PREPARING FRANCHISE AGREEMENTS FOR

Document Sample
PREPARING FRANCHISE AGREEMENTS FOR Powered By Docstoc
					                American Bar Association
                 Forum on Franchising




      PREPARING FRANCHISE AGREEMENTS FOR
     ENFORCEMENT IN TRANSITIONAL ECONOMIES




The People's Republic of China and The Russian Federation




                     By Paul Jones
                  Miller Thomson LLP
                   Toronto, Ontario




                 October 13 – 15, 1999
               Weston Mission Hills Resort
                  Rancho Mirage, CA




              1999 American Bar Association
                                 PREPARING FRANCHISE AGREEMENTS FOR
                                ENFORCEMENT IN TRANSITIONAL ECONOMIES

                                                           By Paul Jones
                                                        Miller Thomson LLP
                                                         Toronto, Ontario


                                                  TABLE OF CONTENTS

I.         INTRODUCTION...................................................................................................... 1

      A.        SUMMARY OF OBSERVATIONS ON THE PEOPLE'S REPUBLIC OF CHINA .. 2

      B.        SUMMARY OF OBSERVATIONS ON THE RUSSIAN FEDERATION ................. 3

II.        THE PEOPLE'S REPUBLIC OF CHINA. ................................................................. 4

      A.        INTRODUCTION .................................................................................................. 4

      B.        LEGAL STRUCTURE AND THE COURT SYSTEM ............................................. 5
           1.      Type of Law: ..................................................................................................... 5
           2.      Type of State:.................................................................................................... 6
           3.      Court System: ................................................................................................... 7
           4.      Access to the Law: ............................................................................................ 7
      C. GENERAL CONTRACT LAW ............................................................................... 8
           1.      Application: ....................................................................................................... 8
           2.      Formation: ......................................................................................................... 8
           3.      Relationship Standards: .................................................................................... 9
           4.      Fair Dealing and Good Faith: ............................................................................ 9
      D. SPECIFIC TYPES OF CONTRACTS ................................................................. 10
           1.      Leasing: .......................................................................................................... 10
           2.      Trade-marks, Copyrights and Licensing: ........................................................ 11
           3.      Trade Secrets and Technology Transfers: ...................................................... 13
      E.        COURT PROCEEDINGS AND EXECUTION ..................................................... 13
           1.      General Matters: ............................................................................................. 13
           2.      Property Preservation and Advance Execution: .............................................. 14
           3.      Enforcement of Civil Judgements: .................................................................. 15
      F.        ARBITRATION ................................................................................................... 16

      G. FRANCHISE MEASURES AND CONCLUSION ................................................ 17



                                                                    -i-
                                        Table of Contents (continued)


III. THE RUSSIAN FEDERATION............................................................................... 19

  A.        INTRODUCTION ................................................................................................ 19

  B.        LEGAL STRUCTURE AND THE COURT SYSTEMS ........................................ 20
       1.      Type of Law: ................................................................................................... 20
       2.      Type of State:.................................................................................................. 21
       3.      The Court System: .......................................................................................... 22
  C. GENERAL CONTRACT LAW ............................................................................. 23
       1.      Formation: ....................................................................................................... 24
       2.      Relationship Standards - Good faith: .............................................................. 24
       3.      Liquidated Damages and Currency: ................................................................ 25
  D. SPECIFIC TYPES OF CONTRACT ................................................................... 25
       1.      Leasing: .......................................................................................................... 25
       2.      Trade-marks, Copyrights and Licences: ......................................................... 27
       3.      Trade Secrets: ................................................................................................ 28
  E.        COURT PROCEEDINGS AND EXECUTION ..................................................... 29
       1.      General Matters: ............................................................................................. 29
       2.      Interim Relief or Obespechenie Icka: .............................................................. 29
       3.      Enforcement:................................................................................................... 30
  F.        ARBITRATION ................................................................................................... 31
       1. Introduction: .................................................................................................... 31
       2. Domestic Arbitration: Arbitration under the International Commercial Arbitration
       Courts of the Chamber of Commerce and Industry: ............................................... 31
       3. Enforcement of Domestic and Foreign Arbitral Awards: ................................. 33
  G. CONCLUSION.................................................................................................... 34




                                                           - ii -
                   PREPARING FRANCHISE AGREEMENTS FOR
                  ENFORCEMENT IN TRANSITIONAL ECONOMIES:

            The People's Republic of China and The Russian Federation



                                 I.     INTRODUCTION

        With the end of the cold war the emergence of various economies in transition
has presented enormous new markets for retailers, distributors and franchisors. These
transitional economies also present significant difficulties and problems for Westerners
trying to understand them and to prepare enforceable agreements.

        Markets do not exist in a "state of nature" but rather are usually regulated by the
state. This is something that franchise lawyers are particularly familiar with. While both
the People's Republic of China and The Russian Federation have abolished or made
great strides in abolishing their former command economies, often the officials
responsible for market regulation in these economies are overwhelmed by the
complexity of the problems they confront. They tend to rely heavily on pre-existing
policy frameworks that they are familiar with in their day to day dealings with the new
market economy, adjusting their decisions only in limited situations to accommodate
distinctively market economy features.

       Any evaluation of the enforceability of the agreements that make up a franchise
system in a transitional economy will have to not only take into account the state of the
legal system in such economy, but also the state of the economy and the development
of the political system. In both China and Russia, the development of the legal systems
are still incomplete, allowing local officials varying degrees of power in the local
economy and in the enforcement of judgements or arbitral awards. For this reason, for
each country there are discussions on the development of the internal state structure,
the court system and the legal system in general.

        In this regard, it should be noted that Russia and China have followed very
different paths. Russia followed a "big bang" approach which involved the rapid and
simultaneous liberalisation of prices and privatisation of public enterprises. In many
cases this destroyed many state institutions needed to govern the economy during the
transition process. Russia's economy has yet to fully recover.

       On the other hand China has taken a much more gradual approach. While
currently its rate of growth is consistently slowing, it has had a long period of increasing
economic growth after the Cultural Revolution that has no doubt assisted it in
dampening the social tensions of the transition. Whether it can continue and complete
the transition without a recession or significant social unrest remains to be seen.

       This paper is based on such information as became available before going to
press. However as of the time of writing, no specific example had been found of the
enforcement of a franchise agreement, either through the courts or through arbitration,
                                     - Page 2 -


in either China or Russia. While several firms are preparing franchise agreements for
use in China and Russia, it appears that none of them have been tested as to
enforceability. Consequently it is difficult to evaluate the differing methods used for
preparing franchise agreements, which occasionally results in vagueness in the
observations in the paper.

       Vagueness also sometimes occurs because the papers are dealing with
incomplete civil law legal systems. In some cases the answer is not yet known. In other
cases it is because civil law systems appear to common law practitioners to have a
certain amount of inherent vagueness in their drafting.

       Extensive discussion of the existing franchise laws or regulations in China and
Russia has been avoided because the specific provisions of these laws are available in
other publications. It was felt that it was more important to place the specific laws in the
contexts of the overall legal system in order to assess their enforceability. The best
example is Russia, where the specific provisions on Commercial Concession must be
read within the context of the larger Civil Code provisions.

A.     SUMMARY OF OBSERVATIONS ON THE PEOPLE'S REPUBLIC OF CHINA

             As customary business practices and standards are not well established in
              China, it may be to the franchisor's advantage to spell out what is
              expected in detail rather than simply rely on such words as "reasonable".
              Similarly rather than simply giving the franchisor discretion to change or
              adapt the system, procedures for dealing with changes should be set out
              in greater detail. This would improve the enforceability of the agreement
              were the franchisee is relying on a "good faith" defence.

             Franchisors who are planning to have a direct involvement in franchising
              in China may wish to consider the use of location control to improve the
              enforceability of their franchise agreements. For a variety of reasons,
              including China's incomplete development of a system of municipal
              finance, local courts may be inclined to be sympathetic to an enterprise
              that pays local taxes. This is more likely if the franchisor is actually the
              tenant for the location.

             Franchisors should require copies of their franchisee's incorporation
              papers to ensure that they have authority to enter into the franchise
              agreement.

             With respect to trade-marks, China is a first to register jurisdiction. The
              first thing that a franchisor should do is to ensure that it has validly
              registered trade-marks to protect the system. This includes choosing and
              registering an appropriate Chinese Character trade-mark and the
              registration of any licenses or sub-licenses.
                               - Page 3 -


        At an early stage it should be determined, through discussions with local
         counsel and the relevant government officials, what parts of the system
         constitute a technology transfer. This should then be made the subject of
         a separate technology transfer agreement for which approval and
         registration from the government must be obtained. The unbundling of
         other aspects of the franchise agreements may also be considered.

        Where a franchisor intends to rely on treaty provisions in the enforcement
         of its agreements, such treaty provisions should be included as schedules
         to the text of the agreement.

        While enforcement of the agreement will ultimately be done by a local
         authority, franchisors do have the option of choosing domestic or
         international arbitration under CIETAC. Generally CIETAC arbitrators have
         more experience and sophistication in commercial disputes than local
         judges.

        It would be a definite advantage to the enforcement of the agreement to
         have a dispute resolution clause providing for negotiation and mediation in
         the agreement, and to exercise such provisions prior to proceeding to
         arbitration or to trial.

B.   SUMMARY OF OBSERVATIONS ON THE RUSSIAN FEDERATION

        Franchisors should be aware that the Civil Code will override any "entire
         agreement" or "no waiver clauses".

        To compensate for Article 428 of the Civil Code it will be important to
         evidence the voluntary acceptance by the franchisee of a standard form
         franchise agreement, and particularly any exculpatory clause or other
         clauses that a Russian judge may consider burdensome.

        With respect to trade-marks, Russia is a first-to-register jurisdiction, and
         accordingly a valid registration is a basic prerequisite to franchising. In
         addition to registering the trade-mark, franchisors should also obtain an
         appraisal of the value of the trade-mark to assist in determining the
         damages from unfair competition and infringement. Care should be taken
         to ensure that the trade-mark is registered for all the appropriate classes
         or "options".

        If the franchise agreement will contain unliquidated damages clause, care
         should be taken to justify the formula used for the calculation of the
         penalty. In this respect the valuation of the trade-mark will be of
         assistance.
                                      - Page 4 -


             Franchise agreements which are also licences to use a trade-mark will
              have to be registered twice, once as a franchise agreement and once as a
              trade-mark licence. However the trade-mark licence may be registered in
              a short form.

             Franchisors should require copies of their franchisee's incorporation
              papers to ensure that they have authority to enter into the agreement. If
              the franchisee is a legal entity, where possible two signatures should be
              obtained on the agreement.

             Copyrights should be registered, although registration is not required,
              because the certificate will assist with enforcement.

