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Associate Baker McKenzie — Kyiv
Junior Associate Baker McKenzie — Kyiv
What Foreign Companies Should Know about Franchising in Ukraine: Hints and Tips
Franchising is no longer a new concept in Ukraine. The country’s market has already seen a number of successful international and local franchising projects that have won the hearts of Ukrainian consumers. However, everlasting legal nuances are still holding back the full potential of the franchising model in Ukraine and repelling many foreign companies.
Regulating Legal Acts
The franchising legislative landscape is far from being extensive or exhaustive. Despite attempts to adopt a special law devoted to franchising, the Civil Code and Commercial Code remain the main laws regulating this area, though to a very limited extent. Instead of using the term “franchising,” Ukrainian law defines a “commercial concession agreement”, which is an equivalent of a franchise agreement in Ukraine. Based on this definition, it may be logically inferred that from a Ukrainian legal standpoint franchising is considered a contractual relationship under which a franchisor undertakes to grant, in return for remuneration, a franchisee the right to use a set of the franchisor’s rights with the purpose of producing or selling certain goods and/or providing certain services.
As follows from further provisions of Ukrainian law, the agreement should meet at least the following criteria to be qualified as franchising in Ukraine:
- Subject: The franchise agreement has a specific subject that includes the right to use the franchisor’s intellectual property (IP) rights, commercial experience and business reputation. The Civil Code does not limit the scope of IP rights that may be granted, but generally lists trademarks, designs, inventions, copyrights and trade secrets as possible IP objects. However, the right to use know-how and other commercially valuable and confidential information might also be covered by such an agreement.
- Parties: The parties to the franchise agreement will only be business entities or individual entrepreneurs. Ukrainian law does not allow individuals and other non-entrepreneurial entities to enter into such agreements.
- Form: The Civil Code requires that the franchise agreement must be concluded in writing. In the event that this requirement is not met, such agreement is considered void. Additionally, the Commercial Code mandates that this agreement must be concluded as one single document to be valid.
- Remuneration: A franchisee is required to pay remuneration to the franchisor for the rights granted under the franchise agreement. According to the Commercial Code, such remuneration might be paid as a lump sum, royalties or in another form set out in the agreement.
Scope of Franchisor Control over Franchisee’s Activity
In addition to the basic criteria listed above, a franchising relationship in Ukraine is characterized by regular control of the franchisor over the franchisee’s activity under the agreement, provision of various training and consultancy assistance to the franchisee and the necessity for the franchisee to maintain the quality of goods/services and comply with the franchisor’s instructions.
The Civil Code also allows inclusion into the franchise agreement of provisions regarding the exclusivity of such arrangement, the franchisee’s noncompete obligations or the franchisee’s obligation to obtain the franchisor’s approval for store location and design. At the same time, certain provisions limiting the pricing, categories of clients and location of clients might be considered void and trigger antitrust implications.
Practical Aspects to be Considered by a Foreign Franchisor
To avoid the application of Ukrainian law, foreign businesses often rely on contractual provisions establishing foreign law as the governing law. However, such an approach is not a perfect safeguard, given that the mandatory provisions of Ukrainian law must still be taken into account in case the agreement is executed in Ukraine.
Moving from dry legalese to more practical things, and there is a pool of quite common issues foreign companies regularly face when considering, or entering into, franchising arrangements in Ukraine:
- Absence of IP: Foreign franchisors do not always have their IP properly secured in Ukraine. Trademarks, inventions, designs, etc., must be registered in Ukraine either through national or international procedure so as to be considered valid IP objects in Ukraine. Therefore, the franchisor cannot grant, and the franchisee cannot obtain, the rights to such IP if it is not registered in Ukraine. Although Ukrainian law does not prohibit offering only trade secrets, know-how or goodwill as part of the franchise package, in most cases trademarks are a key part of the franchise business. It is strongly recommended that the respective trademarks rights are properly secured and granted under the franchise agreement. This would protect the franchisor from dishonest third party registrations and prevent possible tax ramifications arising from payment of royalties for non-registered trademarks.
