This article provides a comprehensive and detailed overview of the rules applicable to the termination of franchise agreements on statutory or contractual grounds, or following agreement between the parties under Ukrainian law. The authors further consider the consequences of termination, in particular in the areas of non-competition provisions and trademark registration.

Franchising is a popular tool for companies wishing to capture new markets or to increase the presence of their products or services therein. Ukraine, a market with around 48 million consumers is no exception. Franchising is being used in apparel footwear sale, fast-food, provision of different services (laundry, cleaning, educational) and so on.

The institution of franchising is rather new to Ukrainian law. Franchise relationships were specifically regulated for the first time in Ukraine in 2004, when the Civil Code and the Commercial Code of Ukraine came into effect1.

Even though there are a number of national peculiarities and some pitfalls, in this article we will focus only on issues related to termination of franchise agreements under Ukrainian law.

Statutory regulation of the termination of franchise agreements

Chapter 36 of the Commercial Code of Ukraine and chapter 76 of the Civil Code of Ukraine regulate franchise agreements in Ukraine. They address, among other issues, the termination of franchise agreements and the consequences of termination.

"Franchise relationships were specifically regulated for the first time in Ukraine in 2004, when the Civil Code and the Commercial Code of Ukraine came into effect"

Generally, issues related to termination of franchise agreements are regulated in Articles 1126-1129 of the Civil Code and Articles 374-375 of the Commercial Code, which provide that:

(i) 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 party not less than 6 months prior to termination if a longer term is not stipulated in the agreement;

(ii) the franchise agreement shall be terminated if the franchisor's rights to a trademark or other indication are terminated without replacement by similar rights. In addition, when the trademark or other indication of the franchisor is amended, the franchisee is entitled to request termination of the agreement;

(iii) the franchise agreement shall be terminated if either the franchisor or franchisee is declared bankrupt;

(iv) the franchise agreement shall be terminated in case of death of the franchisor, if his/her rights and obligations under the franchise agreement were not transferred to his/her heirs or other persons conducting business activity.

At the same time, the parties are free to terminate the franchise agreement upon their mutual consent at any time after its conclusion and for any reason.

"Most probably [...] if a foreign law is chosen to govern the agreement, termination related issues shall be determined by the provisions of that foreign law."

Termination or non-renewal of franchise agreements governed by the law of a different jurisdiction

Most probably, according to Article 47 (1) of the Law of Ukraine "On International Private Law", if a foreign law is chosen to govern the agreement, termination related issues shall be determined by the provisions of that foreign law. However, as of today there is no case law or official interpretation of franchising termination issues in Ukraine. It is therefore unclear whether the above provisions of the Civil Code and the Commercial Code would be regarded as mandatory and would therefore apply notwithstanding the foreign governing law chosen by the parties.

Franchisor's right to terminate - grounds for immediate termination, opportunity for franchisee to remedy the breach, notice period

Both Ukrainian law and case law are silent on these issues, except for the notice period to be met if the franchise agreement is concluded for an indefinite period (see above).

Expiry - requirement to grant new term on expiry of initial term, minimum number of years for the initial term, specific grounds for non-renewal of a franchise

Article 1124 of the Civil Code provides that a franchisee that has duly performed its obligations is entitled to enter into the franchise agreement for a new term under the same terms and conditions. It is unclear however, what should be understood by due performance of obligations, whether the conditions shall be the same or some of them may be changed. The franchisor is allowed to refuse to enter into the franchise agreement for a new term only in cases provided specifically by the law. However, as of today neither the Civil Code nor the Commercial Code set forth any cases for such refusal.

Franchisee's right to terminate or "cooling off" periods

Notably, when the trademark or other rights of the franchisor are amended, the franchisee is entitled to request termination of the agreement and indemnification of damages. If the agreement is not terminated, the franchisee is entitled to request a decrease of franchise related fees.

Unilateral termination of a franchise agreement

Ukrainian law stipulates the following forms of agreement termination:

(i) by mutual agreement of both parties;

(ii) by a court authorized to terminate the agreement upon unilateral request of either party in cases set forth either by law or by the agreement (the so-called "unilateral termination" - please see below for details) and

(iii) by unilateral refusal from the agreement by either party in cases directly set forth either by law or by agreement without applying to the court (please see below for details).

Unilateral termination

The Civil Code provides for two cases in which the court is allowed to terminate the contract on the request of one of the parties:

(i) In case of a significant breach of the contract by the other party. A significant breach is a breach of the contract by a party as a consequence of which the other party loses everything it expected to get when concluding the contract.

