Franchising/Commercial Concession Agreement

Search of the most efficient path of business development is a key matter of concern for Ukrainian businessmen. We would like to tell in this article about the system of mutually beneficial partner relations that have been existed in the world for more than a hundred years - franchising.

The franchising as a form of business throws back to medieval England , when citizens obtained franchises (permits) to sale their goods on the territory of a town or city. The franchising appeared in more or less modern form in a system of "associated houses" used by English brewers in XIX century, according to which a brewer received in exchange for a granted loan an inn as an outlet for his beer and alcoholic drinks.

The world practice has proved to date that the franchising is one of the most effective methods of business development. Its essence consists in the fact that in exchange for a part of your profit and independence you receive a world-known trademark (brand), time-proved method of conduct of business and complete set of technologies and know-how.

Actually, the franchising is an organization of business, when a company-owner (franchisor) transfers to an independent businessman or company (franchisee) the right to sell goods and services of this company in exchange for the franchisee's obligation to sell these goods or services:

•  with observance of certain quality characteristics,
•  with application of stipulated technologies,
•  under a developed plan,
•  at a certain specified place
•  under an agreed trademark.

Conditions of mutual relations of the parties may vary and all of them are specified by a franchising agreement, which at the same time is a "guide to action" for the franchisee. This scheme is beneficial to both parties.

Thus, it opens new borders for the franchisee, enables to begin a new business successfully tested by the franchisor. The franchisee obtains the right to use a well-known trademark (brand), opportunity to receive all benefits from the franchisor's wide advertising activity, technology of conduct of business, as well as access to credit resources, since the franchisor may act as a guarantor of credits.

At the same time the franchisor also gets its benefit. It gets a chance to extend its business in new markets, to come near to consumers, it is released from necessity of the day-to-day management, since the franchisee is nevertheless burdened with the primary responsibility for success of business. Besides it minimizes the risk of loss of its own capital and even receives additional incomes owing to the franchisee's payments.

Anyhow all aspects of mutual relations are kept in check of the parties - y ou always have the right to assert your interests (it is desirable to do before conclusion of an agreement) and predetermine all eventual nuances of the conduct of business.

On the basis of its outward signs the franchising is similar to the process of establishment of representations. However the internal mechanism of mutual relations of the franchisor and franchisee enables to speak about essential differences between these models of business. First, the franchising is characterized by legal independence of the franchisee and one cannot say this about a representative. Second, all mutual relations of the franchisee and franchisor are governed by an agreement between the parties providing their free will.

Standard conditions of a franchising agreement are as follows:

• transfer of rights to use a trademark, firm-name, know-how, technology, etc.;
• obligation of the franchisor to arrange preliminary training of the franchisee's personnel;
• right of the franchisor to control the process of production of goods (provision of services) by the franchisee;
• obligation of the franchisee to observe certain specified requirements to the quality of products (services);
• establishment of the procedure of settlements, etc.

And third, the main difference between the franchising and representation is a source of finance. When establishing a representation the financial investments arrive from the parent company, and in franchising relations the burden of expenses falls on the franchisee's shoulders in exchange for the benefits granted by the franchisor (brand, technologies, training of staff, advertising, etc.).

For the sake of definiteness we cite an approximate list of the franchisee's expenses. First of all, it's an entrance fee provided by the majority of foreign companies. The rate of such fee amounts to 5-10 % from the cost of establishment of one retail outlet. After concluding a franchising agreement, the franchisee undertakes obligations to pay periodically a certain part of the gained profit. The procedure, terms of payment and its rate are specified in each agreement individually. More often the part of profit is specified in percentage terms, however in some cases a compensation in the agreement is specified as a flat fee. It is a peculiar form of the franchisor's protection against lack of profit.

Referring to the Ukrainian market, the franchising system is fairly new for it. However, in author's opinion, it should soon become very interesting to the representatives of the Ukrainian business circles, many of which can today act both as franchisors, and franchisees. Franchisors should consider their business expansion policy and declare their intents to the interested public. Contenders to the title of franchisee can simply start to search the companies looking franchisees in different countries of the world. All these lists together with financial conditions are published in foreign mass media and of course in the Internet.

