The Franchise Law Review: Ukraine
Franchising is still in the process of development in Ukraine. It remains a relatively new notion for the Ukrainian business community as it only appeared after the collapse of the Soviet Union in the early 1990s and had no legal framework for the following decade, until the Civil Code and the Commercial Code were adopted in 2003. Moreover, even though the Civil Code and the Commercial Code established a necessary platform, for another decade franchising regulation still lacked several important elements necessary for it to function properly. Ukrainian law still has a rather limited framework and the case law does not yet fully compensate for the missing components. Self-regulated non-governmental associations try to fill the void, particularly given that there has been no special governmental agency to regulate the offer and sale of franchises in Ukraine.
Despite the gaps and inconsistencies of the Ukrainian legal system, international and local franchise businesses have managed to find enforceable franchising structures or employed alternative arrangements to develop their business in Ukraine. For quite some time now, many international brands have successfully operated their franchise businesses, including, among others, McDonald's, Papa John's, KFC, GAP and InterContinental, along with a variety of local franchises in food, retail, services and other industries. The market continues to grow. The Ukrainian Franchise Association publicised information that more than 2,300 franchising companies are now members of the Association.
The recent necessary changes in applicable laws and the new Ukrainian government's general trend of reform towards a competitive and market-based economy give hope for further, even extensive, development of the franchising industry in Ukraine.
i Forms of business entities
A foreign business would usually incorporate in Ukraine to operate a substantial business in the country. A foreign franchisor, however, may choose not to do so if it only licenses its franchise to franchisees in Ukraine.
The typical franchisor would incorporate as a limited liability company (LLC), like most businesses in Ukraine. There are other forms of business entity available, such as a private enterprise or a joint-stock company. However, those other corporate forms are either under-regulated or over-regulated, while the LLC strikes a proper balance. A single-person franchisor may also register as an individual entrepreneur.
The Civil Code, the Commercial Code, the Law on Joint-Stock Companies, the Law on Limited Liability Companies (enacted in 2018) and the Law on State Registration of Legal Entities and Individual Entrepreneurs and Public Organisations govern the formation of business entities. Between them, these laws set a number of requirements for forming and maintaining a business entity.
The first step in establishing a legally formed entity in Ukraine is to file a registration form, founding resolution, statutory documents and (starting from 2020) shareholding structure, as well as copies of identification documents for non-resident ultimate beneficiaries), and to apply for registration of the company with a local state registrar.
Ukrainian law sets out some capital formation and maintenance rules for companies. In particular, a joint-stock company must have a minimum capital of not less than 6.25 million hryvnas2 at its formation. There are also restrictive rules regarding consideration paid for the issue of shares of joint-stock companies. There is no minimum capital requirement for registration of an LLC and capital formation rules are generally less restrictive for LLCs.
A company must have a distinctive name that also contains an indication of its corporate form. Each business entity must have an office located in Ukraine. A company must have at least one responsible director, who must be a natural person.
Business entities must all be registered with tax and statistic authorities, and with the Pension Fund of Ukraine. They are required to keep accounting records and file returns on a monthly, quarterly and annual basis.
Foreign business and foreign investment are generally subject to the national regime in Ukraine, which basically implies the same rights and possibilities as apply to local residents. Moreover, foreign investors have certain statutory guarantees under Ukrainian law and bilateral or multilateral treaties that protect their investment, such as a guarantee of profit repatriation and compensation of losses, a guarantee against nationalisation and a guarantee against changes in the law. However, because of strict currency control regulations, severe restrictions existed until recently with regard to the repatriation of investment and profits. With the enactment of the new Law on Currency in February 2019, currency restrictions were lifted. Nevertheless, the National Bank of Ukraine still reserves the right to temporarily re-introduce them to stabilise the national financial market.