             The use of location control or sub-leasing requires the franchisor to
              evaluate the nature of the sums to be invested to upgrade the property
              against the quality of the title that it may obtain. It also means that any
              dispute resolution procedures will have to occur in the local jurisdiction.

             Care should be taken to ensure that the franchise agreement provides that
              in case of a dispute, the loosing party shall pay the winning party's legal
              costs.

             If the franchisor is not using subleasing as a means of enforcement, then
              the franchisor must consider whether to designate a court outside the
              franchisee's locality to hear any disputes.

             If the franchise agreement provides for arbitration, the provisions in the
              Arbitrazh Procedural Code for interim relief should be incorporated by
              reference, and preferably listed as a schedule, together with other terms
              that the parties agree to.

                     II.    THE PEOPLE'S REPUBLIC OF CHINA.

A.     INTRODUCTION

         China is a vast country. Its territory is the third largest in the world after Russia
and Canada and its population of approximately 1.3 billion is the largest in the world.
According to the South China Morning Post in 1997 it had a GDP of $917.72 billion US
and a GDP per head of $742.30. While its cities are very large, 74% of the population is
still rural. Great changes have been made in recent years but, it is estimated that 40%
of China's economic activity is still conducted by state operated organisations. These
basic differences will have to be kept in mind by any franchisor planning to set up a
system in China.

      China is changing at a rate that is difficult to keep up with. The 8th National
People's Congress, whose five-year term ended in 1998, and its Standing Committee,
                                    - Page 5 -


considered 139 legislative bills and law related decisions, approved 118 statutes or law
related decisions (including amendments to the Constitution), and ratified 60 bilateral or
multi-lateral international treaties, conventions or other agreements. The first session of
the 9th National People's Congress in March 1999, approved, among other things,
China's first general form of Contract Law and amendments to the Constitution including
the addition of the phrase "yi fa zhi guo". While there is considerable debate as to
whether this phrase is the equivalent of the English maxim "rule of law", in a Chinese
context, this appears to be a significant move forward in the development of a legal
foundation for a market economy.

       Many franchisors have been active in China for some time, but it has often been
through corporately owned units. However, one major international franchiser has now
made a decision to proceed with franchising in China. It and others, with the assistance
of a Beijing law firm, and other suppliers, have proceeded to organise the China
International Franchisor's Association. With franchising at such an early stage, there are
few if any examples of the enforcement of franchise agreements in China. Preparing a
franchise agreement for enforcement in China requires a broader understanding of the
Chinese legal system and the experience to date in the enforcement of other types of
contracts, trade-mark rights, leases and debt collection.

B.    LEGAL STRUCTURE AND THE COURT SYSTEM

1.    Type of Law:

        China today is transforming itself from a socialist law system to a civil law
system, not unlike the civil law system that was slowly forming in China from the end of
the Qing Dynasty up to 1949. At the turn of the century in China, civil law became
dominant over common law as the standard for the introduction of western models,
partly through the influence of Japan. It was also partly because the civil law system of
jurisprudence, that derives law from broadly stated general principles, best suited the
pre-existing Chinese legal system.

       In 1978, the Chinese Communist Party announced a shift in focus from political
development, as witnessed in the Cultural Revolution, to economic development, and
adopted an open door policy to attract foreign investment. This led to the need to
transform the economy from a state planned economy to a market economy or
"Socialism with Chinese characteristics".

       This transformation is an enormous task for a country that did not previously
have a true market economy in which the norms and concepts for commercial
behaviour can be established, and in which a generation of people, the generation that
now in North America is in their peak productive years in government and business, lost
their opportunity for higher level education in the Cultural Revolution.

        Despite years of debate and drafting, China has yet to promulgate a civil code. In
its place, partly because of pressure from foreign investors (particularly the Japanese)
seeking security for their investments in China, the General Principles of the Civil Law of
                                     - Page 6 -

the People's Republic of China was adopted at the fourth session of the 6th National
People's Congress and promulgated on April 12, 1986, effective as of January 1, 1987.
The passing of the Contract Law, which will be discussed later, is further progress in the
development of a codified civil law system.

2.     Type of State:

       Altogether China has some thirty-two provinces, autonomous regions (such as
Tibet, Xinjiang) and centrally administered cities (such as Beijing, Shanghai, Tianjin and
recently Chongqing). One of the tasks still remaining to be completed is the
development of a legal infrastructure that will delineate the jurisdiction and taxing
powers of these entities. At present some regard it as an open question as to whether
China can be classified as a unitary or a federal state.

       While according to the Constitution, the National People's Congress, and its
permanent body, the Standing Committee, are the highest organs of state power (Article
57), the Constitution also provides for the establishment of local people's congresses in
provinces, municipalities directly under the central government, cities, counties,
municipal districts, townships, nationality townships and towns, but does not allocate
specific powers to these bodies. Local people's congresses have the power to elect and
recall governors and similar authorities at their respective level. In order to speed up
development of the market economy, local levels of government have been allowed
considerable latitude in passing and adapting laws to suit local conditions, particularly
where the central government has not yet adopted a law setting forth general principles.
While there is some discussion of the application of a doctrine of "central paramountcy"
or "higher level paramountcy" in reconciling conflicts of law, and Article 100 of the
Constitution provides that local regulations must not contravene the Constitution and
"the law and administrative rules and regulations ...", individual lower level judges take
some latitude in deciding specific cases.

        This issue may be a fundamental weakness in the development of the Chinese
economy and legal system. Municipal finance is an increasingly urgent issue in China's
transition to a market economy. The mismatching of revenues and expenditures
encourages the local development of extra budgetary funds and sources of revenue.
These in turn encourage de facto local autonomy and undermine government according
to law. Prior to 1994, local authorities in the provinces have had a flat rate tax system
which allowed them to retain (for local development) all but a set amount of revenue
that was to be remitted to Beijing. This was reformed in 1994 to better match revenues
to social responsibilities, but partly because of the large disparities in terms of economic
development between regions, these reforms are considered incomplete. One recent
report in The Economist (May 29, 1999, at p.76) suggested that Beijing has a revenue
collection problem, when compared to the level of public spending, not unlike that of
Russia prior to August of 1998.
                                     - Page 7 -


3.     Court System:

        At the top of the court structure is the Supreme People's Court (zuigao renmin
fayuan). Below it at the provincial level are 30 Higher Level People's Courts (gaoji
renmin fayuan). Underneath them (as of 1995) are 391 Intermediate Level People's
Courts (zhongji renmin fayuan) established in provinces, autonomous regions and
within centrally administered cities. Finally at the bottom are the 3,074 odd Basic Level
People's Courts (jiceng renmin fayuan). Counties in China can be quite large and as a
significant portion of the population is rural, these courts have often established branch
courts outside the towns in which they may be headquartered.

       Aside from the Supreme People's Court, the judges are not appointed by the
central government. Rather they are appointed by the people's congress and the
equivalent standing committee at the same level as the court. They do not have security
of tenure and this is one of the reasons that they are more susceptible to local
influences.

        Within each court there is an Adjudication Committee. While individual judges will
handle minor non-politically sensitive cases generally free from interference from other
court officials, more important cases, such as significant economic disputes or sensitive
political matters, are handled by individual judges on the advice of the particular court's
Adjudication Committee. Judicial independence in China refers to the independence of
the court as an institution rather than the independence of an individual judge.

        One of the problems with the court system has been a lack of qualified
individuals to serve as judges, partly due to the effect of the Cultural Revolution on
education. This has a stronger impact than it would in a common law system because
Chinese judicial procedure is, like some other civil law systems, basically inquisitorial. A
great deal of initiative to determine the law is left to the judge, instead of to the lawyers
for the parties. As noted in the discussion on the problem of jurisdiction for internal state
organs, finding the applicable law is a significant task. There is a regular system of case
reporting in the Supreme Court, and the judges use it to determine cases when
legislation is not available. However in civil law systems cases are not precedent. Due
to these problems, and because of external pressures, intellectual property tribunals
have been set up for cases involving intellectual property rights.

4.     Access to the Law:

       China does not have a tradition of an independent bar. In the Qing Dynasty,
people who assisted litigants in framing their petitions to government officials were
punished. After the 1949 revolution and until recently, legal advisers were in the employ
of the state and owed their first duty to the state. However as everywhere in China,
things are changing and a Law on Lawyers and Legal Representation was promulgated
by the Standing Committee of the 8th National People's Congress on May 15, 1996.
According to an article in the May 29, 1999 issue of China Daily, there are now almost
110,000 lawyers in China.
                                    - Page 8 -


       Foreigners who do business in China are dependent on their legal advisors or
translations of Chinese law to evaluate the advice they are being given. To promote
foreign investment, the government often provides English translations of relevant laws.
There are also a number of translations available from private publishers, or for free on
various Internet web-sites. The problem is that the Chinese version of the law always
governs, and the translations are not perfectly reliable. As Donald Clarke of the
University of Washington Law School recently pointed out, a noted guide to China's tax
and business laws contained a significant error in its translation of the PRC Income Tax
Law for Foreign Investment Enterprises. The translation had stated that foreign
companies located in special economic zones get a reduced rate, when in fact the law
stated that it was available to all foreign investment enterprises in special economic
zones, and not strictly foreign companies.

C.     GENERAL CONTRACT LAW

       On March 15, 1999, the second session of the 9th National People's Congress
approved a uniform Contract Law to come into force on October 1, 1999. This is a
further step in the development of the civil law system and a civil code, as the law fills
gaps in an array of specific laws and regulations passed to deal with particular issues
(often for investments). Started in 1993, the format follows the general approach of the
Germanic civil code and in a full civil code of the law, it would be part of the section on
obligations.

        It has seven chapters on general contracts, including chapters on formation,
effectiveness, performance, amendment and assignment, termination and breach.
There are a further 16 chapters on specific types of contracts, including sales contracts,
leasing contracts, construction contracts, technology contracts and agency contracts.

1.     Application:

        Unfortunately, the new Contract Law does not appear to be as all encompassing
as its title may suggest. Article 123 provides that contracts for which other laws have
specific provisions will be governed by such other provisions. This is a common
provision in civil codes, as will be seen in the section on Russia. However its effect in
China, where there is not yet a civil code that overrides the possibly conflicting laws of
different ministries or different levels of government, may be quite different. Further
existing contract legislation such as the Economic Contract Law, the Foreign Economic
Contract Law, and the Technology Import Contract Legislation (1985) and its
Implementing Regulations (MOFTEC, effective January 20, 1988), and the
Administration of Trade Importation Technology and Equipment Provisional Measures
(MOFTEC, March 1996) will continue to apply to contracts entered into prior to October
1, 1999.

