Western brands in Russian franchise deals

The Burger King name appears in Russian outside a Burger King fast food restaurant in Moscow, Russia, on Friday, April 5, 2013.

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Ukrainian President Volodymyr Zelelnskyy in his address to U.S. Congress Wednesday reiterated calls for all global brands to exit Russia — a market “flooded with [Ukrainian] blood” — as part of ongoing efforts to apply economic pressure to the pariah state.

More than 400 companies have announced their withdrawal from Russia since the launch of its invasion of Ukraine on Feb. 24, according to a list compiled by Yale School of Management.

For some brands, however, a clean break is easier said than done.

Fast food giants Burger King and Subway, British retailer Marks & Spencer and hotel chains Accor and Marriott are among a number of companies restricted from withdrawing amid complicated franchise agreements.

“Unlike a company-owned operation, a franchise company going into an international market makes a binding, long-term contractual commitment to a sophisticated counter-party, typically a franchisee or licensee,” Dean Fournaris, partner in Wiggin and Dana’s franchise and distribution practice, told CNBC.

Brands with only company-owned operations are better positioned to shut down locations quickly.

Earsa Jackson

Member of Clark Hill’s franchise and licensing team

Under such contracts, a company — known as a franchisor — outsources its brand to a counter-party — known as a franchisee — which then owns and operates the brand in a specific location. Companies looking to expand their footprint in a particular market can find such agreements make sense from an operational or financial perspective. But, as legally binding contracts, once signed, they can leave little room for maneuver.

That has complicated some Western brands’ efforts to step back from Russia — even as many peers have paused operations or exited the market entirely over their rejection of Moscow’s invasion and logistical challenges that have arisen as a result.

“Brands with only company-owned operations are better positioned to shut down locations quickly because they do not have to deal with the layer of the franchise relationship,” Earsa Jackson, a member of Clark Hill’s franchise and licensing team, said.

Halting corporate support

Burger King, which is owned by Restaurant Brands International, announced last week it had halted corporate support for its 800-plus franchised restaurants in Russia and that it would refuse approvals for any expansion. However, the outlets remain in operation under a local master franchisee.

Subway, similarly, has no corporate outlets in Russia but its approximately 450 independently-owned franchised restaurants continue to operate in the country. That as competitors like McDonald’s, which owns the majority of its restaurants in Russia, said it would temporarily close 850 of its restaurants in the country, at an estimated loss of $50 million per month.

The Subway name appears in Russian on a sign outside a Subway fast food restaurant in Moscow, Russia, on Sunday, April 7, 2013.

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“We don’t directly control these independent franchisees and their restaurants, and have limited insight into their day-to-day operations,” Subway said in a statement.

Retailer Marks & Spencer, meanwhile, which has 48 stores in Russia, told CNBC it has ceased supplying products to its franchisor, Turkish company FiBA, but the two remain “in discussions” about the brand’s continued operations there.

Hotel chains Accor and Marriott have also both suspended the opening of new locations in Russia but their existing locations remain in operation by third parties.

A legal battlefield

While all of those companies have expressed dismay at the war and made various commitments to redirect Russian profits or make separate donations to Ukrainian refugees, their continued presence on the Russian high street remains largely at the discretion of their franchisors.

“Some franchisees do not want to stop operation because they claim that the Russian people are not the problem and the brand should continue to serve its customers,” Craig Tractenberg, a partner at the law firm Fox Rothschild, said.

And with most franchisors having made significant investments in, and continued commitment to, their local outlets, any move on their side to cease operations seems unlikely.

Franchise companies and their brands are in a really tough spot when it comes to Russia.

Dean Fournaris

Partner at Wiggin and Dana

“If the franchisee remains ready and willing to perform, a franchisor’s unilateral decision to close a location may result in litigation due to the franchisee’s lost business opportunity,” Clark Hill’s Jackson said.

That leaves many Western brands in a predicament as to how to manage their legal duties while safeguarding their brands in a global landscape that is overwhelmingly opposed to Russia’s war.

“Franchise companies and their brands are in a really tough spot when it comes to Russia. On the one hand, there is a rising public and governmental sentiment in the West that all non-essential business with and within Russia should cease pending some future undetermined event, like a cease-fire or Russian withdrawal from Ukraine,” Fournaris said.

“At the same time, a market withdrawal from Russia would be viewed quite differently by the Russian government and more importantly its people,” he added.

Managing brand reputation

A ratcheting up of Western sanctions and further disruptions to supply chains could offer franchisors some hope of a contractual get-out as franchised brands may no longer have the means to operate.

“Some agreements contain excuse of performance language which could benefit franchise brands. For example, if supply chain issues make it impossible to perform, franchisors may argue that performance is excused,” Jackson said.

A visitor walks past the entrance to a Marks & Spencer Plcstore in the Afimall City shopping and entertainment complex at “Moscow City” business center in Moscow, Russia, on Friday, May 17, 2013.

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But more likely, companies will be left weighing the legal and financial implications of terminating their contract with the wider longevity of their brand.

“This business decision may overlap with a moral decision. Ultimately, the question is which decision best protects the brand,” Tractenberg said.

Meantime, the fallout could mark a new era for franchise agreements, with participants perhaps more likely in the future to make provisions for conflict risks such as “civil unrest, insurrection and related events.”

“The trademark provisions could be argued to support closure where the brand would be blemished by continued operation or aiding and abetting criminal activity,” Tractenberg added.

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