Furthermore, certain limitations and restrictions do naturally apply to foreign businesses and foreign investment and these are mostly related to national security and strategic interests in certain important industries (e.g., financial services, railway, mining, agriculture, publishing and media). Since franchising is usually not related to the above-mentioned strategic industries, it typically does not raise any purely foreign investment restriction issues. It should also be borne in mind that the Ukrainian government currently pursues a sanctions policy in relation to Russia because of the backing of the insurgency in eastern Ukraine and the annexation of Crimea. Accordingly, a number of Russian companies and individuals are under sanctions, which would render their franchising activities in Ukraine impossible.
iv Real estate
The Ukrainian real estate market is structured and fairly well developed. Commercial real estate is rapidly expanding, and this is especially true for metropolitan areas. However, the development level still remains much lower than the usual level or trading area per capita found in Europe or the United States.
Real estate is normally leased or, less often, bought for franchising purposes. From a procedural point of view, real property sale and purchase transactions must be certified by a notary and rights to real estate registered with the relevant state register. Long-term lease agreements of three years and longer must also be notarised, and lease rights thereunder must be registered. This implies additional costs, but it also provides for greater certainty and protection. To avoid notarisation costs, lease agreements are often concluded for two years and 11 months with a pre-emptive right to renew the lease.
Lease agreements must contain certain mandatory provisions (e.g., lease object description, its value with indexation, rent with indexation, lease term and renovations), but, in general, the parties are largely free to determine specific terms and conditions.
i Trademark protection
Ukraine has a number of laws that regulate protection of intellectual property. In addition, the state is a member of international organisations and international agreements (e.g., World Intellectual Property Organization, the Berne Convention and the Paris Convention).
As for trademarks, they are subject to the territorial principle of protection and must be registered to enjoy protection. To safeguard a trademark in Ukraine, the foreign franchisor should either register the trademark in Ukraine directly with the Ukrainian patent office or apply for international registration to the WIPO through the Madrid System. The trademark registration is normally valid for 10 years and may then be extended further.
Some trademarks may qualify as well-known brands, which implies a stronger protection for the trademark holder. For this, a trademark must meet certain stringent criteria of identity and public awareness. To formalise such protection, the trademark holder must file an application with the State Intellectual Property Service of Ukraine, supporting it with substantive evidence, or obtain a court judgment in respect of a trademark dispute.
ii Know-how protection
Know-how is a novel and rather problematic notion for the Ukrainian legal system. Ukrainian law defines know-how as information obtained through experience and tests and that is:
- not public or easily accessible;
- substantive (i.e., important and useful for producing goods and rendering services); and
- defined (i.e., it is properly described in writing in sufficient detail such that it is possible to verify that it meets the criteria of being non-public and substantive).
In court practice, know-how is further defined as technical knowledge, experience, production secrets and information necessary for solving tasks of a technical or other nature. Know-how is understood to be the result of technical creation, technical or other information, necessary for the production of certain products, or a technical decision, performed as an invention, which is not duly patented. Know-how is often associated to commercial and trade secrets, and is therefore similarly protected. There are no formal filings required to receive legal protection. However, some franchisors also employ patent filings to protect some aspects of their franchise other than trademarks.
iii Data protection
Ukraine has rules governing the collection, use, processing and transfer of personal data. Pursuant to the changes in the personal data protection laws of Ukraine, there is no longer a requirement to register personal databases. According to the new rules effective as of the beginning of 2014, the processor of personal data is obliged to notify the Ukrainian Parliament Commissioner for Human Rights only if the processing refers to information related to a particular area of risk (e.g., data on race, political views, health status, sex life, biometric data or movement tracking). In any case, the data controller must ensure an adequate level of protection of personal data it uses and processes.
A company is normally required to obtain consent from an individual to collect and process his or her personal data, with some statutory exemptions. In particular, a company is not required to obtain a consent when it collects and uses basic personal information necessary for a transaction with a consumer or when the law specifically requires the company to collect and retain some personal information (e.g., for the purpose of employment).
When individual consent is required, it must be obtained in either written or electronic form that shows it has been explicitly granted. The company must then retain this confirmation document (information) during the whole time of processing.
With the entry into force of the EU General Data Protection Regulation in 2018, many Ukrainian companies maintaining business ties with the EU and European Economic Area (EEA) undertake to adjust their data protection policies to the legal requirements of that Regulation.