2.     Formation:

       The uniform contract law makes a significant change in Chinese law with respect
to the formation of contracts of which franchisors planning to sell franchises in China
                                      - Page 9 -


should be aware. Previously Chinese law distinguished between civil agreements
between individuals, which were governed by the general principles of civil law
mentioned earlier, and economic contracts between legal entities which were governed
by either the Economic Contract Law or the Foreign Economic Contract Law, depending
on whether the legal entities entering into the contract were both Chinese, or if, one of
the legal entities was foreign. In both of the latter cases the contract had to be in writing.

       However Article 10 allows parties to conclude contracts either orally or in writing,
unless a relevant law or administrative regulation requires a written contract. The
November 14, 1997 Measures for Administration of Franchise Operations (for Trial
Implementation) implies in its wording that franchise contracts must be in writing. The
Contract Law defines "writing" quite broadly. It also should be remembered that in order
to form a contract in the civil law system, consideration is not required. Offer and
acceptance are sufficient. Care will have to be taken in selling franchises to evidence
when both parties have finally agreed, and to what terms.

3.     Relationship Standards:

       In preparing the Contract Law, the drafters relied on concepts such as
"promptness", "reasonableness" and "customary business practice", borrowed from
western civil codes. But China has not yet developed a free market economy that has
the necessary customary business practices to give local content to these terms. In the
short run, this may undermine efficiency and give more discretion to local Chinese
courts and bureaucrats. To avoid this problem, franchisors may wish to carefully define
standards for the exercise of discretion and for normative behaviour to give content to
the general contract provisions.

4.     Fair Dealing and Good Faith:

       Two terms of the new Contract Law deserve particular attention. Article 39
provides as follows:

              "Where a contract is concluded by way of standard terms,
              the party providing the standard terms shall abide by the
              principle of fair dealing in stipulating the rights and
              obligations of the parties under the relevant laws and
              administrative regulations. Standard terms are terms
              prepared in advance by a party for repeated use, and which
              are not negotiated with the other party in the course of
              concluding the contract".
       Article 40 goes on to provide that the standard term shall be invalid if it falls into
any of the circumstances set forth in Articles 52 and 53, or if it excludes liabilities of the
party providing such terms, increasing the liability of the other party, or deprives the
other party of any of its material rights. Article 52 provides circumstances in which a
contract will be invalid and includes where the contract harms the public interest. Article
53 specifically provides for the invalidity of certain exculpatory provisions. A party
                                     - Page 10 -


cannot exclude liability for personal injury, or for property damages caused to the other
party due to intentional misconduct or gross negligence.

       Finally Article 60 provides as follows:

              "The party shall fully perform their respective obligations
              under the contract. A party shall apply by the principle of
              good faith, and perform the obligations of notification,
              assistance and confidentiality, etc., in the light of the nature
              and purpose of the contract and according to the course of
              dealing".
       This latter concept is generally a translation from the German Civil Code of the
principle of Treue und Glaube, or fidelity and trustworthiness.

       These provisions will allow for significant interpretation and intervention by local
judges with regard to franchise contracts. In preparing franchise agreements for use in
China, it may be necessary to rely less on the franchisor having discretion and to
instead set out in as much detail as possible changes that may occur over the life of the
contract.

D.     SPECIFIC TYPES OF CONTRACTS

        China's desire to attract foreign investment has often exceeded even its rapid
drafting of new laws, particularly the laws of general principle that are the basis of a civil
law system. Thus it is also necessary to review certain specific laws that may have an
effect on the enforcement of a franchise agreement. Franchisors choosing to enter
China by means of a local master franchisor will have considerably more flexibility. As
long as they do not set up a foreign investment enterprise (FIE) that has Chinese legal
personality, according to the Foreign Economic Contract Law, they will be free to
choose the governing law of the contract and the location of any dispute resolution or
arbitration.

       However, any franchisor choosing to franchise in China directly, and any master
franchisee franchising in China, will be subject to Chinese law notwithstanding any
choice of law clause in the contract. Generally speaking, franchisors have relied on two
methods to enforce their contract. Where they are prepared to commit to a site for the
long term, they will lease the site from the landlord and sub-lease it to the franchisee,
thus providing "location control". The other method is to de-identify a site (that is move
all trade-marks and trade-dress) and to perhaps also rely on a non-competition
covenant.

1.     Leasing:

      Leasing may not give the franchisor the same access to remedies that it has
under North American law. While there are no restrictions on evicting commercial
tenants, as noted above Chinese law requires a greater degree of basic fairness
                                    - Page 11 -


between the parties to arrive at consensual business relationships. Further, the general
contract laws, as discussed above, may also apply to leases of real estate.

       Until recently, all land in China belonged to either the government or to
agricultural collectives. All enterprises were state owned and were allocated land to
carry out their purposes for no consideration. These allocated land use rights were not
transferable and perhaps for that reason there was not much attempt to maintain a
registry system.

       In 1995 the Law of the People's Republic of China on the Administration of Urban
Real Estate became effective, introducing the concept of "granted" land use rights,
which were codified in amendments to the Constitution in 1998. These new transferable
land use rights are called "granted" land use rights to distinguish them from the
"allocated" land use rights which were developed earlier and which still exist. Granted
rights may be the subject of a lease, but to avoid speculation the tenant must actually
commence the identified use before leasing the property. Buildings and free standing
improvements have a separate identity in Chinese law and can be leased, even though
the underlying interest in the ground cannot. Where the underlying rights are only
allocated land use rights, there is a provision that requires the owner to pay over to the
state a portion of the rent attributable to the land.

       The new registration system that goes with these rights is more than a notice
system, it is the actual creation of the interest. Leases must also be registered, and the
land registration procedure is similar to the process used in North America for trade-
marks. There is a review of the documents and a public notice of the pending
application followed by a commentary period, after which if there are no objections, the
registration is granted. There are further regulations for leasing and recording the leases
of urban buildings.

      Chinese landlords and (presumably sub-landlords) are by law required to
maintain the premises in good order and repair throughout the entire term of the lease.
Although in commercial leases, the responsibility may be shifted by contract, care
should be taken in the drafting of such provisions.

       Further, the statutes provide that the landlord has no right to seek default
remedies until the tenant is more than six months in arrears. While this may be changed
by contract, it will still be subject to the overriding duty of fairness and good faith. On
termination, the landlord may seek court eviction or use peaceable "self-help" eviction,
following a notice of default and a reasonable opportunity to vacate. The more common
procedure appears to be to apply to the court, usually at the lower or basic court level
(jiceng renmin fayuan). It should be noted however a lease contract itself is a credit right
only and not a right in rem.

2.     Trade-marks, Copyrights and Licensing:

      Due to foreign pressure, primarily from the United States, China has made great
advances in the legislative protection of intellectual property rights in general, and in
                                    - Page 12 -


particular to overcome its reputation as a source of counterfeit goods. Within certain
judicial districts (such as Beijing), special Intellectual Property Adjudication Divisions
have been set up within the Intermediate Level Courts (zhongji renmin fayuan).

        China is a first to register jurisdiction and the prior use of a trade-mark in China
will not provide any protection. Accordingly, to commence enforcement of a trade-mark
licence it will be necessary to have a validly registered trade-mark. In practice the first
thing a defendant does is to try to challenge the registration. While foreign language
trade-marks may be registered separately, where there is no associated Chinese
character trade-mark when the product is introduced, a colloquial "nickname" will
usually develop. This may not be the most flattering nickname that may be chosen.
Accordingly, it is important to develop and register the Chinese and English versions of
the trade-marks simultaneously. As the characters used in the PRC differ somewhat
from those used in Taiwan and Hong Kong, it may be necessary to register two forms of
the Chinese character trade-mark.

      In Chinese copyright law, the owner of a work should receive protection without
being required to register the work. The period of protection where the copyright
belongs to a company is fifty years from the date of the first publication.

       Although the Trade-mark Law does not define the concept of a "trade-mark
licence," Article 26 allows a registrant to authorize other persons to use its registered
trade-mark subject to the following terms:

             The licensor shall supervise the quality of the goods.

             The licensee shall guarantee the quality of the goods.

             The name of the licensee and the origin of the goods must be indicated on
              the goods that bear the trade-mark.

             The licence contract must be submitted to the trade-mark office of the
              local administrator for industry and commerce for registration.

       Prior to 1997, there was some ambiguity as to whether sub-licences were
permitted. But on August 1, 1997, the Trade-mark Licencing Contract Recordal
Procedures came into effect and some feel that this clarified the issue for domestic
trade-marks. The Procedures provide that sub-licences can be registered as long as the
licence contract contains a clause permitting the sub-licence or the trade-mark licensor
issues a letter of authorization for the sub-licence.

       There is still some debate as to whether trade-marks registered in China by
foreign individuals or entities can be sub-licensed. Some feel that the provisions of the
Regulations concerning the Administration of Trade-marks in Foreign Trade in force as
of August 1, 1995, prohibit sub-licencing of these trade-marks. Developments in this
area should be monitored carefully.
                                   - Page 13 -


3.    Trade Secrets and Technology Transfers:

       In 1993, the 8th National People's Congress Standing Committee adopted the
Law against Unfair Competition. It covers a wide range of market practices, some of
which are traditional antitrust provisions, and others which might be considered trade-
mark matters. Articles 6 and 12 of this law, and Article 9 of the Technology Import
Contract Regulations contain broad provisions on tying arrangements with no allowance
for a defence of efficiency. Article 10 of the Law against Unfair Competition specifically
provides protection to business secrets. Business secrets are defined as any
technological information or any business operation information which is unknown to the
public, can bring about economic benefits to the person possessing them, have
particular utility and about which the person possessing them has adopted secret-
keeping measures. A specific "Trade Secrets Law" is presently being drafted by the
State Commission for Economics and Trade.

       China also has technology import regulations and has a liberal view as to what
constitutes "technology". It can include "know how" in the form of drawings, data
specifications, and can include technical services. A technology import must meet at
least one of several conditions, which include being favourable to the improvement of
management and being capable of improving quality and performance of products,
reducing production costs and lowering consumption of energy or raw materials.

      This is an important definition that any franchisor must consider, because there
are special regulations with respect to technology licence agreements. In China, at the
end of the term of a technology licence agreement, the right to use of the technology
and know-how usually remain with the licensee rather than reverting to the licensor. The
term of the agreement is usually limited to ten years. Technology transfer or licence
agreements are subject to government approval before they are valid, and government
approval must be had before they are terminated. Any confidentiality provision in such
agreements must also be approved.

E.    COURT PROCEEDINGS AND EXECUTION

1.    General Matters:

        Chinese legal traditions place a great emphasis on conciliation and mediation as
a method of resolving disputes, rather than on the use of coercive measures. In post
1949 China the traditional way to resolve disputes was to find a common superior with
jurisdiction over both parties. The emphasis in Chinese social structure is on
relationships, also known as guanxi. As has been pointed out by North American legal
scholars such as Stewart Macauley and Ian Macneil, in long term relational contracts,
the parties often place more emphasis on mutual benefit than on having legally
enforceable rights. Franchise agreements are often regarded as the epitome of long
term relational contracts.

