three-year period for filing a motion for recognition and enforcement of the foreign court judgment or arbitral award; and
- consistency of the foreign court judgment or the arbitral award with Russian public policy.
If these requirements are not met, a Russian court may refuse to recognise and enforce a foreign judgment or arbitral award.