The Civil and Commercial Codes of Ukraine provide specific regulation of the ongoing relationship between franchisor and franchisee. In particular, these laws set forth some default ongoing franchisor obligations, which may be varied in the franchise contract. Namely, the franchisor is obliged to control the quality of goods produced by the franchisee and to regularly provide technical and consultancy support and training for the franchisee's personnel.
Competition law has to be taken into consideration and may substantially affect the franchise relationship. Specifically, Ukrainian competition law prohibits concerted actions that impose prices or other hardcore restrictions such as limitation of production or technical development, territorial markets and supplier allocation, and tying. The franchise agreement requires careful consideration in this regard, and further relations between the franchisor and franchisee must be constantly controlled for compliance.
When providing payments to a foreign franchisor in foreign currency, currency control laws must be under constant consideration.
ii Definition of a franchise
Ukrainian law does not use the term 'franchise'; instead it provides a definition for a 'commercial concession agreement', which is the equivalent of a franchise agreement in Ukraine. It may be logically inferred that a franchise is a legal relationship based on an agreement under which one party (title-holder) undertakes an obligation to grant for remuneration to the other party (user) the right to use a set of rights of the title-holder with the purpose of production or sale of certain goods and services. Pursuant to further provisions of Ukrainian law, the franchise agreement implies the use of a title-holder's rights, business reputation and commercial experience in the agreed scope, with or without reference to the territory and to particular areas of commercial activities.
iii Pre-contractual disclosure
Ukrainian law does not require formal pre-contractual disclosure in a franchise transaction. The parties decide on the information to present to each other and are not obliged to follow any particular procedure.
A franchisor does have to provide a copy of the technical and commercial documentation and other information necessary for performance of the franchisee's rights under the commercial concession agreement. However, this obligation only arises after the contract has been concluded.
Registration of franchise agreements is no longer required under Ukrainian law. The statutory registration requirement was abolished as of 5 April 2015, in the wake of the business deregulation policy pursued by Ukrainian government.
Nevertheless, to ensure better legal protection, the franchisee may (but is not obliged to) apply for and procure registration of the assignment or transfer of the trademark rights assigned to the franchisee by the franchisor under a franchise or trademark licence agreement. Such an assignment of trademark rights is registered with the State Trademarks Register of Ukraine and the franchisee is issued a registration certificate.
v Mandatory clauses
In general, provisions in franchise contracts should not contradict the statutory provisions of Ukrainian civil and commercial law. Even though some deviation from statutory provisions is generally allowed according to the principle of freedom of contract, this should not be a substantial deviation. Otherwise, there is a risk that the court would render a deviating contractual clause unenforceable and choose to apply a statutory provision instead.
vi Termination of the franchise agreement
If a franchise contract is conducted for an indefinite period, both parties are entitled to its unilateral termination upon a six-month notice unless the contract envisages a longer notice period.
If a franchise contract is conducted for a defined period, termination is only possible upon mutual consent of the parties or on the basis of a court decision. Court ability to terminate the franchise relationship is limited to the general restrictions available in the laws on contract termination. In particular, the court may terminate the franchise contract if the franchisor proves a substantial breach on the part of the franchisee. In some limited circumstances, the franchisor may also claim a substantial change due to unforeseen and irremediable circumstances.
The franchise contract also terminates under operation of law in the following cases: when a franchisor loses its title to the trademark, without substitution; or in the case of the bankruptcy (insolvency) of the franchisor.
vii Guarantees and protection
Guarantees are often necessary to protect the foreign franchisor against the lack of adequate creditor protection rules in Ukraine. Foreign franchisors usually request a surety from beneficial owners or affiliated business entities or, less often, a bank guarantee to secure financial obligations. It should be taken into account, however, that Ukrainian currency regulations may have specific regulatory requirements for the outbound payment under the surety agreement by an individual resident or a Ukrainian legal entity (other than a bank) in foreign currency, which may turn out to be rather problematic.
i Franchisor tax liabilities
A Ukrainian franchisor is subject to corporate profit tax. The general corporate profit rate is currently 18 per cent. There are some simple taxation systems available for small and medium-sized businesses that do not have a substantial turnover.
