License agreement: main practical issues

October 4, 2018

In recent years, business environment of Kazakhstan states the increase of number of transactions related to franchising. Business structures provide their partners or receive from them brands, trademarks, patents and other objects of exclusive rights. Each party of these deals has certain advantages that can lead to beneficial cooperation.

At the same time, lawyers of Linkage & Mind are familiar with the cases when interaction of the franchisor and the franchisee occurs in the way different from the one planned before signing the contract. In such situations, entrepreneurs apply to lawyers, and they, in turn, to the license agreements concluded and applicable laws. As a result, the party which prevented risks in advance by due care to the compliance of the agreement with the law, takes stronger position.

Below we will consider the most important aspects of Kazakhstan's legislation on a franchise licensing and try to caution our partners against the typical mistakes made when concluding license agreements.

To begin with, it is proposed to turn to the definition of franchising provided by the Civil Code of Kazakhstan (hereinafter referred to as the "Civil Code") and the Law "On Franchising" (hereinafter - the "Law"): under a license agreement, one party (the licensor) undertakes to provide the other party (the licensee) for remuneration with a set of exclusive rights (a licensed complex), including, in particular, the right to use a licensor’s company name and protected commercial information, as well as other objects of exclusive rights (trademark, service mark, patent, etc.) provided for by the agreement, for use in the entrepreneurial activities of the licensee. The license agreement shall provide for the use of a licensed complex, business reputation and commercial experience of the licensor in a certain amount, with or without indication of the territory of use, in relation to a certain area of activity (the sale of goods received from the licensor or produced by the licensee, implementation of other commercial activities, provision of services).

The aforesaid demonstrates the key role of agreement in the relationships between the franchisor (licensor) and the franchisee (licensee), as it should specify the volume, territory, scope of work and other conditions for granting the franchise.

At the same time, in our opinion, high attention should be paid to Article 900 of the Civil Code, which establishes that the restrictive terms of the license agreement are null and void, by virtue of which:

1) the licensor has the right to determine the sales price of goods by the licensee or the price of the works (services) implemented (provided) by the licensee, or to set the upper or lower limit of these prices; or

2) the licensee has the right to sell goods, perform work or provide services exclusively to a certain category of customers (clients) or exclusively to customers (clients) who have a location (place of residence) on the territory specified in the agreement.

The reason for this restriction is the basic principles of Kazakhstan's legislation on the protection of competition. In accordance with Article 4 of the Law, one of the principles of governmental support of franchising in Kazakhstan is the protection of competition and the restriction of monopolistic activities. Articles 169 and 170 of the Business Code of Kazakhstan define a number of criteria, in accordance with which anticompetitive agreements and anticompetitive concerted actions of market entities are prohibited. The ban on setting the upper or lower limit of prices, as well as the territorial restriction of doing business are, among others, in the list of the above criteria.

In this regard, at the stage of discussing a deal on franchising, it is important to understand these anticompetitive constraints, which can be decisive for determining the terms of cooperation.

It also seems important to highlight Article 901 of the Civil Code, according to which the licensor bears subsidiary responsibility for the claims imposed on the licensee in respect to non-conformity of the quality of goods (works, services) sold (performed, rendered) under the license agreement. In accordance with Article 357 of the Civil Code, should the principal debtor (i.e. the licensee) refuse to satisfy or not fully comply with the creditor's request or should the creditor not receive a response from the debtor within a reasonable time, the claim in the part unsatisfied can be brought to the person who has subsidiary responsibility (i.e. the licensor).

Thus, the compulsory norm of the Civil Code cannot be changed by the license agreement and, consequently, carries certain risks for the franchisor in relation of improper fulfillment of obligations by the licensee before third parties. As practice shows, these risks are rarely taken into account by the companies providing franchises to their business partners.

Another important aspect of the cooperation in the framework of franchising is the preemptive right granted to the licensor by Article 14 of the Law with regard to the of licensee’s enterprise when it is in selling process. Since this rule is also mandatory, no agreement of the parties can exclude this right of the licensor and, accordingly, the licensee's obligation to offer an enterprise for purchase by his franchisor before its alienation to third parties.

These duties of licensee are rarely fulfilled in practice, and licensors sometimes are not aware of such a preemptive right, although the use of it can contribute to the economic development of the company that provides brand and patents.

The aforesaid demonstrates only some of the factors which justify that the activity in the area of franchising, on the one hand, carries certain risks for the parties and, on the other hand, grants them the rights the use of which can bring certain privileges.

In this regard, Linkage & Mind law firm proposes market players to pay due attention to such a phenomenon as license agreement which at a first glance may seem simple and void of risks.