On July 1 and 2, we, representing the International Franchise Association, met with China’s franchise regulators in Beijing and Shanghai. The conversation would be familiar to anyone who has been closely following the development of the franchise regulatory regime in China in the last eight years, since the government adopted the current Administrative Regulations on Commercial Franchises (the “Franchise Regulations”) in early 2007:
- How to satisfy the “two units one year” requirement?
- How to simplify the approval process for foreign franchisors and its Chinese subsidiaries to franchise in China?
- How to deal with some of the disclosure obligations, which are either vague (e.g., disclosure of the financial statements), or appear overly intrusive (e.g., disclosure of franchisees’ “operational results”)?
This reminds one of the flurry of meetings that we had with the Chinese regulators leading up to the adoption of the Franchise Regulations, centered around the issue of whether the two units would have to be located within China. (The “within China” limitation was dropped eventually, at the very last minute.) This year, the cast of officials sitting across the table is different (hardly a surprise given China’s current political environment), but the issues sound familiar. So, is this déjà vu all over again? Are we back where we started a little more than eight years ago?
The impetus of the meeting in Beijing with the Ministry of Commerce (MOFCOM) officials was to express IFA’s concerns with regard to MOFCOM’s recent change in its policies regarding the “two units one year” requirement. In May, MOFCOM abruptly abandoned its long-standing policy of accepting corporate units owned by a franchisor’s parent or subsidiary. This affected a number of foreign franchisors’ plans to franchise in China, including many IFA member companies.
There was no public deliberation related to this switch (not surprising for this type of policy change); one suspects that it had something to do with the top franchise regulator being new to franchising and trying to avoid exercising discretion outside of the express language in the Franchise Regulations. But unlike eight years ago, this time it was fairly straightforward to figure out who is making which decisions, and a face-to-face meeting with MOFCOM’s top franchise regulator at their offices was agreed to quickly.
MOFCOM officials were also rather receptive to our arguments. They listened to our presentation; they asked many good questions; and they took copious notes. At the end, MOFCOM officials indicated that they would be willing to be more flexible in applying the “two units one year” requirement with regard to “established” foreign franchisors, including the use of units owned by affiliates, if certain conditions are met. These conditions ought not be burdensome for most foreign franchisors. Although it remains to be seen what documents MOFCOM would require for the satisfaction of these conditions, one has to be heartened by the results and, perhaps more so, by the meeting itself.
This positive development perfectly reflects the larger narrative of the development of the franchise regulatory regime in China in the last eight years – the increasing sophistication and competence of the regulators and courts in dealing with franchise issues; the still largely non-existent public participation in policy deliberations; and, on balance, practical and franchise-friendly results reached through a still flawed process that is sometimes more about politics than about policies.
Another recent result of this political process is the rejection of MOFCOM’s draft new franchise regulation by China’s Supreme People’s Court and China Chain-store & Franchise Association. The motivation may be political – the Supreme People’s Court apparently was not enthusiastic about MOFCOM’s attempt to grab more regulatory power by strengthening the franchise registration requirements, but the result is that a flawed proposal was sent back to the drawing board.
The Supreme People’s Court’s seemingly practical approach to franchising should come as no surprise. Although the Court itself has not had a chance to consider a franchise case (which would be nearly impossible given China’s judicial system), it has made its voice heard through many other channels. In one of the rare franchise cases that were appealed all the way up to the provincial high court, Yongxian Wu v. Liu Zhou Subway Food and Beverage Management Co., Ltd. (High People’s Court of the Guangxi Autonomous Region, Jun. 6, 2012), the Supreme People’s Court in a response to the Guangxi High People’s Court stated that the failure to comply with the “two units one year” requirement and the franchise registration requirement “should not automatically lead to the franchise agreement being invalid.”
It should be noted that MOFCOM has also been moving towards a franchise-friendly regulatory regime in a number of different ways, from issuing “franchise industry standards” that attempt to clarify some issues (e.g., whether there is a bona fide wholesale price exclusion from the franchise fee definition), to revamping the implementation rules concerning the disclosure requirements and the registration process in early 2012. There is also indication that MOFCOM is willing to re-examine some of these implementation rules and provide further clarity.
Compared to MOFCOM officials, the franchise regulators at the provincial level face an additional challenge – how to navigate the local budgeting process to ensure that enforcement activities are properly funded. The Shanghai officials are currently being sued by a former franchisee for failure to enforce the Franchise Regulations against a franchisor based in Shanghai. It will be very interesting to see how the courts attempt to resolve this issue and how that may impact the enforcement of the Franchise Regulations in China.
However, one thing is certain: with the highest number of franchise systems in the world, and the second highest number of franchise outlets, China’s franchising industry has come a very long way in the past eight years, and so has its franchise regulatory regime.
If the past is any indication, a bright future lies ahead, although the path to get there may be bumpy.