For tax purposes, franchise fees shall fall within the definition of royalties under Ukrainian tax law. As a general rule, Ukraine charges a 15 per cent withholding tax on outbound royalty payments. Withholding tax is usually withheld and then paid into the state budget by a local franchisee. Where there is a double-tax treaty between Ukraine and the country in which the franchisor is domiciled for tax purposes, the applicable withholding tax may be lower (e.g., 10 per cent, 5 per cent or even zero per cent). Such treaties have priority over Ukrainian domestic legislation. The franchisor must, however, provide certificated confirmation of its place of residence. Starting in 2020, the new principal-purpose test applies: the parties to cross-border transactions (such as royalty payments) will not be able to make use of applicable preferential withholding tax rates or tax exemptions under applicable double-tax treaties if the principal purpose of the transaction is solely to take advantage of that preferential tax treatment (unless that aim corresponds to the object and purpose of the double-tax treaty).
Generally, royalties are not subject to VAT. Normally, however, supply transactions of goods (including their import) and services are subject to VAT at the rate of 20 per cent in Ukraine.
Foreign franchisors must be careful not to create a permanent establishment on the territory of Ukraine, as a permanent establishment would be subject to general corporate taxes in Ukraine.
ii Franchisee tax liabilities
Ukraine tax law limits deductibility of royalty payments made by Ukraine-resident companies to non-residents (including those having offshore status) to an amount not exceeding 4 per cent of income (revenues) received from the sale of products (goods, works and services) during the year that precedes the reporting year.3 Payment of royalties exceeding 4 per cent of the previous year's turnover would just add to the Ukrainian franchisee's tax burden, unless it can prove that the arm's-length principle applies to the royalties.
The Tax Code of Ukraine provides for further specific restrictions on the deductibility of royalty payments in addition to the above-mentioned turnover limitation. In particular, royalty payments made to non-residents will not be deductible at all where:
- a non-resident receiving such payments is not a beneficiary of the royalty payments (except in cases where the beneficiary has granted the right to receive the payments to the said non-resident);
- royalties are paid in respect of intellectual property that initially belonged to a Ukrainian resident (i.e., if the rights to the intellectual property were first owned by a Ukrainian resident, then transferred to a non-resident and then licensed to a Ukrainian resident); or
- a non-resident receiving royalty payments is not subject to taxation in respect of the royalties in its country of residency.
If the franchisee is a company, it will pay corporate profit tax unless it opts in to the simplified taxation regime. In addition, VAT is likely to apply to supply transactions of goods and services (including the transfer or assignment of intellectual property rights to the franchisor under licence, franchise or other agreement) conducted by the franchisee as a franchise business is always presumed to involve a trading business. Alternatively, in certain cases for small and medium-sized businesses, the franchisee may choose to pay a 'unified' tax (if it opts in to the simplified taxation regime), which can substitute for corporate profit tax and VAT.
Transfer pricing may also be a factor if:
- the foreign franchisor and the Ukrainian franchisee are related persons;
- the foreign franchisor is incorporated or is tax resident in a country (territory) that is classified as an offshore zone by the Cabinet of Ministers of Ukraine, namely that corresponds at least to one of the following criteria:
- the rate of corporation tax in the franchisor's home jurisdiction is more than 5 per cent lower than the Ukrainian rate, or the franchisor's home jurisdiction provides for a preferential taxation regime, or the franchisor does not in fact pay any corporation tax;
- the franchisor's home jurisdiction does not have an information-exchange agreement with Ukraine; or
- the franchisor's home jurisdiction does not ensure an exchange of tax information on request by the Ukrainian tax authorities;
- the foreign franchisor does not pay any corporation tax or is not tax resident in the country of its incorporation (pursuant to a list of legal entity forms approved by the Cabinet of Ministers of Ukraine);
- the franchisee's annual income in the relevant tax year, according to accounting standards, exceeds 150 million hryvnas; and
- the value of all transactions between the foreign franchisor and the Ukrainian franchisee in the relevant tax year exceeds 10 million hryvnas.
