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14 June 2019

When choosing a governing law for franchise agreements, franchisors usually try to find an option with fewer mandatory obligations for themselves. At first sight, one may believe that Ukrainian law offers such a ‘safe harbour’ because both the Civil Code of Ukraine and the Commercial Code of Ukraine[1] do not stipulate mandatory pre-contractual disclosure or mandatory testing of franchises before granting under franchise agreements. They also do not stipulate any mandatory compensation to franchisees for the termination of franchise agreements. Nevertheless, this is not the case in practice. This article highlights the most questionable provisions of Ukrainian franchising regulations that require careful evaluation by franchisors if they choose Ukrainian law.

Pre-contractual disclosure

Ukrainian law does not stipulate any pre-contractual disclosure requirements unlike many jurisdictions (for instance, Italy and the United States) where applicable regulations set forth the scope of disclosure and relevant timeframes as well as negative consequences for violation. However, the absence of any direct provisions in Ukrainian law does not mean that franchisors are allowed to hide certain essential terms and conditions or to present them in a false manner. In Ukraine, contract relations are based on such fundamental principles as good faith, justice and reasonableness. Moreover, franchisees are not deprived of the right to refer to general provisions of the Civil Code[2] applicable to all types of agreements and to request termination of franchise agreements as concluded by mistake or by fraud with indemnification of all damages caused.

To be on the safe side, before the conclusion of franchise agreements, it is advisable to disclose all essential terms and conditions to franchisees to help them to precisely understand the nature of the agreement, the scope of the franchise granted, rights and obligations of all parties and other essential terms and conditions.

Testing of the franchise

Both Ukrainian law and case law are silent on the testing of the franchise, even though in many jurisdictions (such as England and Italy) testing of the franchise before its granting under an agreement is a mandatory requirement.

At the same time, there are reasonable grounds to believe that it is virtually impossible to grant an untested franchise under franchise agreements within the framework of Ukrainian governing law. In particular, under the Civil Code, a franchise agreement covers commercial experience and goodwill of the franchisor.[3] Moreover, the franchisor is obliged: (1) to provide the franchisee with technical and commercial documents and any other information necessary to perform the rights set forth by the franchise agreement; and (2) to ensure continuous technical and consulting support for the franchise operation.[4] Needless to say, this is impossible in the absence of at least one working franchise.

It seems reasonable to assume that violation of these obligations by franchisors may be potentially considered a serious breach, entitling franchisees to request the termination of a franchise agreement and indemnification of damages.

Form of franchise agreement

Under Ukrainian law,[5] franchise agreements shall be concluded in the form of a single document and in writing. Otherwise, they are regarded as null and void.

Until April 2015, the registration of franchise agreements was the talk of the town because it was one of the biggest obstacles to the development of franchising in Ukraine. Specifically, under the previous requirements, a franchise agreement, its amendments and termination were subject to registration. Even though failure to register the franchise agreement did not make it null or invalid, it had negative consequences. First, the parties to the franchise agreement were entitled to refer to the agreement and any amendments in their relations with third parties only after state registration. According to the existing case law, third parties were defined very broadly as any persons, except for the parties to the agreement, including other natural persons, legal entities and state agencies, including tax and customs authorities. Thus, in some cases, the tax authorities refused to accept the franchise agreement for tax purposes in the absence of state registration. Second, failure to register the franchise agreement divested the parties of the right to refer to this agreement in the case of future disputes.

The main problem with registration was the absence of order. Some state authorities refused to register franchise agreements while others merely stamped agreements as ‘registered’, which had unclear legal status. To be on the safe side, often parties concluded a set of agreements (for example, a licensing agreement, services agreement and supply agreement) instead of a franchise agreement.

In April 2015, the registration requirement was abolished. In December 2017, however, the Draft Lawon Franchising No 7430 was registered with parliament.[6] If adopted, the same registration requirement will be applicable again.

Product liability

The Civil Code and the Commercial Code[7] stipulate that the franchisor and the franchisee bear subsidiary liability for consumer claims related to the quality of products manufactured by the franchisor and further resold by the franchisee. At the same time, when the franchisee is a producer of the franchisor’s products, they bear joint and severable liability.

Notably, the provisions do not fully match the Law on the Protection of Consumers’ Rights (the ‘Law’), which specifically regulates product liability claims brought by consumers who qualify legally as natural persons. Pursuant to the Law, a consumer with this status is entitled at their discretion to bring a product liability claim against: (1) the seller of the products (ie, the franchisee); (2) the manufacturer of the products;[8] or (3) a designated representative office or branch of the manufacturer or seller.

Taking into account the mandatory nature of these requirements, one could reasonably believe that any provisions stipulating the transfer of the risk of product liability claims solely to a franchisee may be regarded as restricting consumers’ rights and thus invalid under the Law.

Termination of franchise agreements

It goes without saying that based on the freedom of contract principle, franchisors and franchisees are free to terminate a franchise agreement upon their mutual consent at any time after its conclusion and for any reason.