      Court proceedings and execution in China are governed by the Civil Procedure
Law of the People's Republic of China, adopted by the 1st session of the 7th National
                                    - Page 14 -


People's Congress on April 9, 1991, and a lengthy Supreme People's Court Opinion of
September 20, 1992 that supplements many of the provisions of the law. It should be
remembered that in a civil law system individual cases are not counted as precedents
and are thus not well reported. Superior court opinions serve to assist in the
interpretation of legislation.

       According to some Beijing law firms, litigation is not only becoming more and
more acceptable, but it is also becoming more practicable and successful. Generally
speaking, debt obligations have a two year limitation period, and the litigation process is
shorter and less expensive than is perceived. Article 5 of the Civil Procedure Law states
that foreign enterprises shall have the same rights and obligations as Chinese citizens
provided that their home country follows a principle of reciprocity. While the parties are
free to deal with their own litigation in the way that they prefer within the scope provided
by the law, Article 14 provides that the People's Procuratoraters have the right to
exercise legal supervision over civil proceedings.

      The Basic People's Court (jiceng renmin fayuan) are the courts of first instance
except with respect to major cases, including cases with foreign elements, in which
case the court of first instance is the Intermediate People's Courts (zhongji renmin
fayuan).

       Part 4 of the Civil Procedure Law contains special provisions for cases involving
foreign elements, but the term "foreign element" is not defined. Generally speaking in
these cases, where there is a conflict between an international treaty that China has
acceded to and the provisions of the Civil Procedure Law, the treaty will apply unless
China has made specific reservations. Judges are not always familiar with the treaties
to which China has acceded, and any franchisor intending to rely on treaty provisions
for the enforcement of its agreement, would do well to cite the relevant provisions in the
text of the agreement. The language of such proceedings shall be Chinese but
translation may be provided at the request and expense of the parties concerned. Only
Chinese lawyers may appear on behalf of the foreign element that is a party.

       Parties to a dispute over a contract with a foreign element may, by written
agreement, choose the court of the place which has practical connections with the
dispute to exercise jurisdiction (Article 244). Otherwise actions against the defendant
who has no domicile within China are to be brought in the people's court of the place
where the contract was signed or performed, or where the object of the action is, or
where the defendant's distrainable property is located, or were the tort occurred, or were
the defendant's representative office is located.

       Finally pursuant to Article 138, the judgement obtained shall set forth inter alia
the outcome of the adjudication and the costs to be borne.

2.     Property Preservation and Advance Execution:

       Civil law systems generally do not have a common-law concept of equity
(although they do use an equitable approach in determining cases), and therefore have
                                    - Page 15 -


no equitable remedies, such as an injunction. Specifically in China, there is no concept
of "contempt of court" that is necessary for the enforcement of an injunction. However,
Chapter IX of the Civil Procedure Law does make provision for property preservation
and advance execution where:

              "the relationship of rights and obligations between the parties
              concerned is clear and definite, and the denial of advance
              execution would seriously affect the livelihood or reduction of
              operations of the applicant and .... "
the person against whom the application for advanced execution is made is capable of
fulfilling his obligation. There are also penalties there and elsewhere for obstructing
courts in enforcing a judgement or award.

3.     Enforcement of Civil Judgements:

        Donald Clarke of the University of Washington has written several articles on this
topic, the most significant of which is "Power and Politics in the Chinese Court System;
the Enforcement of Civil Judgements", 10 Columbia Journal of Asian Law 1, (1996).
While there is a perception by Westerners and by Chinese (as expressed in reports on
the matter to the National Peoples' Congresses) that judgements in China are not
sufficiently enforced, Professor Clarke's exhaustive study points out that this perception
may not be warranted. He cites some interesting statistics suggesting that in 1993, the
reported success rate on referred domestic Chinese cases was about 80%.

        However, a more careful examination of cases from the Jiangxi Higher Level
People's Court shows that out of 473 debt cases surveyed, 277 had not been enforced,
giving an enforcement rate of about 41%. Of the 277 cases, the failure to enforce in 166
cases was due to debtor insolvency. As a reference point, Professor Clarke goes on to
cite a study in eleven New Jersey counties in 1987 that found that only 25% of the writs
of execution in civil cases were returned fully satisfied. Seven percent were returned
partially satisfied and the remaining 68% were returned unsatisfied or simply dropped.

         On August 24, 1999, the Vice-President of the Supreme People's Court (zuigao
renmin fayuan) announced that the Higher Level People's Courts (gaoji renmin fayuan)
would be in charge of the law enforcement of local courts. The Vice-President cited
difficulties in enforcement caused mainly by local and departmental protectionism. Other
difficulties included the generally weak awareness of the law and the financial difficulties
experienced by state-owned enterprises.

       There are of course obstacles to the enforcement of civil judgements in China.
Internally the courts are reluctant to use the coercive measures available to them and
some lawyers feel this is the main reason for execution difficulties. The divisions of the
court responsible for execution have traditionally been the refuge of the less qualified,
which has not aided enforcement rates. Traditionally, socialist law systems have had a
greater emphasis on substance rather than procedure. This appears to have led to
several ways in which a party can contest judgements by petitioning higher authorities.
This lack of finality in a judgement hinders enforcement.
                                    - Page 16 -


       Externally there is the issue of local protectionism. Remember that court officials
are appointed by their local administrative bodies and are dependent upon them for jobs
and finances. In one particular instance, a judge in Fujian executed a judgement against
a local enterprise and then found that his daughter had been transferred the next day by
her employer, the county, to an isolated post on a small island. Rank counts for more in
China than in other systems, and courts are unable to enforce judgements against
defendants who are on the same administrative level as the court.

       Notwithstanding the fact that a court judgement is theoretically good across
China, Chinese court systems are generally reluctant to enforce the judgements of the
courts of another area. This would essentially cause resources to flow out of their own
area. To overcome this places such as Shanghai have entered into "treaties" of
reciprocity with other courts. This practice has been denounced in some legal councils
and the agreements do not appear to have legal force. In some instances, such as a
reported case in Shenzhen, banks have had a rule not to enforce freezes on customer
accounts unless the order came from a local court, notwithstanding notices from the
Supreme People's Court to the contrary.

       Finally, despite the recent amendments to the Constitution regarding the rule of
law, significant cases that may affect party policy may result in the interference and
intervention of the local party secretary. On August 27, 1999, a draft bill was tabled in
the National Peoples' Congress Standing Committee that would formalize this
procedure at the provincial level, to combat graft. The ultimate result of these cases will
be one test of the meaning of "yi fa zhi guo".

F.     ARBITRATION

       China has two arbitration systems, one for domestic arbitration governed by the
Arbitration Law adopted at the 9th Standing Committee Session of the 8th National
People's Congress in 1994, and the other for international arbitration through the China
International Economic Trade Arbitration Commission (CIETAC). China is a party to
various international conventions and treaties, and most importantly to the 1958 New
York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.
CIETAC currently handles more international arbitration cases than any other arbitral
body in the world. It has a panel of 428 arbitrators, one third of which are foreigners.

        Under the provisions for domestic arbitrations, foreign investment enterprises
that used a form of incorporation that had Chinese legal personality were considered
Chinese persons. Accordingly, arbitrations involving such entities were to be conducted
under the domestic arbitration procedure rather than the CIETAC rules. This did not
often fit with the substance of the dispute. On June 8, 1996, the State Council issued a
notice that expressly authorised domestic arbitration commissions to administer foreign
related cases. In May 1998, CIETAC revised its arbitration rules to clarify that CIETAC
can administer cases between foreign investment corporations and Chinese companies.
Foreign franchisors registered as Chinese legal entities now appear to have the right to
choose either of the arbitration systems in their franchise agreements.
                                   - Page 17 -


        One of the significant differences between these venues is with respect to
enforcement. Domestic foreign investment related awards and foreign arbitration
awards are reviewed only to ensure that there are no procedural irregularities before
they are enforced. In contrast the Chinese courts are permitted to review domestic
arbitration awards on both procedural and substantive issues. However, the Civil
Procedure Law further grants the people's courts the right not to enforce an arbitral
award if doing so would compromise the "... social and public interest of China",
although this right has been rarely exercised.

        It appears that China has a significant commitment to enforcing foreign
arbitration awards. In August 1995, the Supreme People's Court issued a Notice on
Handling Awards Involving Foreign Interests and Foreign Arbitral Awards that required
that any People's Court seeking to refuse enforcement to first obtain approval from a
superior People's Court in the same jurisdiction. With respect to CIETAC awards, in
1995, 26 out of 34 awards were enforced, and in 1996, 43 out of 64 awards were
enforced. In the period from 1990 to 1996, of the 37 awards that were not enforced, in
16 cases the reason was lack of assets. There were two cases where enforcement was
held to be contrary to the social and public interest. However those with an interest in
arbitration in China do not feel that these numbers are reflective of their experiences.

       Professor Randall Peerenboom of UCLA has recently commenced a study of the
enforcement of arbitral awards in China. It will be interesting to see if the results
matched those of the Arbitration Research Institute of the China Chamber of
International Commerce noted above. Generally speaking in drafting for arbitration, the
Chinese parties insist upon arbitration in China. Having arbitration in another country
puts them at a significant cost disadvantage. On the other hand, the use of arbitration
allows the parties greater latitude in choosing the applicable law, the language of the
proceeding and the use of non-Chinese legal representation. Foreign lawyers may also
appear before a Chinese domestic arbitral tribunal. Generally CIETAC arbitrators have
more experience and sophistication in commercial disputes.

      There have also been problems with the reciprocal enforcement of arbitral
awards between Hong Kong SAR and China. To resolve this on June 21, 1999 an
"Arrangement on Mutual Enforcement of Arbitral Awards" was entered into. Hong Kong
hopes to have implementing legislation in force by the end of 1999.

G.    FRANCHISE MEASURES AND CONCLUSION

       While China is making tremendous progress in the development of a legal
structure for a market economy, it is fair to say that such a legal system is not yet
complete. This will be seen more clearly when reviewing laws in place in the Russian
Federation in the next section.

       The recent amendment to the Constitution to include the phrase "yi fa zhi guo" is
certainly a step forward. However the Chinese Constitution, unlike constitutions in other
countries, is not directly justiciable. The amendment does give significant leverage for
the rule of law over party policy and provides leverage for the protection of individual
                                    - Page 18 -


rights. According to Professor Peerenboom, it may also be a way for the central
government to exercise power over the increasingly independent local governments and
is useful in the campaign against corruption and the use of guanxi in economic
development.

