After 24.02.2022 many western brands have declared either suspending their activities in Russia, or leaving the market. However, in certain cases companies that structured their business under the franchising model, have found themselves unable to close the stores due to legal limitations.
Moreover, Russian Government has been introducing counter-measures against the sanctions imposed by foreign states. This includes, in particular, regulations geared at enabling local businesses to retain the use of intellectual property belonging to right holders from the states that introduced sanctions.
Franchising Models Used in Russia
Franchising model implies that a right holder grants to a third party a package of rights allowing it to run the business under an established brand and use the technologies, experience and standards developed by the right holder.
Usually, franchisors do not acquire shares in franchisees, since franchisees are expected to run the business on their own. Instead, franchising is typically structured under one of the following contractual models:
- Direct franchise agreement between the right holder and each franchisee
- Development franchising that provides granting to the franchisee the right to develop a specific territory by opening an agreed number of units
- Master franchising under which one partner concludes an agreement with the right holder and enjoys the right to grant subfranchises to other businesses.
In contrast to companies that run and control the business upon their own discretion, the freedom of franchisees to decide upon their presence on the market is limited by the law of contract.
Unilateral Termination of Franchising Agreements by Right Holders
The Russian Civil Code provides that obligations must be duly performed in accordance with the conditions of these obligations and requirements of law. Unilateral withdrawal from or change of obligations is prohibited unless otherwise is defined by law.
Under Russian law, unilateral termination of the franchising agreement by either party is possible if the agreement is concluded for an indefinite term. Such termination is subject to a 6-month notice period unless a longer term is established by the agreement.
Unilateral termination is also possible for fixed-term and indefinite agreements with a 30-days' notice if the agreement provides for the possibility of termination against payment of a certain compensation.
If the above termination options are not applicable under a particular franchising agreement, termination by the franchisor is possible only if the franchisee has committed a breach and did not cure it within a reasonable timeframe following receipt of written notification of the franchisor, or has committed such a breach repeatedly within 1 year. In particular, Russian law allows such termination in case of the following breaches:
- Non-compliance with quality requirements
- Gross violation of the franchisor's instructions and directions intended to ensure compliance with the character, manner and conditions of the use of the provided exclusive rights; and
- Failure to timely pay remuneration to the franchisor
If the general termination options do not apply, Russian courts refuse to recognize unilateral repudiation of contracts by franchisors if they fail to prove the breaches.
Russian Law Consequences of Terminating Activity without Legal Ground
Under Russian law all participants in civil law relations must act in good faith regarding the establishment, exercise and protection of civil law rights and the performance of obligations.
Execution of civil rights with the only intention to harm another person, other actions to circumvent the law with illegal purpose, as well as any other execution of rights in bad faith is recognized as abuse of right and expressly prohibited.
In the current situation, massive winding-up operations on the Russian market by foreign companies may have severe impact on the 140 million population of the country depriving it of the very basic amenities, jeopardizing their health and lives by causing deficit of food, hygiene products, vital services, etc.
If termination of activity is not justified by a legal ground, deliberate winding-up of established business, including repudiation of franchising agreements, may be considered as an intention to harm Russian population and businesses and therefore not recognized by Russian courts. Moreover, persons which are affected by the abuse of right shall be entitled to claim compensation of the incurred damages.
Obviously, potential attempts of franchisors to impede the activities of franchisees without economic justification may be treated as the abuse of right also if the franchisors do not terminate the agreement. This can be the case, for example, if the franchisors stop providing technical assistance, trainings, materials or products which the franchisees must receive from them or suppliers authorized by the franchisors due to the conditions established by the franchising agreement.
At the moment there is still no court practice regarding application of legislation on the abuse of right to termination of franchising agreements initiated by foreign franchisors after 24.02.2022. However, there is already an example of a case where the court refused to protect a British right holder in a dispute regarding trademark infringement against a Russian individual entrepreneur.1 In this case the court of first instance considered that in the end of February – beginning of March 2022 Great Britain introduced political and economic measures against the Russian Federation, its legal entities, individuals and officials. Taking into account these measures and the status of the claimant located in Great Britain, the court considered actions of the claimant as an abuse of right. Despite the somewhat awkward argumentation provided by the court in this particular case, and the fact that the decision in question most probably will be disputed by the claimant, a possibility of such rulings in the current conditions should not be ignored.
