Overdue royalties: how franchisors should manage debt

When preparing an established business for franchising, it is important to define not only the royalty rate but also what happens if payments are late. Without a clear process, managers may promise extensions verbally while the accounts team continues to accrue charges, leaving the franchisee unsure how much to pay. A sustainable franchise network needs a straightforward procedure: verify the debt, establish the reason for the delay, propose an acceptable solution and document the agreement.

1. Set the rules before selling your first franchise

In Russia, commercial concession arrangements—the legal framework used for franchising—are governed by Chapter 54 of the Russian Civil Code. Article 1030 allows various forms of remuneration, including fixed periodic payments and a share of revenue. The term ‘royalty’ alone therefore does not establish when a payment becomes overdue: the agreement must make this clear.

Specify the calculation period, payment deadline, the point at which the payment obligation is deemed fulfilled and how the calculation will be supplied. For example, if the franchisee pays after receiving an invoice, state how and where it will be sent. Otherwise, a dispute over late payment may become a dispute over whether the payment period ever started.

Set separate rules for disputed amounts. A practical option is to require payment of the undisputed portion and a reasoned objection to the balance. It is also worth setting a deadline for the franchisor’s response.

The legal basis for granting rights also matters when recovering debt. Under Article 1028 of the Russian Civil Code, the grant of the right to use a bundle of exclusive rights under a commercial concession agreement must be registered with the state. Without registration, that grant is deemed not to have taken effect. This does not automatically invalidate the entire agreement, but it creates significant risks in a payment dispute.

Before starting operations, agree three areas with a lawyer:

• the basis and timing for royalty charges;
• liability for late payment;
• methods for delivering legally effective notices.

2. Verify the debt before discussing penalties

The first step after a missed deadline is verification, not a penalty. The accounts team should confirm that the payment is genuinely missing, rather than received with an incorrect payment reference or allocated to another period. The manager should check for any signed agreement deferring payment or changing the payment terms.

Create an arrears record covering the franchisee, agreement, calculation period, principal debt, due date, payments received and supporting documents. Keep royalties, supplies, advertising contributions and services separate: each may have a different contractual basis and payment deadline.

Next, send a neutral notice with a breakdown of the amount due and a request to explain the delay. A conversation can help distinguish an administrative error from a cash-flow shortfall or a disagreement over the charge. Confirm the outcome of any call in writing, but do not assume that correspondence automatically replaces a formal amendment to the agreement.

Appoint one person to handle communications. If the accountant demands immediate payment while the franchise manager promises to ‘wait until the season starts’, the franchisor is creating uncertainty. Internal procedures should make clear who verifies the amount, who discusses a solution and who has authority to approve it.

3. Treat payment deferrals as controlled exceptions

Deferring payment may be more sensible than pursuing immediate recovery if the outlet is trading, the franchisee acknowledges the obligation and proposes a workable schedule. But a deferral should not be granted simply because one franchisee presses harder for concessions than others.

Set internal criteria: the reason for the delay, previous payment history, the accumulated debt and the ability to clear arrears while keeping up with current charges. Request only the information genuinely needed for that assessment, rather than the business’s entire set of records.

The written agreement should specify:

• which obligations and amounts it covers;
• the revised payment dates and amounts;
• how ongoing royalties will be paid;
• how any contractual penalties already accrued will be treated;
• the consequences of failing to meet the revised schedule.

Distinguish between extending a payment deadline and agreeing instalments for an existing debt. These arrangements may affect the calculation of penalties differently. Do not leave wording such as ‘penalties are temporarily suspended’ unexplained: does accrual stop, is collection deferred, or are some claims waived?

Check the signatories’ authority and comply with the formal requirements for amending the agreement. Keep the amendment with the main contract documents so that a new manager does not begin recovery action under the old terms.

4. Apply penalties and pre-action procedures consistently

A contractual penalty must be agreed in writing; the general rules are set out in Articles 330 and 331 of the Russian Civil Code. Specify the calculation base, rate and accrual period. Under Article 333, a court may reduce a penalty that is disproportionate to the consequences of the breach: a high penalty does not guarantee recovery of the full amount claimed.

When considering interest under Article 395 of the Russian Civil Code, take account of its interaction with contractual penalties. As a general rule, where a penalty applies to late payment of a monetary obligation, this interest cannot also be recovered unless the law or the agreement provides otherwise.

If no agreement can be reached, prepare a formal demand setting out the basis of the claim, the calculation, payment details and a deadline for compliance. Retain evidence that it was sent. Many contractual monetary disputes heard by Russia’s commercial courts are subject to a mandatory pre-action demand procedure: proceedings can usually be brought only after 30 calendar days have elapsed from the date the demand was sent, unless the law or the agreement provides otherwise.

Do not automatically suspend support or access to materials or operating systems. Whether such measures are permissible depends on the agreement and the law; breaching your own obligations may complicate debt recovery. Any decision to terminate the relationship also requires a separate legal review.

Practical takeaway: before recruiting franchisees, establish a consistent process for overdue payments: verify the amount, send written notice, agree a course of action and monitor compliance. This helps protect the franchisor’s income without turning every delay into a dispute.