Neither Ukrainian legislation nor case law stipulates which breaches of a franchise agreement shall be regarded as significant allowing for unilateral termination of the agreement. However, we believe that a franchisee's undue use of the franchisor's trademarks, or non-payment or undue payment will, most probably, be regarded as significant breaches.

(ii) In case of significant change of the circumstances which guided the parties when concluding the contract, provided that the following conditions are met:

  • while entering into the contract, the parties thought that such change would not occur;
  • certain changes are due to conditions, which the interested party was not able to remedy in spite of all its diligence and prudence;
  • fulfillment of the contract would disturb the balance of the parties' property interests and would deprive the interested party of everything it expected to get when entering into the contract;
  • the essence of the contract or business practices do not result in the risk of the changed circumstances being born by the interested party.

Unfortunately, as of today there is no case law clarifying the issue of significant change of circumstances in respect of franchise agreements. However, according to the recent case law applicable to other types of contracts, the abolishment of tax privileges considerably affecting the profitability of the project, introduction of mandatory licensing being too burdensome for the parties were considered by courts as significant change of circumstances allowing unilateral termination of agreement.

(iii) In other cases established by law or the agreement.

"... when the trademark or other rights of the franchisor are amended, the franchisee is entitled to request termination of the agreement ..."

"... the parties should assess on case-by-case basis whether or not termination of the franchise agreement complies with the [principles of "good faith" and "fair dealing"]."

Unilateral refusal

Pursuant to Articles 214, 615, 651 of the Civil Code the agreement may be terminated by the party's unilateral refusal of the agreement if the right to such a refusal is determined by the agreement or by law. The unilateral refusal may be further challenged in the court. The parties are entitled to provide for the right to unilateral refusal as well as grounds for the latter e.g. refusal for breach of the contract etc. in the contract.

Taking into account the above, we believe that unilateral refusal is the vehicle that the parties to a franchise agreement would use in Ukraine to unilaterally terminate it without referring the above issue to the court. Therefore, below we refer to unilateral termination of franchise agreements by way of unilateral refusal.

Application of principles of "good faith" and "fair dealing"

First of all, neither the Civil Code nor the Commercial Code stipulates how the principles of "good faith" and "fair dealing" shall be applied to contractual termination rights.

At the same time, according to Article 3, 509 (3) of the Civil Code, principles such as justice, good faith and reasonableness are key principles of the Civil Code and all obligations shall be based on these principles. The case law is silent on how these principles should be applied or interpreted. Hence, the parties should assess on case-by-case basis whether or not termination of the franchise agreement complies with the above principles or not. We believe that in order to act in good faith the parties should not terminate without notice, should provide for a reasonable notice period prior to termination of the franchise agreement, should have balanced rights as to the unilateral termination etc.

Contractual termination of franchise agreements

Termination without cause

Generally, Ukrainian law does not prohibit stipulating the respective parties' right to terminate without cause in the franchise agreement. However, in the absence of relevant case law, it is unclear whether a court would consider such termination as being beyond the above principles of justice, good faith and reasonableness.

Termination for breach

Serious breaches that provide for immediate termination

Neither case law nor Ukrainian law provides for a list of breaches or their criteria allowing for immediate termination of a franchise agreement. At the same time, in our opinion the following may be regarded as serious breaches of franchise agreements: non-payment by the franchisee during a certain period, undue use by a franchisee of the franchisor's IP rights; non-performance by the franchisor of actions necessary to allow the franchisee's access to the respective IT systems of the franchising chain (e.g. global hotel reservation system).

Breaches where franchisee is allowed a period of time to remedy, failing which the franchisor can terminate

Both Ukrainian law and the case law are silent on the matter.

Termination for insolvency

Both the Civil Code and the Commercial Code stipulate termination of the franchise agreement if one of the parties is declared bankrupt.

Notice requirements

The Civil Code and the Commercial Code stipulate notification requirements only for termination of franchise agreements concluded for an indefinite period. Particularly, under Article 374 (3) of the Commercial Code and Article 1126 (1) of the Civil Code the respective notice to the other party shall be sent not less than 6 months prior to such termination, unless a longer term is stipulated in the franchise agreement.

As for the form of a termination notice, according to Article 654 of the Civil Code the contract shall be terminated in the same form as it was entered into, unless otherwise established by contract, law or business practice. Article 1118 (1) of the Civil Code, Article 367 (1) of the Commercial Code set forth a mandatory written form for the franchise agreement and Article 188 (2) of the Commercial Code stipulates that the party to the contract intending to terminate the agreement shall send to the other party a proposal on termination. On that basis, we believe that the termination notice in case of franchise agreements should be in writing.