When a desirable partner is found, the following important step will be conclusion of a franchising agreement.

On January 1, 2004 , a new Civil Code came into force in Ukraine providing a commercial concession agreement corresponding to the franchising agreement according to its legal nature. A whole chapter of CCU - Chapter 76 - is dedicated to the commercial concession agreement.

The subject of the above agreement is a right to use intellectual property objects (trademarks, industrial designs, inventions, works, trade secret, etc.), commercial experience and business reputation.

And it is stipulated that the mentioned rights will be transferred in package (which distinguishes essentially the commercial concession from the license) and subject to payment.

It is significant that only subjects of business activity (both legal entities and individuals) may be parties to the commercial concession agreement. Such provision corresponds to the definition of agreement and emphasizes once again that the commercial concession agreement is used exactly for the purpose of business activity.

The commercial concession agreement shall be subject to the state registration by a body, which carried out the state registration of an owner of rights (or a person, which will use the package of rights, if the owner of rights is non-resident). The same relates to the registration of termination of agreement.

At present the procedure for registration of the commercial concession agreement (and its termination) is not regulated, i.e. there is no subordinate legislation in this field.

Since the registration of legal entities and individual entrepreneurs is carried out at present by state registrars, it is possible to suppose that they will be charged with a function of the registration of commercial concession agreements.

According to the general provisions of CCU concerning agreements, the commercial concession agreement shall be considered to be concluded only from the moment of the state registration. From the same moment, according to Article 1118 of CCU, the parties may refer to the commercial concession agreement in their relations with the third persons.

Let's review for comparison some features of franchising regulation in foreign countries.

The legislation of the Russian Federation also lacks a term of franchising but stipulates a commercial concession agreement, under which one party undertakes to transfer to another party for a certain compensation for a fixed or indefinite term the right to use a package of exclusive rights in the business activity. Such agreement should be registered with a registering body at the place of registration of an owner of rights (or user, if the owner is a foreign person) but the registration with the federal patent office is obligatory too.

The legislation of the USA and Canada gives definition of a so-called "franchise". In many states (Washington, Hawaii, California, etc.), the registration of the franchise before conclusion of an agreement between the parties is obligatory.

Characteristic feature of the legal regulation of franchising in the USA are detailed regulated requirements to the franchise information and documents, which should be provided by an owner of rights to a potential franchisee. The similar approach is reflected also in the legislation of several provinces of Canada . The legal relations after concluding the franchising agreement in these countries are left in many respects at the discretion of the parties, or the rules of the respective law (contract, competitive, etc.) are applied to them.

The French legislation stipulates also the 20-day term, within which a franchisor is obliged to provide the franchise information to a potential franchisee. The same term is also applied in Spain , where in addition a register of franchisors is kept.

In Brazil, a package of documents disclosing the essence of the proposed franchise should be agreed with a patent office, and only after that it may be provided to a potential franchisee not later than 10 days prior to signing thereof. In Mexico, the agreement itself is subject to the registration with a patent office.

According to CCU, an owner of rights provided under the commercial concession agreement is obliged to transfer to another party the technical and commercial documents, other information necessary for the exercise of rights, as well as to inform such party and its employees on the related matters.

The preliminary disclosure of information is not stipulated for the commercial concession agreement. This matter is left fully at the discretion of the potential parties to the agreement.

CCU does not contain a precise definition of information and documents, which should be transferred under the commercial concession agreement. Therefore it is necessary to attend to the mentioned question, when concluding the agreement, so that the transferred package of documents really gives an opportunity to use the successful experience of the owner of rights in business.

The permanent consulting and technical assistance, including training and professional development of employees, and quality control of the goods (works, services) are determined as conditions applied "by default". However a particular agreement can regulate otherwise the relations of the parties not charging an owner of rights with the above obligations.

