Franchise penalties: what to check before signing the agreement

Franchise penalties are not limited to late royalty payments. An agreement may impose penalties for window displays, late reports or failure to follow service procedures. In the Russian franchise market, quality control helps maintain trust in a brand, but prospective franchisees need to understand the limits of their liability in advance. Look beyond the amounts and check the whole sequence: the obligation, the breach, the evidence, the opportunity to put things right and the financial consequences.

1. Identify every ground for liability

Start with the draft agreement and every document it refers to. Penalties may appear in a separate schedule, an outlet operations manual or inspection procedures. If a schedule has not been provided, you cannot assess the risk from the main agreement alone.

Create a table with five columns: the franchisee’s obligation, the grounds for the penalty, the amount or calculation formula, the procedure for establishing a breach, and the deadline for remedying it. For each entry, identify the document and its version. This will help you spot overlapping grounds and vague wording.

Pay particular attention to clauses such as ‘for any breach of standards’ or ‘for actions that damage the brand’s reputation’. These are not necessarily invalid, but they leave considerable room for disagreement. Ask for specific actions and assessment criteria to be listed.

Distinguish between the different consequences:

• Fixed penalties — a specified sum, or another contractual method of calculating a penalty for a breach.
• Late-payment or delay penalties — penalties usually accrued over the period of delay.
• Damages — a separate claim that requires more than simply referring to a table of penalties.
• Other measures — for example, suspending access to resources or terminating the agreement, where there are legal grounds to do so.

These other measures may affect an outlet more severely than a financial penalty. Consider them together, even if they appear in different sections of the agreement.

2. Check the legal basis and limits of penalties

In Russia, commercial concession agreements — the legal framework used for franchising — are specifically governed by Chapter 54 of the Civil Code of the Russian Federation. Article 1032 requires the user of the rights, among other things, to ensure that the quality of its goods, work or services matches that of the rights holder’s equivalent goods, work or services, and to follow the rights holder’s instructions as provided for by law. Article 1031 provides for quality control by the rights holder, unless the agreement states otherwise.

However, these provisions do not establish a universal list of penalties for all franchises. Financial liability must be assessed against the terms of the particular agreement and the general provisions of the Russian Civil Code. Under Article 330, a penalty may be established by law or contract; the creditor does not have to prove that it suffered loss in order to recover it. Under Article 331, an agreement on penalties must be in writing.

Check how the agreement treats the relationship between penalties and damages. The general rule under Article 394 is that damages are recoverable to the extent that they are not covered by the penalty, although the law or the agreement may provide otherwise. For example, a clause allowing damages to be recovered in full on top of a penalty substantially increases potential exposure.

Do not assume that a court will automatically reduce an excessive penalty. Article 333 allows a manifestly disproportionate penalty to be reduced, but a business debtor must apply for this, and reducing a contractual penalty is subject to additional restrictions. It is safer to agree an acceptable mechanism before entering into the deal than to budget on the assumption of a future court reduction.

3. Agree on evidence and the opportunity to remedy breaches

A clearly stated penalty amount does not protect you from a disputed inspection. Clarify who is authorised to record a breach: an employee of the franchisor, an external inspector or another representative. Ask for a sample inspection report and a list of the evidence used to support its findings.

It is useful for the inspection procedures to specify:

• the date, location and scope of the inspection;
• a reference to the specific clause breached;
• photographs, documents or other supporting evidence;
• how the report is sent to the franchisee;
• the opportunity to provide explanations and objections;
• the procedure for a follow-up inspection once the issue has been remedied.

Discuss separately what happens if the outlet’s representative refuses to sign the report. Refusal to sign should not automatically be treated as an admission of a breach: propose a procedure for recording disagreements and sharing the evidence with both parties.

For issues that can be remedied, ask for a warning and a reasonable period to put things right before a penalty is imposed. This is a matter for negotiation, not a universal franchisee right. Breaches involving safety or unlawful use of rights may require immediate action.

It is also important to define what counts as a repeat breach: the period over which it is assessed, whether it must involve the same type of breach, and when an issue is considered resolved. Otherwise, a single sign that has not been corrected could trigger several claims following successive inspections.

4. Test the combined financial exposure using examples

Before signing, ask the franchisor to work through several hypothetical situations: a late report, a departure from a standard, or an overdue payment. For each, record all possible consequences and the sequence of actions each party would take.

For example, a late report might trigger both a penalty for failing to provide information and a general penalty for not following procedures. Clarify whether both are intended to apply at the same time. Do not leave the answer solely in correspondence with a sales manager: the agreed mechanism should be reflected in the contractual documents.

Discuss a cap on accruing delay penalties, limits on total penalties over a specified period, and a prohibition on duplicate penalties for the same breach. These limits do not arise automatically — they must be agreed. Check separately whether the franchisor can deduct disputed amounts from a security deposit and whether you would then have to replenish it immediately.

Practical takeaway: before buying a franchise, make sure the grounds, evidence, calculation method and objections procedure are clear for every penalty. If a liability clause cannot be explained using a concrete example, have it revised with a lawyer before signing.