        An example of the developing legal system is the Circular of the Ministry of
Domestic Trade Concerning Promulgation of the Measures for Administration of
Franchise Operations (for Trial Implementation) that was issued on November 14, 1997.
It is understood that these apply only to domestic transactions between Chinese legal
persons and not to master franchise arrangements. They are however an example of
specific provisions in other laws that will overrule the Contract Law that was adopted by
the National Peoples' Congress on March 15, 1999.

        While this appears to be superficially similar to the situation in Russia where the
specific provisions on Commercial Concessions in the Civil Code overrule the general
provisions on contracts, it should be remembered that in Russia the specific provisions
are part of the overall Civil Code. The Russian Civil Code takes precedence over the
legislation of any member state and all administrative decrees. As China does not yet
have such a civil code, the provisions of Article 123 of the new Contract Law, while
necessary in a Chinese context, make it more difficult to determine the applicable law.

        The Franchise Measure reflects several of the policy issues expressed in the
Contract Law and other Chinese Laws. Article 4 provides that franchise questions shall
be conducted in adherence to the principles of voluntariness, fairness, compensation,
good faith and standardisation. Not only must the franchisor have unique and
transferable managerial and administrative technology or knowhow, but pursuant to
Article 10, one of the fundamental rights of the franchisee is to acquire the management
technology and the business secrets provided by the franchisor. This appears to reflect
the provisions of the laws governing technology transfers.

       The Franchise Measures specifically give the franchisor the right to terminate the
franchisee for breach of contract, or infringing on the lawful rights and interests of the
franchisor, or undermining the franchise system. They further provide that the franchisor
may require the franchisee to provide some security money in order to guarantee the
franchisee's performance under the contract. These matters will undoubtedly aid in
enforcement, although the latter provision may not assist franchise sales.

       While Article 15 provides that disputes arising during the term of a franchise
agreement can be dealt with according to the procedures set out in the agreement, it
also provides that where the transfer and licensing of intellectual property rights are
involved, the matter shall be handled in accordance with relevant state policies and
regulations. How many franchise agreements do not involve a trade-mark licence ?

       For reasons such as this, the one Beijing law firm recommends that in preparing
a franchise agreement for the People's Republic of China, the franchise agreement
must be broken up into separate components in order to secure the needed government
registration or approval. In other words, the trade-mark licencing agreement, which must
                                     - Page 19 -


be registered, would be separated from the technology transfer agreement which must
also be registered. They also recommend separate contracts with respect to
management consultancy, advertising, international services, and construction and
design services. How well this would work in enforcing the franchise arrangement in a
specific province or county is yet to be seen.

       In general it would appear that in order to enforce a franchise agreement in
China the agreement would have to appear in the eyes of the court to be relatively
balanced and a franchisor will gain points for having made an effort at conciliation or
mediation. This appearance of balance may require less reliance on the use of
franchisor discretion in the franchise agreement and more reliance on explicit provisions
regarding some aspects of the agreement.

       Enforcement in a local court may also be assisted by the development of a
relationship with the local community. It may be to the franchisors advantage to use
location control as a method of enforcement (providing that the franchisor is comfortable
with the lease that it obtains) as would demonstrate a long term commitment and
contribution to the local economy. Notwithstanding the administrative burden, a
franchisor may wish to ensure in the sublease that local taxes are paid to it by the
franchisee for remittance by the franchisor to the relevant authority.

        In addition to the legal system, China's transition with respect to its political
system is still incomplete. The development of a governance structure that more clearly
defines the authority of the various administrative units and the revenue sharing formula
would assist in the development of the uniform enforcement of contracts across the
country. The ability of the internal government units to collect tax revenue in proportion
to their social service obligations to individuals left behind in the economic transition
needs to be monitored. If China's growth rate continues to slow, this could lead to
political tensions. However China appears to have taken great note of the difficulties
that Russia has had, and to date has been adept at avoiding them.

                          III.    THE RUSSIAN FEDERATION.

A.     INTRODUCTION

       In Russia, in contrast to China, the changes in the political system have
preceded the changes in the economic system, in part due to the 1991 siege of the
Russian parliament. With the adoption of the 1993 Constitution and of Parts One and
Two of the Civil Code in 1994 and 1995 respectively, there is no question that as a
matter of law, the Russian Federation is no longer a socialist state, but rather a
capitalist one. The first article of the 1993 Constitution states that Russia shall be a "... a
democratic federal, rule-of-law state with a republican form of government." Article 1 of
the Civil Code requires that legislation be based on the principles of equality, the
inviolability of ownership, freedom of contract, and the absence of arbitrary interference,
among other things.
                                      - Page 20 -


       However as in China, the detailed implementation of these principles takes some
time to bring into effect. For example, the legislators and the President have not yet
agreed on an acceptable form of Land Code. In the meantime the economy has not yet
recovered from the effects of the transition from a command to a market system, as the
August 1998 collapse of the ruble has demonstrated. In contrast China has experienced
continued (although declining) growth in its GDP during this same period.

       These two factors, the transition and delay in the implementation of a new legal
system, and the collapse and slow rebirth of the economy, appear to have contributed
strongly to a power vacuum. The general perception is that organised crime, corruption
and regionalism have thrived in this vacuum. A recent article in The Economist (August
28, 1999) surveyed the problem and pointed out that some former Soviet republics have
managed to make significant progress in controlling their problems. There is also an
increasing desire on the part of some criminals to become respectable. Perhaps they
sense that Russians do not have an infinite tolerance for their activities.

B.     LEGAL STRUCTURE AND THE COURT SYSTEMS

1.     Type of Law:

       Russia today has in place a civil law system that is firmly rooted in the continental
European civil law tradition. While Part Three of the Civil Code dealing with Private
International Law and other matters is still in draft form and has not been adopted, Parts
One and Two of the Civil Code are in force, and have a scope of subject matter that
takes the Code much further than many of its European prototypes. The Russians have
combined into one code both the civil and commercial codes, which traditionally in
continental Europe have been kept separate. According to Christopher Osakwe (see
"Anatomy of the 1994 Civil Codes of Russia and Kazakstan: A Biopsy of the Economic
Constitutions of two post Soviet Republics" 73 Notre Dame Law Review 1413, 1998),
the Russian Civil Code is unique among continental European civil codes in the
phenomenal breath of its coverage and its quasi-constitutional status within the Russian
legal system.

      The working group responsible for its preparation consisted largely of law
professors trained in the Soviet system of law. However they used a variety of outside
consultants, and relied primarily on those from the University of Leyden in the
Netherlands. There are also influences in the Civil Code from the American Uniform
Commercial Code and the pre -1991 Soviet Civil Code.

       Article 71 of the Russian Constitution of 1993 sets out the exclusive powers of
the Federal government as including "civil legislation". The Civil Code uses this
provision in its Article 3 to define "civil legislation" to "... consist of the present Code and
other federal laws adopted in accordance therewith ..." regulating the relationships
specified in the Civil Code. In doing this the Civil Code may have gone beyond the
original intention of drafters of Article 71 of the Constitution. These provisions claim to
give the Civil Code supremacy over the acts of the member states of the Russian
Federation.
                                    - Page 21 -

       The Civil Code is intended to set out the more general principles of the laws that
regulate various types of relationships. The Duma may pass other laws and the
President may issue decrees to further regulate these matters, provided that they are
not in conflict with the Civil Code. The hierarchy of the regulation of civil law
relationships in Russia is then as follows; The Constitution, the Civil Code, other
Federal civil legislation, Presidential decrees, executive regulations, and finally business
custom. The Civil Code does however yield to binding norms of international law.

       It should be noted that not all Soviet law has been swept away. Soviet law that
does not contradict the Constitution, Russian legislation and the Agreement on the
Formation of the Commonwealth of Independent States still has legal force. There is a
debate as to the status of laws that had been passed but not yet put into effect as of the
date of dissolution of the Soviet Union. The prevailing view is that absent special
enabling legislation, they are not in effect.

        The Civil Code is not yet entirely in force, as other elements are yet to be worked
out in the transition from a socialist system to a civil law system. Specifically Chapter 17
of the Civil Code will go into force only after the new Land Code has been adopted, and
this has not yet occurred.

        Russia, in contrast with China, has had a long history of an independent bar.
However currently in Russia, lawyers are not viewed in a particularly favourable light.
Informal surveys conducted by Osakwe in 1997 found that the average Muscovite was
significantly more knowledgeable about the provisions of the Civil Code than of the
Constitution, and placed significantly more faith in the Civil Code than in the Constitution
as the guarantor of the new economic system.

2.     Type of State:

        Russia is a federal state of 89 subject units in six classes: 49 oblasts; 1
autonomous oblast; 6 krais (or territories); 21 republics (including Chechnya) 2 federal
cities; and 10 autonomous okrugs or districts. The Commonwealth of Independent
States, which includes the former Soviet Republics, is not a federation but rather a
confederation of independent states. While legislation such as Russia's Civil Code
serves as a model to the other states (the Civil Code was particularly influential in
Kazakstan and Kyrgyzstan), it is not law there unless adopted by the specific state.

        The divisions of the Russian Federation reflect the administrative regions of the
old Soviet state. Russia is not as ethnically homogenous as China and there are
significant non-Russian minorities who were given "homelands" by the Soviets. For
example, The Republic of Tatarstan, based in Kazan on the Volga River, is home to the
descendants of the hordes of Genghis Khan and since 1991 has undergone an Islamic
revival. By an agreement between the Russian Federation and the Republic of
Tatarstan executed on February 15, 1994, the limits of the federal powers set out in the
Constitution were altered and Tatarstan is now allowed to conduct its own foreign trade
and economic policies. Tatarstan was estimated in 1998 to rank among the four biggest
regions in terms of foreign investment.
                                    - Page 22 -


      The republics, as significant ethnic homelands, have enjoyed a high degree of
autonomy, each having the right to its own constitution and to the election of its own
President. Oblasts and krais are run by governors. They were previously appointed by
the President, but since 1997 have been elected. Elected governors are proving to be
more powerful than their predecessors, contributing to the difficulty that Moscow is
having in collecting revenues.

3.     The Court System:

       The 1993 Constitution specifies that the Federal Government is solely
responsible for the system of the law courts, but that the Federal Government and the
individual members of the Federation are jointly responsible for the appointment of the
personnel of the judiciary and law enforcement agencies and the regulation of lawyers
and notaries. The Russian Federation has three types of courts. The Constitutional
Court deals only with constitutional matters. In addition to it there are two parallel court
systems, the Courts of General Jurisdiction and the Arbitrazh Courts. With the coming
into force of the new code of civil procedure for the Arbitrazh Courts in 1995, the
Arbitrazh Courts have become the commercial courts, while the Courts of General
Jurisdiction handle all other matters, including the enforcement of foreign arbitral
awards (based on Soviet era legislation that continues in force).