Nevertheless, based on the nature of the commercial concession agreement and its ultimate end, i.e. development of the so-called franchising network, the mentioned technical and consulting assistance can be an important contribution to the successful development of the relations of the parties and maintenance of reputation of the owner of rights.

Thus, the US federal laws stipulate that a franchise means granting of aid in methods of business administration by an owner of rights to a franchisee. The federal legislation of Mexico stipulates that granting of technical knowledge and assistance in production of goods (rendering of services) for the purpose of maintenance of the image and reputation of an owner of rights are necessary preconditions of the franchising legal relations.

CCU establishes the obligations of a user as follows:

.  to use the trademark and other designations of the owner of rights in a manner specified in the agreement;

.  to ensure compliance of the quality of the goods (works, services) produced (performed, provided) under the commercial concession agreement with the quality of the similar goods (works, services) of the owner of rights;

.  to follow instructions and directions of the owner of rights aimed at ensuring the compliance of the character, methods and conditions of use of the package of granted rights with the use of these rights by their owner

.  to provide any additional services to buyers, which they could expect purchasing the goods (works, services) directly from the owner of rights;

.  to inform buyers in the most obvious manner of the use of the trademark and other designations of the owner of rights under the commercial concession agreement;

.  to keep the trade secrets of the owner of rights, other confidential information received therefrom.

Based on the substance of the provisions of CCU, one of the cornerstones of the commercial concession agreement are, nevertheless, exclusive rights in intellectual property objects, as a rule - trademarks.

Thus, in case of the termination of right in a trademark or other designation being the subject of a commercial concession agreement the agreement itself should be terminated. The above provision is not applied to other rights granted under agreement, their termination shall not entail the termination of the entire agreement, only effect of the provisions concerning such right shall be terminated, and the user can refer to this as a ground for demanding the reduction of the payment under agreement.

For example the French legislation stipulates a number of general requirements to the agreements providing the grant (transfer) of rights to use intellectual property objects, including the franchising agreements.

In the USA , for the purpose of application of the federal legislation to the franchising legal relations, such legal relations should provide the rights in a trademark, control over the franchisee's activity and fee for use of the granted rights.

On the whole the subject of a commercial concession agreement is far broader than the subject of a license agreement.

The commercial concession agreement can also include the so-called "special" conditions. For example, a number of conditions concerning competitive policy can be stipulated: obligations of the user not to compete with the owner of rights on a certain territory, not to receive the similar rights from any competitors or potential competitors of the owner of rights. Such conditions limit the rights of the user (franchisee). The rights of the owner can also be limited by obligations not to transfer the similar package of rights to other persons, or to refrain itself from similar activity on a certain territory.

The commercial concession agreement can not limit the user in pricing for goods or services, though, for example, the fixing of prices lower than prices of the owner of rights can be considered as competition. It is interesting that the legislation of the European Union, since June 1, 2000 , has allowed the franchisor to recommend the prices and even to fix the price ceiling but prohibited to fix the exact prices or to determine the minimum prices.

Attention should also be claimed to the matter of responsibility for the claims brought against the user as a manufacturer of goods or in connection with non-compliance of the quality of goods (of works, services). In the first case the owner of rights bears responsibility jointly with the user, and in the second case - the solidary responsibility. Such provisions should stimulate the high quality of products (services) both of the owner of rights and the user, and they also explain the expediency of including in the agreement of the provisions concerning the quality control over the user's products (services). Moreover, it is expected that the granting of the considerable consulting and technical aid in business administration by the owner of rights to the user can protect both parties from losses related to the claims.

Thus we can say that since January 1, 2004 the franchising agreement has obtained in Ukraine a new legal covering in the form of commercial concession.

The Civil Code governs the most general aspects of the commercial concession (franchising) legal relations, a great number of issues should still be solved, which inevitably arise both during conclusion of agreements and execution thereof.

Nevertheless, the preconditions for the development of franchising systems, which efficiency is confirmed by the world practice, have been laid.

Let's hope that the appearance of legislative regulation of the franchising relations will become yet another impact for the introduction and wide development of this mechanism in Ukraine