There are no mandatory requirements as to the content of termination notices. According to our practice, it usually depends considerably on the grounds for termination and the relevant provisions of the agreement e.g. if the agreement is terminated because of either party's violation, the termination notice usually refers to such violations and in the end, stipulates directly the other party's intent to terminate the agreement starting from a particular date.

The method of delivery is also not specifically addressed in Ukrainian law. At the same time, in practice it is advisable to send a termination notice by such means that allows confirmation of receipt thereof by either party e.g. usually in Ukraine by registered letter with return receipt and description of attached.

In the absence of mandatory rules on notification issues, it is advisable to stipulate the issues above directly in the agreement.

"There are no mandatory requirements as to the content of termination notices."

Negotiations with franchisee following a breach notice/waiver of rights to terminate

Both Ukrainian law and case law are silent on the matter.

Franchisee action for wrongful termination - Grounds and remedies

The Ukrainian legislation does not contain any specific regulation as to franchisee actions for wrongful termination of franchise agreements. Hence, the general rules of civil law apply. A party may challenge unilateral termination before a court and request continuation of the contract and/or claim for damages arising out of such termination.

Agreed termination

Legal requirements

The Civil Code does not stipulate any mandatory procedure to be followed to terminate the franchise agreement voluntarily. The only requirement set forth by Article 654 of the Civil Code is that the agreement shall be terminated in the same form in which the agreement was concluded if another form is not set forth by the agreement or law or customary business practices. At the same time, bearing in mind that termination of franchise agreements is subject to state registration (see below), such termination shall be performed in writing.

Contrary to the Civil Code, the Commercial Code sets forth the procedure to be followed to terminate agreements, including franchise agreements. First, the party intending to terminate the agreement ("initiator") shall generally send the respective notice to the other party. Within 20 days after receipt of the termination notice, the other party to the agreement shall notify the initiator on the results of consideration thereof. If the parties do not agree on termination or the initiator does not receive any comments regarding the termination notice within the set term, a claim can be brought before the court. Noteworthy, neither Commercial Code nor case law clarifies whether this procedure is mandatory or whether the parties are allowed to deviate from this procedure in their agreement.

Required contractual terms

There are no requirements established by legislation or case law.

At the same time, termination is generally formalized by means of an additional agreement to the franchise agreement signed and sealed by both parties that contains the parties' express intent to terminate the agreement, the date starting from which the agreement shall be regarded as terminated and sometimes other covenants usually relating to settlement of all outstanding issues after agreement termination. Therefore, for unilateral termination it is advisable to set out in detail in the agreement a specific procedure of termination by written notice.

Notification to relevant authorities

First and foremost, pursuant to the Civil Code and the Commercial Code, the franchise agreements, amendments and termination thereof shall be registered by the state body that performed the state registration of the franchisor (if established under the laws of Ukraine) or of the franchisee (if the franchisor is established abroad).

Failure to comply with the registration requirement does not result in invalidity of the franchise agreement. However, the parties are not entitled to refer thereto in relations with third parties or in case disputes arise, until its due state registration.

At the same time, Ukrainian legislation does not stipulate the exact order of such registration. The responsible authorities usually refuse to register the franchise agreements and/or amendments and/or termination thereof. Therefore, in Ukraine the status of all franchise agreements and/or amendments and/or termination thereof is quite questionable. The latter is confirmed by recent case law.

Consequences of termination

Right for compensation under agency or other similar laws

As indicated above, both the Civil and the Commercial codes are silent as to the consequences of failure to renew a franchise agreement on expiry, even though it is mandatory if the franchisee duly performs its obligations. Moreover, the case law does not clarify this issue either. Ukrainian law also does not allow for the application of agency law to franchising relations.

Requirement to notify authorities or remove registration

Ukrainian law does not stipulate any restrictions on the appointment of new franchisees if termination of the previous franchise agreement is not registered.

Contractual enforceability of post termination non-compete provisions

Article 1122 of the Civil Code and Article 372 of the Commercial Code directly allow inclusion into franchise agreements of the following restrictions:

(i) The franchisor's obligation not to grant to other persons the similar set of rights for use on the territory allocated to the franchisee or to refrain from its own similar activities in this territory;

(ii) 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;

(iii) The franchisee's obligation not to obtain similar rights from the franchisor's (potential) competitors;

(iv) The franchisee's obligation to approve with the franchisor location of premises to be used for sale of products, works, services as well as their internal and external design.

