Franchise lawi Legislation
Under Chinese law, there are specific commercial franchising regulations that stipulate among other items, franchise-specific pre-contractual disclosure and franchise requirements. These regulations apply to both foreign-invested and local Chinese franchisors.
Commercial franchising operations are generally defined under Chinese law as:
arrangements whereby a franchisor, by contract, authorises a franchisee to use its relevant operational resources, such as its trademark, trade name, logo, patent, proprietary know-how and the franchisee conducts the business in accordance with the franchisor's standardised business model (i.e., uniform visual image, business concept, management model, etc.) and pays fees for participating in the franchise in accordance with the franchise agreement.
However, simply not charging fees does not automatically mean that an entity is not running a franchising operation, as other factors will also be taken into consideration.
The two types of franchising arrangements most commonly seen in the Chinese market are arrangements whereby the franchisor authorises the relevant franchisees to (1) open and operate stores in a specific territory, without any right to grant further sub-franchises; or (2) act as the master franchisor for a specific territory, with the right to grant further sub-franchises to other downstream sub-franchisees as well as directly operate its own franchises as a franchisee. However, the relevant laws and regulations address only franchising as a direct relationship between two parties, and do not distinguish between the different types of franchising arrangements.
An entity must satisfy the following requirements to be eligible to conduct a franchising business in China:
- it must be an enterprise;
- it must own or have the right to use the relevant operational resources, such as the relevant trademark, trade name, logo or well-established operational model, etc.;
- it is capable of providing long-term operational guidance and training support to franchisees;
- it (or any of its subsidiaries or its controlling shareholder) must have established at least two directly operated stores and have operated those stores for a period of no less than one year;
- it must have established a stable supply system that can ensure sound product quality and render relevant services where the franchising arrangement requires the franchisor to supply the relevant goods; and
- it must be of good repute and does not have any record of fraudulent operational activities.
A franchisor should positively disclose in writing to the franchisee, at least 30 days before signing the franchising contract, certain information about itself:
- basic information on the franchisor and franchise activities (e.g., full name, registered address, registered capital, business scope);
- basic information on the business resources of the franchisor (e.g., trademarks, proprietary technologies, business models);
- basic information on the franchising expenditures (e.g., franchising fees, deposit, payment, refund);
- information on prices and conditions of the products, services and equipment provided to the franchisee;
- plans on continued provision of support or training services to the franchisee;
- the methods and content of guidance or supervision over the franchise activities of the franchisee;
- investment budget for the network of franchises;
- information on the franchisees within the territory of China (e.g., number, regional distribution, operational status);
- abstracts of the franchisor's financial and accounting reports and audit reports for the past two years audited by accounting firms or auditing firms;
- information on major litigation and arbitrations concerning franchises of the franchisor in the past five years, including the cause of action, litigation and arbitration claims, jurisdiction and results;
- information on the records of gross violations (i.e., above a certain threshold of fines or amounting to criminal offences) of the franchisor and its legal representative; and
- the franchise contract:
- a sample franchise contract; and
- a sample of other contracts relating to the franchise if the franchisor requires the franchisee to sign any with the franchisor (or its affiliate).
A franchisor is obligated to provide its franchisees with authentic, accurate and complete information, and keep the franchisees informed of updated information in a timely manner. If a franchisor hides any related information or provides false information to a franchisee, the franchisee will be entitled to terminate the franchise contract and the franchisor may also be ordered to rectify the matter and be punished by a fine of up to 100,000 yuan, with a public announcement if the responsible governmental body (MOFCOM) thinks the franchisor's violation is severe.
Pursuant to the Beijing Appellate Court's Interpretation on Several Issues regarding Adjudication on Franchise Agreement Disputes (effective as of 23 February 2011), the franchise agreement may be invalid when undisclosed false information is material to the operation of the franchise and the franchisee entered into the franchise agreement on the basis of that information. The courts shall also consider the adverse impact of undisclosed or false information in relation to the performance and purpose of a franchise agreement so as to adjudicate whether the franchise agreement is valid. This interpretation suggests that violation of the disclosure obligation does not necessarily render the contract invalid in every instance.
If any of the information provided constitutes trade secrets, the franchisor may ask the franchisee to enter into a non-disclosure agreement.iii Registration
Within 15 days of entering into a first franchising contract in China, the franchisor is required to make a filing with the Ministry of Commerce. The franchise contract template, operational manual, business plan for the proposed franchising arrangement and the documents evidencing that it has satisfied the relevant requirements to serve as a franchisor must be submitted as part of the filing.
Regulations are not clear on what constitutes a 'first franchise agreement'. It may be interpreted that the franchisor should only file the franchise agreement concluded with their first franchisee but not every franchise agreement it enters into. According to informal enquiries to the Ministry of Commerce, the franchisor should record as a template the franchise agreement entered into with its first franchisee. After this filing, the franchisor is required to make an online renewal of this filing at the MOFCOM website each year in March to be able to register any new franchisees. This confirms that the franchisor does not need to record every franchise agreement entered into with new franchisees.iv Mandatory clauses
The franchisor and the franchisee must enter into a written franchise contract; and the main content of the franchise contract shall include the following:
- basic information in respect of the franchisor and the franchisee;
- content and term of the franchise;
- type, amount and payment method for the franchising fees;
- specific content and methods for providing business guidance, technical support, business training and other services;
- quality requirements and standards for the product or service and methods for assurance thereof;
- sales promotion, advertising and publicity in respect of the product or service;
- protection of consumers' rights and interests and the assumption of compensation liabilities in the franchise;
- alteration, annulment and termination of the franchise contract;
- liabilities for breach of the contract; and
- methods for dispute resolution.
The franchisor and the franchisee may stipulate in the contract any other matters as they like.
The qualification and validity of a franchise agreement would depend upon the nature of the actual commercial arrangement as set out in the relevant agreement among the parties, even if the agreement itself was not identified as a franchise agreement. This question has been confirmed by the Supreme People's Court recently. The Supreme People's Court also decided on whether a franchise agreement should be invalidated where the franchisor does not comply with the above franchise-related requirements. The question of the non-compliance of the franchisor appears to depend upon whether the non-compliance is remediable; for example, failure on the part of the franchisor to comply with the requirement of directly operating at least two stores will not affect the validity of its agreements with franchisees, whereas franchise agreements entered into by any non-enterprise entity or individual (which by law is not permitted to enter into franchise agreements) will be deemed as invalid.v Guarantees and protection
The laws and regulations relating to guarantees and protection under Chinese law that are applicable to general commercial transactions would also apply to franchising activities in China, but there are no provisions specifically applicable to franchising.