- Shortcomings of IP-related provisions: Ukrainian IP laws are quite strict in terms of adequate identification of the IP objects at issue under the agreement. Provisions simply granting the rights to all of the company’s trademarks or other IP will not do. The parties must prepare a detailed schedule with sufficient information about each IP object covered by the agreement. Moreover, to make the granting of IP rights, the parties should explicitly set out all the rights granted and all the ways in which the IP in question can be used.
- No precontractual disclosures: Unlike many other jurisdictions, including the US, Ukrainian law does not require mandatory precontractual disclosure. This means that the franchisor is not obliged to disclose to the franchisee the material information regarding the franchise prior to entering into a formal franchise agreement. Without such information, the franchisee might improperly evaluate the franchise opportunity and, therefore, try to terminate the franchise agreement upon receipt of more detailed franchise-related information. To mitigate risks for both parties, the procedure of precontractual disclosure should be agreed by the parties in due course. Major disclosure issues include the scope of information to be disclosed, the form in which it should be presented, the term between such disclosure and signing of the franchise agreement, etc.
- Payment deficiencies: It is not uncommon for foreign businesses to indicate a third party (e.g., another member of the company group) as a beneficiary of the franchise fees/payments. However, the local franchisee may face serious difficulties with purchasing foreign currency to settle payments in the absence of formal agreements or acts signed with such third party. In addition, the parties sometimes forget to set out the detailed payment settlement procedure or do not sign acceptance acts that might result in problems with the tax authorities.
- Termination aspects: Along with the standard causes of termination (i.e., mutual agreement, court decision), Ukrainian law also provides that the franchise agreement may be terminated in the event that the franchisor loses the trademark rights granted or one of the parties goes bankrupt. Foreign companies should bear this in mind and keep track of trademark renewals. Another important thing to note is that in the event that the franchise agreement is governed by foreign law with a binding arbitration clause in place, the franchisor will not be able to go to Ukrainian courts to request termination of such an agreement. As a result, the franchisor should note that the franchisee might continue using the franchise for some time while the franchisor is getting prepared for arbitration proceedings.
Tips and Hints on How to Avoid Complications
Not all of these issues can be addressed and resolved without amendments to legislation. However, the lengthy period without sufficient and consistent regulation has resulted in a few key recommendations shaping the current practice by which foreign companies can enter the Ukrainian franchise market.
I. First, the foreign franchisor should start with due diligence of its IP assets. This will enable it to identify and cure possible deficiencies in local IP protection, as well as form the full list of IP covered by the franchise offering. As noted above, this will also help to prevent dishonest registrations of IP assets by third parties and comply with formal requirements of Ukrainian law.
II. The second step is to carry out due diligence of prospective counterparties. A good partner is a prerequisite of a sound commercial relationship. Thus, thorough checks of background information, real estate, corporate, financial and other aspects is a big step towards establishing trust between potential partners and confidence in each other’s good standing.
III. Another important preparation phase is conducting a market sweep investigation to check whether the franchised IP assets have been used in Ukraine by any unauthorized third party. Any unauthorized use may potentially create competition for the future franchisee, reduce the price of a deal, or even lead to failure to conclude a franchise agreement. If any such use has been detected, the foreign franchisor should immediately start an enforcement campaign to halt any unauthorized use in order to retain the status of exclusivity for a prospective franchise agreement.
IV. Finally, while it is common for foreign companies to want all their standard one-for-all-jurisdictions terms to be packed into a localized franchise agreement, all mandatory provisions of Ukrainian law and local specifics must be kept in mind while negotiating, drafting and concluding such agreement. However, there is always room for such non-local instruments as pre-contractual disclosures, which might help the parties to save both time and money.
Conclusions and Prospects
To conclude, the buildout of a franchising model in Ukraine is hindered by the lack of progress in the regulation of this area. Since the abolition of mandatory state registration of franchise agreements in 2015, there have been no major developments to date. Both franchise-specific legislation and case law remain scarce and do not allow foreign companies to have all the benefits of franchising schemes on the Ukrainian market. This prevents many foreign businesses from entering the local market through this model. One of the most famous examples is McDonald’s, a franchise-driven business, which does not have any franchisees in Ukraine. Of course, there are some great cases with global franchising leaders, such as IKEA and KFC, which entered the local market quite recently. However, the general trend is unlikely to change without a considerable overhaul of franchising regulations in the near future.