Distribution and Franchising in Russia

Distribution
Franchising

For the purposes of dynamic development of any large and ambitious company, entering a new market is always extremely vital. For the company that, for some reason, does not plan to create its own company, affiliate or subsidiary in a foreign jurisdiction, there are two ways of international expansion: (1) through distribution or (2) under franchising. The Russian market is no exception here – many foreign companies have entered (and keep entering it) by using one of these two commercial schemes.

Below are key practical and legal aspects of doing business by using these instruments in Russia.

Distribution

Distribution can be defined as a business activity of one company (Distributor) aimed at organizing sales of goods of the respective seller or product manufacturer (Company) in a certain territory and during the agreed term. In addition, such sales will be usually accompanied with provision of certain services for bringing the contractual goods onto the market, their promotion and advertising, as well as after-sales services. Typically, a distribution agreement is understood as the written agreement of the parties under which the Company appoints the Distributor for a contracted territory and within a specific term to sell, market and distribute a particular product of the Company bearing a trademark and/or other intellectual property rights, as stipulated under such agreement.

Practically, the legal basis for distribution is a supply agreement, which is mixed with service, agency and other forms of parties’ arrangements, depending on the structure of their business relationship. Quite often, a distribution agreement will be accompanied by other supportive documents or ancillary agreements, such as – guarantees, trademark/IP license agreements, service agreements, option agreements and others. That is why the distribution transaction is much broader in its content and volume, than merely supply, license or service agreements.

Within the framework of distribution agreement, the Company can inter alia assume the following obligations towards the Distributor:

• To secure methods of product supply and delivery in the contracted territory;
• To provide information and advertising materials for the sale of goods;
• To grant exclusive or non-exclusive rights to use trademarks and other IP assets in the contracted territory;
• To provide training programs for employees of the Distributor; and
• To secure all other/necessary advisory and technical support during the term of the contract.

Pursuant to the provisions of such contract, the Distributor may be obliged towards the Company:

• To accept and distribute goods in the contracted territory;
• To pay the price of the contract to the benefit of the Company;
• To limit product sales related to direct competitors of the Company (subject to antitrust restrictions);
• To follow the Company business network standards during the term of the contract;
• To follow the Company’s standards related to advertising and promotion of goods;
• To follow the Company’s instructions related to the use of trademarks and other IP assets;
• To deduct a certain percentage of revenues or profits to a special marketing fund;
• To refuse to register trademarks, domain names and other IP rights similar to those owned by the Company (to avoid infringement and confusion on the market).

As such, a distribution agreement is not regulated by the provisions of Russian law, comparing to other contracts or agreements. Indeed, due to the dispositive nature of rules of civil legislation in Russia, parties can insert more ‘freedom’ or ‘essential’ terms and conditions into such contract, taking into account the legal restrictions established by other pieces of Russian legislation, including from the antimonopoly, Customs, tax perspectives and technical regulations.

It should be also noted that distribution is a complex business model and it can be the legal basis for long-term commercial cooperation between the Company and the Distributor. At the same time, such agreement will contain specific termination clauses under which the Company can quickly repudiate from the contract, if the Distributor is in breach or improperly fulfill its contractual obligations during the term of the same.

Franchising

Franchising is also a method of distribution. However, it is more based on IP assets rather than goods and services supplies.

There is a separate Chapter 54 of the Russian Civil Code, which is dedicated to franchising. Franchise relationship may be also impacted by other chapters of the Russian Civil Code and local laws, including those relating to general contract law and law of obligations, real estate and consumer protection, taxation and currency control regulations.

According to Article 1027 of the Russian Civil Code, under the contract of ‘commercial concession’ (i.e., franchise agreement), the franchisor agrees to grant the franchisee, for consideration, within or without the term, the right to use a set of intellectual property rights, including trademarks and other IP rights, such as trade names and know-how, in the business of the franchisee. In other words, an IP license grant will be the principal legal basis for the franchise agreement under Russian law.

The key element of franchise agreement is a trademark, which must be protected (registered) in Russia. In the absence of national or international trademark protection (registration), the contract may not be classified or interpreted as a franchise under Russian law. In addition to the licensed trademark, the franchisor shall grant to the franchisee at least one additional and properly protected IP subject matter, or all of them, such as: trade name (e.g. logo), copyrighted subject matter (e.g. design), software (e.g. computer program), or know-how (e.g. operations manual). If such (additional) IP element is missing, or has not been provided to the franchisee, the agreement will not be treated as a franchise. Russian law emphasizes that a franchise is a bundle (set) of IP rights to be granted (licensed) from one party to another.

In practice, all types of franchises are used in Russia, including direct franchising, master franchising, sub-franchising and multi-unit franchising. If it is master franchising or sub-franchising, the franchisor’s consent must be explicitly given in the underlying agreement or separately.

Pre-sale franchise disclosures are not stipulated by the Russian law. Nevertheless, pre-contractual and contractual disclosure obligations may be established on the basis of the civil-law doctrine of culpa in contrahendo and the main principle of good faith at the time of contractual negotiations or on the basis of agreement of the parties.

When a franchise agreement is signed, the franchisor will be obliged to provide technical and commercial documentation, and any other information necessary for franchisee to develop and operate the franchise in the contracted territory. The franchisor has to instruct the franchisee (its employees) on the related technical and commercial aspects associated with the relevant operations (e.g. by way of training or similar sessions).

A franchise, even if set out by the agreement governed by a foreign law, must be recorded with Rospatent. A franchise that is not recorded with Rospatent will be regarded as invalid (Article 1028 (2) of the Russian Civil Code). Therefore, in order to close the deal, it is necessary to file an application for franchise recordal and obtain franchise registration upon the execution of the contract.

From the IP perspective, the contract should address the following material provisions:

• Subject matter (trademark registration and description of the other licensed IP rights),
• Franchised products (goods/services under the licensed trademark registration),
• Scope of rights (permitted use of trademark/IP and description of franchisee’s business operations),
• Compensation (franchise-entrance fee, franchise ongoing fees, etc.),
• Type of franchise (exclusive or non-exclusive franchise),
• Term and termination (mutual and/or unilateral),
• Territory (whole of Russia or certain specific areas/regions),
• Sub-franchising (permitted or prohibited).

Of course, the franchise agreement will also contain other important clauses, including duties of the parties, opening and exploitation of units, product advertising and quality control, protection of IP rights and confidential information, governing law and dispute resolution.

According to Article 1037 of the Russian Civil Code, any party may terminate a franchise agreement with an indefinite term at any time. In that case, six months’ prior written notice is required, unless the contract indicates a different notice period. Generally, either party may terminate the franchise relationship at any time by sending a written notice to the other party 30 days in advance and by paying the termination fee.

Also, if the right to a licensed trademark (or trade name) is lost for any reason, the franchise agreement will be terminated, unless any similar (effective) exclusive right is granted (substituted) by the franchisor. Finally, if the franchisor or franchisee becomes insolvent (bankrupt), the franchise agreement will be terminated.