Termination of Franchising Agreements concluded under Foreign Law
In practice, franchising agreements granting franchises on the territory of Russia can be concluded under foreign law. However, in these cases certain mandatory rules of Russian law apply anyway. Such mandatory rules can be expressly stipulated or recognized as such due to their extraordinary importance (e.g, if they are aimed at protecting rights and legitimate interests of participants in civil relations). Foreign law will not apply if the consequences of its application would obviously contradict the fundamentals of the Russian legal system.
In this context, the author believes that if foreign law governing a franchising agreement provides to the franchisor broader termination rights than ones established by Russian law, currently there is a risk that Russian courts will not recognize their application.
Another important aspect that must be considered in this connection is an opportunity to resolve a dispute in a foreign government court or international arbitration court. The forum which is authorized to consider the disputes arising from the franchising agreement is usually defined by the parties directly in its text. Due to the absence of relevant international treaties decisions of government courts operating in most of the western countries, including the European Union and the USA, are not recognized in Russia. As to foreign arbitral awards, they are recognized and enforced on the basis of the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards.
At the same time, it must be considered that starting from June 2020 Russian Arbitrazh Procedure Code provides for an opportunity to refer the disputes involving parties affected by foreign sanctions to Russian government courts, even if the agreement establishes application of a foreign government court or an international tribunal located abroad.
Counter-Measures of the Russian Government in the Field of Intellectual Property
As a reply to sanctions imposed by foreign states upon Russia, Russian Government established a list of so called “unfriendly countries”. As of 27.03.2022 this list includes:
- Great Britain (including Jersey island and controlled overseas territories - Anguilla, British Virgin Islands, Gibraltar)
- European Union member states
- New Zealand
- Republic of Korea
- North Macedonia
- The USA
- Taiwan (China)
Special regime was introduced regarding different transactions with parties from these states, including in the sphere of currency control, transactions with real estate, export of certain goods, etc.
Regarding intellectual property, Government Decree No. 299 as of 06.03.2022 was adopted. According to the said Decree, patent holders connected with “unfriendly countries” will receive no remuneration for the use by third parties of compulsory licenses to their patents protecting inventions, utility models and industrial designs. In particular, this rule applies if a patent holder is a citizen of an “unfriendly country”, is registered, has its primary place of business or profit generation in such country.
Under the Russian Civil Code, the rights to use patents can be granted by the Russian Government to third parties without a consent of the patent holder in case of emergency related to ensuring the defense and security of the state, and protecting life and health of citizens. As a general rule, such granting of rights requires notification of the right holder and payment of commensurable compensation.
Furthermore, in accordance with the Federal Law No. 46-FZ as of 08.03.2022, in 2022 Russian Government may approve lists of goods to which certain provisions of the Civil Code regarding IP protection cannot apply. By the date of this article (27.03.2022) no such lists have been approved yet.
Most probably, such lists will be established in respect of inventions, equipment, software and technologies that might disappear from the market as the result of sanctions or deliberate actions of foreign companies which are not connected with any legislative prohibitions imposed by foreign states upon Russia, its citizens, legal entities or officials.
In addition, in accordance with the Draft Law No. 92282-8 which was introduced into the State Duma on 22.03.2022, it is proposed to impose a ban on unilateral termination of agreements aimed at execution and protection of intellectual property by one of the parties, unless the other party substantially breaches the agreement. Moreover, the validity term of license agreements shall be prolonged for the duration of sanctions, unless the Russian individual or legal entity refuses to prolong the relationship. It is now uncertain how the Government will enforce these regulations in case they are approved.
Russian legislation is now changing extremely fast, which is challenging both for foreign and local businesses. Companies that would like to reconsider their presence in Russia after 24.02.2022 are strongly recommended to seek professional legal assistance of advisors practicing Russian law, who can help navigating in the changing legal environment.
1 Decision of the Arbitrazh court of Kirovskaya Region as of 03.03.2022 in the case No. А28-11930/2021
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.