Ukrainian tax legislation undergoes frequent changes, even following its substantial revision and codification in 2011. In particular, these changes have included a reform of the tax system to facilitate easy tax administration. In 2020, the Tax Code saw the introduction of material changes, which are frequently referred to in Ukraine as the 'anti-BEPS package law'.
Impact of general law
i Competition law
The franchisor should bear in mind aspects of competition law that prohibit the imposition of certain vertical restraints on the franchisee in the franchise agreement. In particular, the franchisor should be careful regarding restrictions imposed on the franchisee that may affect competition. In practice, competition is considered to be substantially restricted when the undertakings involved approach a dominant position, separately or collectively. The imposition of such restrictions on the franchisee may also fall under certain market-based exemptions and the block exemption for intellectual property rights transfer. If none of these exemptions applies, the provisions may still be cleared by an approval from the Anti-Monopoly Committee of Ukraine (AMC).
The Law on Protection Against Unfair Competition is also relevant to the typical franchisor. As mentioned above, a franchisor may be held accountable for any deceptive or misleading statements about its franchise to potential franchisees. Besides that, on the other hand, the law provides certain protection to the franchisor against dishonest franchisees or third-party competitors in relation to passing off, infringement of trademarks and other intellectual property, trade libel, unlawful collection, misappropriation and unauthorised disclosure of trade secrets.
To enforce the provisions of unfair competition laws, the franchisor may file a lawsuit directly with the court and argue under general competition principles on the basis of the evidence it has collected. Alternatively, the franchisor may file a complaint with the AMC, or its local division, which would take up some of the burden of collecting evidence against a breaching party. As a result of its investigation, the AMC may order the cessation of any violation and impose a substantial fine. Moreover, once the violation is confirmed, the franchisor may then, on the basis of that established fact, apply to the court for damages. There are, however, drawbacks to the AMC investigation process for the franchisor. First, because of bureaucracy, it takes an overly long time for the AMC to conclude the process. Second, the franchisor has no access to the information collected by the AMC during its investigation proceedings and, therefore, the franchisor has little influence on the course of such an investigation.
ii Product liability
A franchisor bears subsidiary liability with franchisees for consumers' claims in relation to the quality of products manufactured by the franchisor and further resold by the franchisee (i.e., a consumer is entitled to bring a claim against the franchisor only after the franchisee has been found unable to satisfy the claim in full).
At the same time, if the franchisee manufactures the products under the technology and the standards granted under the franchise agreement, the franchisor and the franchisee shall be jointly liable. Note, however, that currently there is no case law addressing the issue of product liability under the relevant provisions of Ukrainian law. Furthermore, in general, product liability cases are not often tried in Ukrainian courts.
Ukraine has recently updated its law on product liability. The new law defines that consumers are entitled to bring claims in respect of the following:
- against an actual producer and any person that is the brand holder of a product (i.e., this can actually be the franchisor or its related companies);
- against any importer of a product for sale, hire, leasing or any form of distribution as a producer (i.e., usually the franchisee or its related companies); and
- where a producer cannot be identified, each supplier (i.e., the franchisee or its related companies) shall be liable as a producer unless they inform an injured person of a producer or an importer within 30 days. Moreover, under the new law if several persons are liable for damages (e.g., a producer and an importer, in the case of imported products), an injured person is entitled to address its claims either to all liable persons jointly or to one of them separately.
At present, there is no comprehensive case law or official interpretation of the new product liability law. It is difficult to predict how most of its provisions will apply in practice. It is especially unclear how new rules will correlate with existing civil and consumer protection law.
Under Ukrainian conflict-of-laws rules, Ukrainian consumer protection laws apply mandatorily if the consumer claims derive from products sold in Ukraine. However, there is an exception if the goods are not produced in Ukraine (and merely available on its territory). In this case, a claimant has a right to choose the law of the country of manufacture to be applied as well.
iii Dispute resolution
Most disputes concerning franchising matters are heard by the courts of either civil or commercial jurisdiction (depending on the parties), including contractual and non-contractual matters. Whenever a public act or failure to act is challenged, the case is resolved by the courts of administrative jurisdiction. The criminal proceedings in public prosecutions are overseen by the courts of criminal justice. As regards franchise matters, a criminal prosecution may be initiated for intellectual property infringement. Under the judicial reform enacted at the end of 2017, the establishment of a new High Court for Intellectual Property is envisaged. This Court will have jurisdiction over all disputes related to intellectual property, including those arising out of franchise agreements.