        The Arbitrazh Courts (not to be confused with arbitration panels) were developed
under the Soviet Union to resolve disputes between state owned enterprises. In that era
their primary concern was economic expediency rather than the rights or relative fault of
the parties. With the demise of the Soviet Union, the Supreme Soviet felt that the
general courts were unprepared to adjudicate business disputes. They therefore chose
in 1991 to transform the former State Arbitrazh bodies into a new system of commercial
courts, with an Arbitrazh Court Act enacted on July 4, 1991 and the first Arbitrazh
Procedural Code enacted on March 5, 1992. In 1995, there were further structural
changes in the new Arbitrazh Procedural Code. The 1995 legislation extended the
jurisdiction of the Courts equally to Russian and foreign legal entities and physical
persons having formally registered as entrepreneurs, and accorded the courts federal
status, which reduced their dependence on local government patronage. An
intermediate level of appellate courts, known as circuit courts was established, and
attempts were made to reduce the investigative role of the judge and to move the court
proceedings further towards an adversarial model.

       Arbitrazh Courts are established at the city, krai, oblast, autonomous oblast,
autonomous okrug, and republic level within the Federation. While many of the current
Arbitrazh judges also worked in the former Soviet Arbitrazh system, pursuant to Article
119 of the 1993 Constitution, judges must now be twenty-five years old, hold a law
degree and have worked for five years in the legal profession. These criteria are similar
to those used in other civil law systems.

      It is important to note that in matters involving breaches of contract, the plaintiff
has the option of filing in the venue where the contract was to be performed, but the
venue of the action may also be established by the agreement of the parties. With
                                    - Page 23 -


certain limitations, a franchisor in Russia may choose to designate a court outside the
franchisee's locality to hear any disputes.

       Court costs, that is the fees charged by the court on the filing of a claim, are
determined according to a sliding scale currently ranging from 5% to 0.5%, depending
upon the amount of the claim. When the matter is resolved, these are allocated between
the parties in proportion to the extent to which the plaintiff prevailed. However, with
respect to attorney fees, the Arbitrazh Courts follow the American rule. Each side pays
its own fees unless otherwise stipulated by agreement. This is something that
franchisors may wish to provide for in preparing agreements. In contrast, the Courts of
General Jurisdiction adopt the English rule, whereby the loser pays the prevailing
parties legal fees.

        Observers suggest that competency of the Arbitrazh Courts is growing and that
they are more effective than is generally perceived in the West. With ready access to
civil law traditions, there is an impressive level of discourse in Russian law journals
which often feature articles by Arbitrazh Court judges. An Arbitrazh Court judge is less
exposed than a General Court judge to criminal elements because they do not have
criminal jurisdiction.

        The Arbitrazh Courts are not immune to threats and corruption. However
appellate review puts meaningful constraints upon the ability of a corrupt judge to
manipulate the outcome. There are two levels of appeal, and the first level of appeal is a
trial de novo before a panel of three judges from the same court that originally decided
the case. The second level of appeal, known as Cassation, is to the circuit courts that
are removed from local influence.

C.    GENERAL CONTRACT LAW

        Article 8 of the Civil Code generally provides that civil rights and duties shall
arise, inter alia, from contracts (dogovor) and other transactions (sdelka), whether or not
they are provided for by law, so long as they are not illegal. Obligations (obiazatelstvo)
arise from a contract, as a consequence of causing harm, or as otherwise specified in
the Civil Code.

       Article 420, on the concept of contract (dogovor), incorporates the rules on
transactions (sdelka), and the general provisions on obligations (obiazatelstvo) arising
from contracts, unless otherwise provided by the rules of the general chapter on
contracts or the specific provisions on the twenty-six named or "nominate" types of
contracts including, in Chapter 54, Articles 1027-1040, Commercial Concessions
(kommercheskaya kontsessiya) or franchises. The special provisions on franchise
agreements in the Civil Code cannot be read by themselves. The general provisions of
the Civil Code and the provisions on obligations, transactions and contracts apply
unless they are overruled by the special provisions set out in Chapter 54. Any franchisor
planning on franchising in Russia would be well advised to obtain a copy of the Civil
Code (English translations are available) as a reference to assist in understanding the
advice it receives from local counsel.
                                    - Page 24 -


1.     Formation:

       As in other civil law systems, consideration is not necessary for the formation of a
contract. The making of a contract requires only an offer, an acceptance, a meeting of
the minds on the significant conditions, in compliance with the requisite form. Article 161
requires that contracts with juridical persons (e.g corporations) must be in writing. Also
as in other civil law systems, third party beneficiaries of a contract have a right to the
enforcement of the benefits allocated to them under certain conditions (see Article 430).

       In designing a sales system for Russia, franchisors should take into account the
provisions of Article 431 on the interpretation of contracts. If the literal meaning cannot
be established from the words and the ambiguity cannot be resolved by comparisons
with other conditions and with the overall sense of a contract, the intent of the parties
may be determined by taking into account the purpose of the contract. In doing so the
court may take into account the negotiations preceding the contract and
correspondence, practice established by the mutual relations of the parties, custom, and
the subsequent conduct of the parties. These provisions would override any "entire
agreement" or "no waiver clauses".

2.     Relationship Standards - Good faith:

       Article 309 of the general provisions on obligations requires that obligations be
performed " ... duly in accordance with the conditions of the obligation ... and in the
absence of such conditions and requirements, in accordance with business custom ...".
Osakwe summarises this provision as requiring that contracts be performed in good
faith and in the proper manner, which appears to be an expansion by him upon the
Russian phrase "nadlezhashchim obrazom", which may be translated as only "duly" or
"properly" or literally as "... in the appropriate manner."

       However other articles also allow for the intervention of the courts to set
relationship standards. Article 428 defines a contract of adhesion or accession as one
whose conditions have been determined by one of the parties in formulas and other
standard forms and may be accepted by the other party by no other way than to accede
to the proposed contract in its entirety. Section 2 of Article 428 provides that a party to
such a contract has the right to demand dissolution or change to the contract even if the
contract otherwise complies with the law, if the contract deprives the party of rights
usually granted under contracts of that type, excludes or limits the responsibility of the
offer or for a violation of an obligation, or contains other conditions clearly burdensome
for the adhering party which the adhering party would not have accepted if it had the
opportunity to participate in determining the conditions of the contract. It would appear
that when franchising in Russia, a little negotiation with each franchisee would be an
advantage, as would evidence of the voluntary acceptance of the standard form
contract. Section 3 of Article 428 provides that a party to a contract of adhesion shall not
obtain the remedies mentioned if they knew or should have known the conditions on
which the contact had been concluded.
                                     - Page 25 -


        Finally, Chapter 29, and in particular Article 450, talks about the grounds that a
party may have for obtaining a change or a dissolution of a contract. Section 2 allows
the contract to be changed in the event of a material breach of the contract by the other
party. A material breach is defined as a breach by one party which entails such loss for
the other party that the other party is deprived to a significant degree of that which it had
a right to expect in concluding the contract.

3.     Liquidated Damages and Currency:

        In the general provisions with respect to obligations, there are, in Chapter 23,
provisions for securing the performance of obligations. In particular parties have rights
to make agreements which provide that penalties or liquidated damages are payable on
breach of contract without the creditor having to prove that it suffered losses. However
Article 33 provides that , where the penalty is not commensurate with the consequences
of the violation of the obligation, a court has the right to reduce the penalty. In preparing
franchise agreement for Russia, it would be appropriate to take care in the drafting of
the liquidated damages clause to justify the formula used for the calculation of the
penalty.

       Article 317 of the Civil Code requires that the monetary obligations must be
expressed in rubles. Further provisions allow for an obligation to be payable in rubles
equivalent to a determined amount in a foreign currency, in which case the exchange
rate will be the official exchange rate of the Central Bank on the day of payment unless
the parties agree otherwise.

D.     SPECIFIC TYPES OF CONTRACT

       In any civil law system, one of the steps to be taken in the analysis of the
contract is to determine whether it is a nominate or named type of contract in the civil
code and therefore governed by a specific set of rules, or whether it is an unnamed type
of contract and governed only by the general provisions. Chapter 54 of the Russian Civil
Code has specific provisions for commercial concessions that includes (in Article 1035)
an automatic right of renewal for the franchisee who has duly performed his duties
under the contract. Further each of the parties to a contract of commercial concession
has the right to terminate the contract on six months notice (Article 1037) unless the
contract provides for a longer notice period.

       A franchisor wishing to rely on either location control or de-identification to
preserve its system in Russia will have to examine carefully the specific laws relating to
leasing of real property and personal property and its rights to protect its trade-marks
and trade secrets.

1.     Leasing:

        There is not yet a free market system for land in the Russian Federation. In the
Soviet Union, all land belonged to the State. The development of rules for the
privatization and sale of land has been particularly controversial. Although different
                                      - Page 26 -


versions of the new land code have been proposed by the Duma, they have all been
vetoed or returned unsigned by President Yeltsin.

        In the absence of agreed upon federal legislation, the rules governing land have
been based on Presidential decrees, government regulations or specific regional laws
which are either based on the presidential decrees or based on the absence of federal
legislation. For example, a Presidential decree of November 26, 1997, generally allowed
the sale of land plots or the right to lease land plots in cities to citizens and legal entities
through tenders. In Moscow and St. Petersburg, local legislation has been passed to
allow foreigners to buy lease rights lasting up to 49 years. In Saratov Oblast, a land law
was passed in the fall of 1997 that allowed sale of land plots with limitations regarding
agricultural lands and prohibitions on foreign citizens and legal entities from owning
land.

       These legal difficulties may also be coupled with other difficulties in finding good
locations. Many urban buildings at good locations need considerable capital upgrades
(such as heating and electrical systems) to meet western business standards. The
owner of the property may not be able to afford the upgrades. Any franchisor planning
to lease from such owner will have to evaluate the nature of the sums to be invested
against the quality of the title that it may obtain.

       While there is difficulty over the land code, other necessary laws have been
approved. An Urban Development Code passed through the Duma and was signed into
law on May 7, 1998. This provides for comprehensive planning and zoning in urban
areas. Furthermore in July of 1997, a Law on the State Registration of Rights to
Immovable Property and Transactions Therewith was passed to allow for the recording
of land titles, similar to the system used in the United States. Procedures for the
registration of rights were adopted by Government Regulation Number 219 on February
18, 1998 and the setting up of the Registry System is proceeding.

        A lease is a named form of contract in Chapter 34 of the Civil Code. This chapter
deals with leases for both immovable and movable property. Pursuant to Article 609,
leases for over a period of more than a year, or leases were one of the parties is a legal
entity, must be in written form. Leases for immovable property are subject to state
registration unless specifically exempted.