At the same time, the Civil Code[9] and the Commercial Code[10] stipulate some specific circumstances for the termination of franchise agreements, namely:

  • each party to a franchise agreement concluded for an indefinite period has the right at any time to terminate the agreement by notifying the other partynot less than six months prior to terminationif a longer term is not stipulated in the agreement;
  • the franchisee, which has duly performed its obligations under the franchise agreement concluded for a definite period, is entitled to prolong for the same term or enter into a new franchise agreement under the same terms and conditions as the original agreement. Only the laws shall stipulate the conditions, subject to which the franchisor will be allowed to decline the agreement conclusion for the new term. It is worth emphasising that there are presently no such laws. Moreover, it is unclear exactly what should be understood by due performance of obligations or whether the conditions shall be the same or some of them may be changed;
  • the franchise agreement shall be terminated if the franchisor’s rights to a trademark or other indication are terminated without replacement by similar rights. If the trademark or other indication of the franchisor is subject to amendment, the franchisee is entitled to request termination of the agreement. If the agreement is not terminated, the franchisee is entitled to request a decrease in franchise-related fees;
  • the franchise agreement shall be terminated if the franchisor or franchisee is declared bankrupt; and
  • the franchise agreement shall be terminated in case of death of the franchisor, if their rights and obligations under the franchise agreement were not transferred to their heirs or other persons conducting business activities.

Non-compete obligations

The Civil Code and the Commercial Code[11] directly allow for the introduction into franchise agreements of the following restrictions:

  • the franchisor’s obligation not to grant to other persons a similar set of franchise rights on the territory allocated to the franchisee and to refrain from similar activity on the territory;
  • the franchisee’s obligation not to compete with the franchisor on the territory covered by the franchise agreement within the business activity carried out by the franchisee with use of the rights transferred by the franchisor;
  • the franchisee’s obligation not to obtain similar rights from the franchisor’s (potential) competitors; and
  • the franchisee’s obligation to approve with the franchisor the location of premises to be used for sale of products, works and services as well as their internal and external design.

At the same time, the Civil Code[12] directly prohibits any stipulation in the franchise agreement terms and conditions:

  • entitling the franchisor to establish prices for products, works, services or maximum or minimum price rates; or
  • providing that the franchisee shall sell products, services only to certain kinds of consumers or exclusively to consumers located on the territory defined in the franchise agreement. The said provisions shall be regarded as null and void.

Notably, Ukrainian law and case law are silent on the subject of whether the parties are allowed to set out post-contractual non-compete obligations and if they are, which requirements shall be complied with.

Trademarks and other IP objects

Often unregistered trademarks or other intellectual property rights objects (‘IP objects’) are licensed under franchise agreements in Ukraine. According to the Civil Code,[13] if certain IP objects are effective only after registration (eg, trademarks, inventions and utility models), they may be licensed only after registration. Thus, all IP objects to be licensed under franchise agreements must be duly registered in Ukraine under national or international procedures. Notably, there is at present no case law addressing the legal consequences of licensing unregistered IP objects under a franchise agreement and no way of knowing whether they would be regarded as invalid or even null and void. The main risk of using unregistered IP objects is that neither the franchisor nor the franchisee will be able to fully protect against and prohibit unauthorised use of the IP objects by a third party. Recent case law revealed an additional risk of tax deductibility of the royalties paid for the use of unregistered IP objects. The case law confirmed the tax authorities’ position that royalties paid for usage of IP objects that are not duly registered shall not be tax deductible. Therefore, franchisors and franchisees should make all efforts to protect the status of their IP objects in Ukraine.

[1] Ch 36 of the Commercial Code of Ukraine and Ch 76 of the Civil Code of Ukraine regulate franchise agreements in Ukraine.

Instead of internationally recognised terms – ‘franchising’, ‘franchise agreements’, ‘franchisor’, ‘franchisee’ – Ukrainian law uses the terms ‘commercial concession’, ‘commercial concession agreements’, ‘titleholder’ and ‘user’. For avoidance of doubt, we will use the internationally recognised terminology.

[2] Art 229 of the Civil Code stipulates the legal consequences of an agreement concluded by mistake, while Art 230 stipulates the legal consequences of an agreement concluded by fraud.

[3] Art 1116 of the Civil Code.

[4] Art 1120 of the Civil Code; Art 370 of the Commercial Code.

[5] Art 1118 of the Civil Code; Art 367 of the Commercial Code.

[6] See the Law Draft accessed on 1 February 2019.

[7] Art 1123 of the Civil Code; Art 373 of the Commercial Code.

[8] The definition of ‘manufacturer’ is very broad and comprises: (1) the manufacturer producing the products (most probably, the franchisor); (2) a person claiming to be the product manufacturer by placing its name, trademark or other identification element on the product, packaging or in accompanying documents; or (3) an importer of the products (most probably the franchisee).

[9] Arts 1126–1129 of the Civil Code.

[10] Arts 374–375 of the Commercial Code.

[11] Art 1122 of the Civil Code; Art 372 of the Commercial Code.

[12] Art 1122 of the Civil Code.

[13] Art 1109 of the Civil Code.

 

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