Besides the system of state courts, parties can choose to submit their dispute to an arbitration tribunal. Although binding on the parties, decisions of arbitration tribunals can be appealed to the courts.
Foreign courts may also be used as an alternative. To enforce the decision of a foreign court in Ukraine, however, the courts of both jurisdictions should have established mutual recognition of judgments. A significant disadvantage is the burdensome and time-consuming notification process under the Hague Service Convention.
Dispute resolution in international arbitration tribunals is allowed and enforceable in Ukraine. Ukraine is a party to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards and Ukrainian courts respect and frequently enforce arbitral awards. There is an established international tribunal at the Ukrainian Chamber of Commerce.
The major advantage of international tribunals is that the case is heard by either a sole professional international practitioner or a bench of such arbiters selected in the manner agreed by the parties. This provides greater certainty of a fair and just award being made in the case. The Ukrainian courts may, however, refuse to enforce an arbitration award on the grounds set forth by the New York Convention. The most common grounds for such a refusal are those of public policy. The other disadvantage is that injunctions in support of arbitration procedures are not currently practicable in the Ukrainian courts.
In 2018, the new Law on Limited Liability Companies became effective. It provides detailed regulations on this most widely used form of legal entity and it gives those concerned the flexibility to govern certain limited issues in the company charter or their shareholders' agreement differently from the Law itself.
With the entry into force of the GDPR in 2018, many Ukrainian companies maintaining business ties with the EU and EEA undertake to adjust their data protection policies to the legal requirements of that Regulation.
The new High Court for Intellectual Property is expected to commence its work shortly. The Court shall assume jurisdiction over all disputes related to intellectual property, including those arising out of franchise agreements.
Ukraine has substantially liberalised its foreign exchange legislation and currency control regulations. With the enactment of the new Law on Currency and Currency Transactions, as well as relevant by-laws in 2019, most existing restrictions on cross-border payment transactions (such as restrictions on dividend payments and investment repatriation, payment deadlines and mandatory conversion of currency proceeds) were lifted.
Other major developments pertain to tax law. In 2020, material changes to the Tax Code took effect, concerning almost all aspects of taxation in Ukraine. In particular, there are new rules on capital gains tax on non-residents' proceeds from the sale of shares in some Ukrainian companies and on taxation of constructive dividends; and detailed provisions on controlled foreign companies have been introduced. As noted above, the law stipulating these changes is frequently referred to in Ukraine as the anti-BEPS package law; because of some inconsistencies and difficulties with its implementation, certain revisions and adjustments are expected in the near future.
Further, in 2020, Ukraine significantly updated its anti-corruption and financial monitoring legislation. These changes include, in particular, expanded and detailed regulations requiring the disclosure by companies of ultimate beneficial owner, and regular updates of this information.
Finally, in response to the covid-19 pandemic, the Ukrainian government imposed a period of quarantine. Nationwide and local recommendations and mandatory health orders are in place, providing health and safety regulations to be followed by businesses to prevent and contain the spread of coronavirus (including physical distancing, mask wearing, temperature screening, increased frequency of cleaning and disinfection, and training for staff on preventive measures).
Numerous businesses (such as retail, hospitality, tourism and transportation) suffered from the restrictive quarantine measures and were expecting the government to provide adequate relief. However, because of budgetary constraints, the state has in large part been unable to implement any broad and comprehensive relief programmes to address the knock-on effects of the pandemic. Therefore, the response of the government has largely been limited.
1 Volodymyr Yakubovskyy is a partner at Nobles and Graeme Payne is a partner at Bird & Bird.
2 As of 1 September 2020. The amount is equal to 1,250 minimum statutory wages and therefore increases with the adjustment of that figure (as a rule, every year).
3 See Section 140.5.6 of the Tax Code of Ukraine.