        Where the lease is for an indefinite term, separate notice periods are provided for
movable and immovable property unless otherwise specified in the contract. This would
be something that franchisors would want to consider. Article 612 generally provides
that the lessor shall be liable for defects in the leased property which will wholly or
partially obstruct the use of such property, unless such defects are stipulated when
concluding the lease, or were previously known or should have been known by the
tenant. This would be a further area of concern for the franchisor in subleasing. Similarly
the lessor shall remain responsible for capital repairs, unless otherwise provided for in
the contract.
                                     - Page 27 -


       Articles 619 and 620 set out the grounds for the dissolution of the lease contract
before its expiry at the demand respectively of the lessor and the lessee. In each
instance, it is specified that the lease may be dissolved by a court and there does not
appear to be any right for the lessor to unilaterally terminate the lease and use self help
remedies to retake possession of the property. Article 622 provides that in the event of a
termination of a lease, the property is to be returned, failing which the lessor shall have
the right to demand the making of the lease payments for the entire time of the delay.

         Generally speaking, it appears that the use of leases by franchisors to maintain
location control in the Russian Federation will not be as advantageous to the franchisors
as it is in North America.

2.     Trade-marks, Copyrights and Licences:

       The Russian Federation (but not necessarily any other member of the CIS) is a
party to the Universal Convention on Copyright and the Berne Convention and thus
materials copyrighted in the United States will also be protected in Russia. Materials
created in Russia will be governed by the Law on Copyrights and Neighbouring Rights
(July 9, 1993) and its amendments (July 19, 1995). Copyrights arise by virtue of the
creation of the work and do not have to be registered, but copyright should be claimed
by making the appropriate copyright notice.

     In disputes, other parties and Russian officials are still more respectful of
documents with numerous stamps and ribbons, and the better strategy for a franchisor
may be to make the maximum use of existing registration procedures.

        With respect to trade-marks, Russia is a first to register jurisdiction rather than a
first to use. Accordingly a valid registration of a trade-mark is imperative for any
franchisor planning to operate in Russia. In addition to registering the trade-mark,
franchisors should also obtain an appraisal of its value. The certificate of registration
and the valuation certificate are the main documents used in a court proceeding and will
assist in determining the damages from unfair competition and infringement. Care
should be taken to ensure that the trade-mark is registered for all the appropriate
classes or "options". Rights have been lost by distributors who have registered their
trade-mark only for "manufacturing" and not for "sales".

       Article 26 of the Law on Trade-marks, Service Marks and Names of Places of
Origin of Goods (September 23, 1992) allows for the licencing of trade-marks provided
that the licence contains a condition that the quality of the goods of the licensee will not
be lower than the quality of goods of the licensor and that the licensor will effectively
control the fulfilment of this condition. Licence agreements must be registered with the
Ministry of Justice (Russia's Patent and Trade-mark Office was abolished by
Presidential Decree on May 25, 1999), failing which they are null and void. This means
that a franchise agreement, which is also a licence to use a trade-mark, will have to be
registered twice, once as a franchise agreement and once as a licence.
                                    - Page 28 -


       Pursuant to the Law on Trade-marks, there are rules for the registration of
agreements on the assignment of trade-marks and licence agreements. If only a licence
agreement is being registered, it is acceptable to use a short form to preserve
confidentiality. The basic items that must be present in the short form agreement for
registration are specified in the rules. The agreement must relate the scope of
transferred rights to the certificate number of each and every trade-mark in question.

       In preparing licences and other agreements for use in Russia, two rules from the
Soviet era should be followed. The ultra vires doctrine provided that the contract
concluded by legal entity may be invalid if involves a purpose not stated in its charter.
Therefore a franchisor should ensure that a franchisee corporation has correctly
specified that it has the power to enter into the franchise agreement (as set out in Article
173 of the Civil Code) and further, it should ensure that its franchise or licence
agreement complies with the two signatures rule (i.e. the signatures of two authorized
signing officers, one of whom should be the chief financial officer, are required to
validate the agreement).

       Finally it is recommended that the contract should provide on termination that the
licensee loses all rights and must pay significant liquidated damages if it misuses or
devalues the trade-mark, or if during the time of the contract it breaches its
responsibility for quality control.

       Permanent injunctions are available to protect trade-marks and other intellectual
property. In certain circumstances, infringing goods can be confiscated through a
criminal proceeding. However, there are no administrative procedures for customs
actions.

3.     Trade Secrets:

        The protection of trade secrets is something relatively new for the Russian
Federation. In the Soviet era such a concept was foreign to the system. However,
Article 139 of the Civil Code provides that information shall constitute an employment or
a commercial secret when the information has real or potential commercial value by
virtue of its been unknown to third person; there is no free access to it on legal grounds;
and the possessor of the information takes measures to protect its confidentiality. There
are restrictions on the type of information that can be the subject of this article, but the
restrictions are relatively narrow in scope.

       The Law on Information further provides that ownership title to information shall
belong to the physical or legal persons that finance the creation of such information or
acquired it on other lawful grounds.

       It appears that this is an area that has not been well explored in Russian
jurisprudence.
                                    - Page 29 -


E.     COURT PROCEEDINGS AND EXECUTION

1.     General Matters:

       Proceedings in the Arbitrazh Courts are governed by the Arbitrazh Procedural
Code (Arbitrazhnyi Protsessualnyi Kodeks), a revised version of which was enacted in
1995. Generally speaking, proceedings before the Arbitrazh courts are expeditious. The
court is required to issue a decision within two months of the filing of the claim, and
generally this is adhered to. However, approximately 40% of Arbitrazh Court claims are
simple claims for non payment for goods or services which may be routinely disposed
of.

       As in other civil law systems, it is the judge rather than the lawyers who takes the
stronger role in the proceedings. The judge controls the sequence of proof and is the
principal examiner of witnesses. While some of the 1995 changes shifted the burden of
proof to the petitioners (rather than only requiring them to respond to requests of the
judge) informal commentaries suggest that the judges in the Arbitrazh Court system still
tend to be lenient with parties who have not taken sufficient initiative in proving their
case, and will thus request documents for them. There is no provision for direct party to
party discovery.

       As in many civil law countries, documentary evidence is preferred to oral
testimony. Franchisors may wish to take note of this while conducting their dealings with
Russian franchisees. The court will also determine whether an expert is necessary and
will also select the expert and the question to be presented. The court is also
responsible for determining the existence and content of foreign law that may be
applicable to the dispute. If the court cannot determine the law, it is likely that it will
apply Russian law.

2.     Interim Relief or Obespechenie Icka:

       Chapter 7, Articles 75 - 80 of the Arbitrazh Procedural Code set out the
provisions governing interim relief or actions for security or maintenance (obespechenie
icka). A party may seek such remedies or relief at any stage of the Arbitrazh
proceedings if the failure to take such measures would possibly hinder or make
impossible the implementation of the court's decision. The court is required to act upon
a request for interim relief within one day.

       The measures for interim relief (mery po obespecheniyu iska) may include
seizure of property or financial resources belonging to the respondent; a ban or
prohibition on the respondent accomplishing, carrying out perpetuating or committing
certain acts, a ban or prohibition on other parties carrying out certain acts that relate to
the matters in dispute, and the suspension of other proceedings or decisions or
implementation of decisions. Failure to comply may result in the imposition of a fine of
up to 200 times the minimum monthly wage.
                                     - Page 30 -


3.     Enforcement:

        Arbitrazh Court judges, including the Chairman of the Higher Arbitrazh Court and
the chairmen of oblast level courts, have identified implementation of their decisions as
the single biggest problem facing their courts and the development of respect for the
rule of law. This is relatively new to them, as under the Soviet system all enterprises
were state owned and their awards would essentially be carried out automatically.
Glenn Hendrix, in his article "Business Litigation and Arbitration in Russia", 31 The
International Lawyer 1075 (Winter 1997), quotes a Ministry of Justice press conference
of December 6, 1995 in which it was claimed that only 50% of the court rulings involving
the recovery of money were implemented. Given the state of the Russian economy, and
the earlier statistics from China and New Jersey on the successful enforcement of
judgements, foreign parties may not share the Chairman's perception of the
effectiveness of the implementation of Arbitrazh Court decisions as being such a big
problem, relative to other countries.

       Kathryn Hendley in her article "Re-making an Institution: The transition in Russia
from State Arbitrazh to Arbitrazh Courts", 46 American Journal of Comparative Law 93
(1998), identifies four reasons for difficulties in implementation from her personal study
of the Arbitrazh Court system during the summer of 1996 and the spring of 1997 in
Moscow, Saratov and Ekaterinburg. The Arbitrazh Courts at that time had no
enforcement capacity. Instead they relied upon the officials of the Courts of General
Jurisdiction. These personnel were poorly paid and had been described by the
Chairman of the Constitutional Court as persons who could not find any other jobs. If an
enforcement order is unsuccessful against the bank account, then the petitioner must
seek the assistance of these people and they are obliged to find the defendant and
locate assets to satisfy the judgement.

         The burden placed on the petitioner, though not unique to Russia, is another
reason for the difficulties in implementing the decision. Generally parties with a
judgement outstanding against them will want to satisfy the judgement to preserve their
reputation. However, because of the state of the Russian economy, non-compliance
with Arbitrazh Court decisions does not appear to have an adverse reputational effect.
Although the initiative rests with the petitioner in most jurisdictions, in Russia this
initiative is more burdensome.

       The third reason given for the difficulty in enforcing judgements is the difficulty in
finding hidden assets. The techniques used in Russia for hiding assets are not unknown
in the West, but the techniques for finding assets provided to family members or trusted
colleagues, such as piercing the corporate veil, are not as not well developed. One
method of overcoming this problem is to seek interim relief by having assets frozen.
Judges apparently exercise caution in proceeding with these remedies only to ensure
that the money will be there when the judgement is finally rendered. More is needed
than simply the suspicions of the plaintiff, and emphasis seems to be on the prior
behaviour of the defendant. It should be noted that the likelihood of the petitioner
prevailing on the merits of the case is not something that the judges consider in granting
interim relief.
                                     - Page 31 -


      Finally of course, because of the state of the Russian economy, many Russian
enterprises are simply broke. In all countries this is a barrier to the enforcement of
judgements.

       Some measures have been taken to rectify this problem. A Law On Court
Officers was enacted in July 21, 1997 to provide for the creation of a corp of marshals
responsible for enforcing court decisions. They will be part of the Ministry of Justice. It is
not expected that they will be fully staffed until sometime in 1999. In July 1997, a law
was enacted "On Enforcement Proceedings". This law provided for fines and deadlines
for compliance with the court orders. Repeated non-compliance may result in criminal
prosecution. A revised Criminal Code effective January 1, 1997 makes prosecution for
contempt of court a more potent threat. Prosecutions for contempt of court are taken in
the Courts of General Jurisdiction.