"Ukrainian law does not require mandatory registration of the license agreement or license clauses for usage of intellectual property rights ..."

At the same time, the Civil Code directly prohibits inclusion in the franchise agreement of the following terms and conditions:

(i) entitling the franchisor to establish prices for products, works, services and/or maximum or minimum prices; and/or

(ii) setting out 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 above contractual provisions shall be regarded as null and void.

However, Ukrainian law does not stipulate whether non-compete obligations apply only during the validity of the franchise agreement or also after expiry thereof. The competition legislation also does not contain a direct answer to this question. At the same time, the Draft Order of the Anti-Monopoly Committee of Ukraine "On Approval of Typical Requirements to Concerted Actions of Commercial Entities related to Supply and Use of Products, Compliance with which Allows Performing such Actions without Permits of the Bodies of the Anti-Monopoly Committee" (the "Draft Order") allows non-compete obligations to be imposed after termination of the agreement if the following conditions are met:

(i) the obligation relates to goods or services which compete with the contract goods or services;

(ii) the obligation is limited to the premises and land from which the buyer has operated during the contract period;

(iii) the obligation is indispensable to protect know-how transferred by the supplier to the buyer;

(iv) the duration of the obligation is limited to a period of one year after termination of the agreement.

Even though as of today it is unclear when this Draft Order will be adopted, the Anti-Monopoly Committee of Ukraine will most probably follow the above approach even now.

Enforceability of contractual rights of franchisor or its nominee to buy business of franchisee on termination

Generally, following the rule of freedom of contract, the parties may give a franchisor the right to buy the franchisee's business. However, in practice there may be different options. If the franchisee is involved in several business spheres, incl. franchising, it is reasonable to set forth that only the franchising business shall be sold. If certain permits or mandatory licenses are required to operate the franchisee's business, it will not be possible for the franchisor to buy the franchisee's business. Instead, the franchisor will be allowed to buy only the premises etc.

Trade mark issues

Ukrainian law does not require mandatory registration of the license agreement or license clauses for usage of intellectual property rights (trademarks, innovations, industrial designs etc.) in the franchise agreement. However, voluntary state registration may be performed.

Therefore, if the parties to the franchise agreement intend to register the fact that certain intellectual property rights are licensed under the franchise agreement, they shall carry out two registrations, in particular: (a) mandatory state registration of the franchise agreement and (b) voluntary registration of licenses of certain intellectual property rights under the franchise agreement.

From a practical point of view, registration of license agreements or licenses may be beneficial for both franchisors and franchisees for the following reasons:

(i) State registration ensures proper notification of third parties on conclusion of the license agreements or issuance of licenses and on transfer of rights to use certain intellectual property rights to particular persons that is essential to ensure a sufficient level of protection for intellectual property rights against violations by the third parties;

(ii) State registration constitutes additional confirmation that intellectual property rights have been transferred without infringement of the rights of the third parties, which may be especially important in the event of the sale of the business by the franchisee;

(iii) State registration may further also be used to maintain registration of an intellectual property right in order to substantiate that certain intellectual property rights are actually used;

(iv) After state registration of the license agreement or the license, the State Service for Intellectual Property retains a copy of the latter, or extract from it, that can be used in the event of any dispute arising between the parties.

At the same time, certain difficulties may arise in the case of cancellation of a trade mark license registration on termination of a franchise agreement. According to the relevant Ukrainian legislation, the registration may be cancelled either by mutual agreement between the parties to be confirmed by the relevant application signed by both parties or by judgement. It may be quite complicated in practice to receive the signatures of both parties in case of franchise agreement termination (especially if such termination takes place because of infringements of either party). This should be borne in mind when deciding whether or not to register the license agreement/license clause of the franchise agreement.

As for provisions stipulating the removal of signs and materials bearing trade marks, trade dress or the return of relevant standard manuals after the termination of franchise agreements, these are widespread in Ukraine. Moreover, franchise agreements usually stipulate not only the obligation of the franchisee to remove the IP objects, but also strict liability in case of violation of this obligation.

Footnotes

1. Instead of internationally recognized terms - "franchising", "franchise agreements", "franchisor", "franchisee", Ukrainian law operates with the terms: "commercial concession", "commercial concession agreements", "titleholder", "user". For avoidance of doubt we will use herein the internationally recognized terminology.

Originally published in the International Journal of Franchising Law. Volume 10 – Issue 6 – 2012

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.