      Notwithstanding these new provisions, it is expected that a real improvement in
the ability to enforce judgements will occur when the Russian economy improves and
when the courts become more effective at tracing assets.

F.     ARBITRATION

1.     Introduction:

        Rather than use the Arbitrazh Court system, the parties also have the option in
the Russian Federation of using either domestic or foreign arbitration, with certain
limitations. Some matters, such as certain types of disputes regarding patents and
trade-marks, are relegated by Russian law to the exclusive jurisdiction of the Higher
Patent Chamber of the Russian Federation (although it is arguable that these are
administrative decisions and thus can be appealed to a court pursuant to Article 11(2) of
the Civil Code) and may not be the subject of arbitration.

        While foreign franchisors may feel more comfortable with arbitration outside of
Russia, the enforcement of their judgement will still be subject to Russian law. Further
Russian parties are increasingly reluctant to agree to arbitration outside of the Russian
Federation as this puts them at a significant disadvantage with respect to expenses.
The devaluation of the ruble since August 1998 has made it significantly more difficult to
afford the luxury of arbitration outside of Russia.

2.     Domestic Arbitration: Arbitration under the International Commercial
       Arbitration Courts of the Chamber of Commerce and Industry:

      The Chamber of Commerce and Industry was first established by the Soviet
Union in 1932 in order to develop a positive international reputation. Its International
Commercial Arbitration Court (ICAC) handles more disputes involving Russian parties
than any competing Arbitral Institution, including the Stockholm Chamber of Commerce.
According to Glenn Hendrix the ICAC itself is widely recognised for impartial decision
making, and a U.S. District Court in 1993 recognised its impartiality and forced an
American party to submit to arbitration under the ICAC for that reason.
                                    - Page 32 -

        In 1993, Russia passed its law on International Commercial Arbitration (the
"Arbitration Law") based on the UNCITRAL Model Law on International Commercial
Arbitration. The jurisdiction of the ICAC extends to include disputes arising between
enterprises with foreign investments and international associations and organisations
set-up in the territory of the Russian Federation, as well as disputes between their
participants, and also disputes between them and other persons subject to the law of
the Russian Federation. Thus disputes between two Russian legal entities, one of which
has foreign investors can be arbitrated, even if the dispute deals solely with matters
occurring within Russia.

       The new Arbitration Law allows the parties to select their own arbitrators
(including non-Russians). This is subject to certain limitations, but the ICAC list includes
foreign arbitrators. The new law also allows the parties to choose the language of the
proceedings as well as the forum. If the parties do not make such choices, according to
ICAC Regulations, the place of arbitration shall be Moscow and the language shall be
Russian.

       While the validity of the arbitration clause will be judged under Russian law
regardless of the wishes of the parties, the choice of law to govern the dispute by the
parties will be respected. However, a franchisor should be careful about too freely
choosing foreign law. At least one of the arbitrators, and possibly two are likely to be
Russians, and the introduction of foreign law concepts to them may be difficult,
particularly if the concepts come from a common law jurisdiction. There is a significant
absence of foreign law libraries in Russia and the arbitrators will have to rely on law and
documents submitted by the parties.

      Article 9 of the new Arbitration Law and Paragraph 30 of the ICAC Rules do
contemplate the existence of interim relief measures, but give no specific guidance on
what are the grounds for such relief, what measures may be used, or how they will be
enforced. Presumably, the ICAC panel would follow the provisions in the Arbitrazh
Procedural Code, or provisions agreed to by the parties.

       Finally, while the new Arbitration Law makes no provision for the recovery of
legal fees, the ICAC states that the victorious party may demand compensation for
reasonable losses born by it, including expenses for legal representation.

       Burke McDavid, in his article "Arbitration Alternatives with a Russian Party", 32
The International Lawyer 119 (1998), comes to the conclusion that because the costs of
using the ICAC are so much more than using the Arbitrazh Courts, and because the
ICAC procedure is similar to a trial, there may be no real advantage in using the ICAC
as opposed to the Arbitrazh Courts, with the possible exception of the flexibility of the
parties to agree to specific terms on procedures. He feels that for this last reason the
ICAC will remain the preferred forum for the time being.
                                    - Page 33 -


3.    Enforcement of Domestic and Foreign Arbitral Awards:

       The Arbitration Law of the Russian Federation does not specify the enforcement
procedures. Based on a 1988 decree, arbitral awards in general are to be enforced by
the Courts of General Jurisdiction rather than the Arbitrazh courts. The rules governing
the enforcement of foreign arbitration awards are detailed in the Civil Procedure Code of
the Russian Federation (Article 437).

        While there are certain concerns about the enforcement of arbitral awards in
Russia, Hendrix states that, with one exception (in which the award was ultimately
upheld), it does not appear that a Russian court has ever refused to recognise an
arbitral award in favour of a foreign party.

       The Soviet Union was a party to the New York Convention on the Enforcement of
Arbitral Awards. In a Moscow City Court Decision of January 1992, the court brushed
aside the defence that the New York Convention had not been ratified by the Russian
Federation and enforced the award.

        In addition to the general rules contained in the New York Convention as
defences to the enforcement of an arbitral award, there are two other reasons why an
arbitral award may not be enforced in Russia. It should be noted that because of the
nature of the Russian court system, these grounds may be discovered by a court
without assistance from the defendant. The other grounds are that the subject matter of
the dispute cannot be submitted to arbitration under the laws of the Russian Federation,
and that recognition and enforcement of the award will be repugnant to the rules of
public policy of the Russian Federation.

        In Russia the criteria for arbitrability are, for the purpose of enforcement, based
on the subject matter rather than the personal status of the parties. However there are
exceptions. One of the principle requirements for a case to be arbitrable in Russia is the
"equality of the parties" which is not found for example in anti-monopoly legislation or
employment relationships. What Russian courts will do with the enforcement of an
arbitral clause in a franchisor / franchisee dispute is an open question.

         With respect to compliance with the rules of public policy, there may be further
difficulties, particularly for a franchisor whose franchise agreement provides for location
control. In accordance with the Arbitrazh Procedural Code, an action related to real
estate may only be heard at the place where it is located and this cannot be changed by
the agreement of the parties. Thus a foreign arbitral award related to real estate in
Russia is likely to be held inconsistent with Russian public policy.

       Further for franchisors relying on the enforcement of their franchise agreement
through de-identification and infringement of their trade-mark rights, the situation is
more difficult. Article 45 of the Law on Trade-marks provides that disputes with respect
to a violation of the exclusive right to use a trade-mark, concerning the conclusion and
performance of a licence contract, contracts on the assignment of the trade-marks or
concerning the illegal use of the name of a place of origin of a good, may be brought
                                     - Page 34 -


before a Court of General Jurisdiction, an Arbitrazh Court or an arbitration panel. But
several other disputes are limited to the Supreme Patent Chamber. Generally speaking,
these concern the validity of the registration of the trade-mark, an issue that is likely to
be contested by the defendant. Because the statute makes specific provision as to the
forum, these matters cannot be subject to arbitration.

G.     CONCLUSION

      The Russian Federation now has a significant body of law in place governing
contracts and intellectual property that will provide extensive guidance to a franchisor
preparing a franchise agreement for enforcement in Russia. The outstanding item
appears to be primarily the development of a Land Code and a registration system,
which would improve the quality of the title obtained on leasing premises.

       In preparing a franchise agreement for use in Russia, a franchisor can make use
of the Civil Code (including Chapter 54 on Commercial Concessions or franchising) to
draft agreements so as to maximise its ability to enforce it. As is illustrated by some of
the examples given in the discussion on general contract law, this will require a
knowledge of the entire Civil Code and not just the chapter on franchising. It will also
most likely require more detailed provisions regarding certain of the obligations of the
two parties rather than simply relying on the discretion of the franchisor to resolve
ambiguities.

      With respect to location control, until land use law is unified, these provisions will
have to be adapted to the laws of the specific city or other region of the Russian
Federation in which the franchise business is located.

       Given the separate jurisdictional provisions for challenging a trade-mark, it would
be prudent for a franchisor relying on de-identification to enforce its trade-mark to pay
particular attention to the quality and the validity of its registrations prior to commencing
franchising. Whether the forum chosen for the franchise agreement is arbitration under
the ICAC rules or use of the Arbitrazh Courts, these proceedings could be held up by a
claim that the trade-mark was not validly registered. A further concern in Russia is that
there appears to be confusion about whether or not post-term restrictive covenants are
valid and enforceable under the Civil Code, which provides that contracts can never be
used to limit competition and that transactions designed to limit in any way the legal
capabilities of an individual are void unless specifically permitted by law.

        The primary advantage of using arbitration appears to be the ability of the parties
to set their own rules for dispute settlement. If this route is chosen, significant care
should be taken in preparing the arbitration clause, including possibly the incorporation
directly or by reference of specific provisions from the Arbitrazh Code of Procedure.

        Overall, it does not appear that the legal system in Russia is the major barrier to
franchising in Russia. The economy and organized crime are the major concerns and
franchisors contemplating franchising in Russia may wish to monitor them and the
political situation carefully. Elections for the Duma are due in December 1999, with
                                           - Page 35 -


Presidential elections to follow next summer. If the situation in Russia continues to
improve, there is an argument to be made for establishing a system in Russia when the
economy is weak and the ruble has a low value relative to the dollar. This would allow a
franchisor to become established at an early stage at a relatively lower cost in the event
that the Russian economy does eventually take off.



Acknowledgements

      The author would like to thank all of the many people who assisted with
information or comments. Particular thanks go to Andrea Redway, Robert Kwauk and
Wu Tong of the Beijing Office of Blake, Cassells & Graydon, Dr. Alexander Mailer of the
Russian Franchise Association, Charles Armitage of Asian Sources, Randall
Peerenboom of the UCLA School of Law, Susan Whiting of the Department of Political
Science of the University of Washington, Andrei Ponomarov and James Kitcatt of the
Moscow office of Eversheds, Judge Li Dong-Tao of the Intellectual Property
Adjudication Division of the People's Court of Haidian District, Beijing Municipality, Wu
Xiaoyan of the Department of East Asian Studies of the University of Toronto, Michelle
Wong, Darren Kirkwood and Henry White, students at Miller Thomson LLP, Mojisola
Akpata, who learned to type from dictation in Russian and Chinese, and all the
members of the ABA Forum on Franchising who responded to requests for information.
The errors and omissions, however, are those of the author.




\\MT_TOR_FS1\DAT2\DEPT\corp\pjones\PUBLICATIONS\ABA China-Russia.doc