On February 6, 2007, the State Council issued the Regulations on the Administration of Commercial Franchising (??????????, ?????485 ?, the “Administration Regulations”), which will come into force as of May 1, 2007 and supersede the Measures on the Administration of Commercial Franchising (??????????, ?????25 ?) issued by the Ministry of Commerce (MOFCOM) on December 30, 2004. However, the Administration Regulations are by no means a perfect document, and much remains to be clarified by the Chinese authorities through detailed guidelines or other rules. To implement the Franchising Regulations, on April 30, 2007, MOFCOM issued the Measures on the Administration of Filing of Commercial Franchising (????????????, ?????15 ?, the “Filing Measures”) and the Measures on the Administration of Information Disclosure of Commercial Franchising (????? ?????????, ?????16 ?, the “Information Disclosure Measures”). The Administration Regulations, the Filing Measures, and the Information Disclosure Measures (collectively the “Commercial Franchising Regulations”) constitute the basic legal framework of China’s commercial franchising regime.

I. Background

Commercial franchising has achieved rapid growth in China in the past few years. According to the data from the China Chain Store & Franchise Association (CCFA), the number of the commercial franchise systems grew rapidly from 410 in 2000 to 2,600 in 2006, ranking number one in the world. Up to the end of 2006, the number of the outlets of all the commercial franchise systems reached 200,000, by which 3,000,000 job opportunities were provided.1

Accompanied by the rapid growth of commercial franchising, various illegal or irregular activities, such as frauds and malicious breaches of contract emerged, which did great harm to the commercial franchising market and the general public. To rectify and standardize the commercial franchising activities, the former Ministry of Domestic Trade issued the Measures on Administration of Commercial Franchising (For Trail Implementation) on November 14, 1997, which was superseded by the Measures on Administration of Commercial Franchising issued by MOFCOM on December 30, 2004. However, being “Rules” issued by administrative authorities in nature and therefore ranking at a lower level of legislation, the above two Measures did not create a strong legal basis for administrative penalty, civil compensation, or criminal pursuance. Therefore, the role the above two Measures played in the commercial franchising market was quite limited.

Circumstances have changed upon the issuance of the Administration Regulations. The Administration Regulations were issued by the State Council, which has much more weight and more teeth in addressing the above mentioned issues. The Filing Measures and the Information Disclosure Measures also provide more detailed guidelines in their respective administration fields.

II. Contents of the Commercial Franchising Regulations

The Franchising Regulations set out the following key contents:

1. Introduction of the “Filing” Mechanism

According to the Administration Regulations, the franchisor shall file with the provincial MOFCOM for those who will engage in franchising within one province, or MOFCOM for those who will engage in cross-province franchising (the “competent commercial authority”) through the government’s Web site (www.mofcom.gov.cn) within 15 days after the franchisor has sold the first franchise.2 A franchisor engaging in franchising before May 1, 2007 shall file with the competent commercial authority before May 1, 2008. 3The competent commercial authority is required to make filing within 10 days following the receipt of all the required documents and send notice to the franchisor. In the event that the documents submitted are not sufficient, the competent commercial authority shall require the franchisor to submit supplementary documents or materials within seven days.4 The competent commercial authority shall publish the name of the filed franchisor on the government’s Web site and update related information from time to time.5

The documents required to be submitted for the filing are as follows:6

a. Basic information on the franchise system.

b. Information on the distribution of all the franchisees within China.

c. Market plan of the franchisor.

d. Copy of the Business License or any other qualification certificate of the franchisor.

e. Copy of the Registration Certificate for registered trademark, patent, and other operational resources concerning the franchising activities.

f. Document issued by the commercial authority at city level certifying that the franchisor owns at least two directly-operated outlets which have been in operation for more than one year. For the directly-operated outlets located outside of China, the notarized and authenticated Certificate of Incorporation shall be provided by the franchisor.

g. Sample franchise contract.

h. Index of the Franchising Operation Manual.

i. In the event that the products or services for franchising are subject to the approval by relevant authorities, the relevant approval documents shall be provided by the franchisor.

j. Statement for the authenticity and the veracity of the filed information affixed with the signature and chop of the legal representative of the franchisor.

In addition, the franchisor shall file with the competent commercial authority for the information on the execution, rescission, renewal, and modification of the franchise contracts of the previous year prior to March 31 of each year.7 When there are changes to the filed information, the franchisor shall file with the competent commercial authority of the updated information within 30 days.8

The filing may be rescinded by the filing authority under the following circumstances:9

a. The Business License of the franchisor is revoked by the competent authorities due to illegal or irregular operation.

b. The filing authority receives judicial advice for the rescission of filing by the judicial department due to illegal or irregular operation.

c. The franchisor holds back any relevant information or supplies false information.

d. The filing is withdrawn by the franchisor itself.

The Administration Regulations and the Filing Measures further provide that the franchisor failing to file with the competent commercial authority shall complete the filing within the given period and will be subject to a fine of more than RMB10,000 but less than RMB50,000, or a fine of more than RMB50,000 but less than RMB100,000 and a public announcement in case of further violation.10

2. Detailed Requirements for the Information Disclosure

Prior to the issuance of the Administration Regulations, the franchisee, as well as the franchisor, shall disclose the relevant information in time before signing a franchise contract and during the process of franchising business operations. 11However, the Administration Regulations only require the franchisor to disclose the relevant information.

According to the Administration Regulations and the Information Disclosure Measures, the franchisor shall disclose the required information in writing at least 30 days prior to the execution of the franchise contract.12 In the event that there is any significant change to the information disclosed to the franchisee, the franchisor is required to give prompt notice to the franchisee.13

The following information is required to be disclosed by the franchisor:14

a. Basic information on the franchisor and franchising activities.

b. Basic information on the franchisor’s operational resources.

c. Basic information on franchise fee.

d. Price and conditions of the products, services, and facilities provided to the franchisee.

e. Conditions of the ongoing services provided to the franchisee.

f. Measures and contents of the instruction and supervision on the franchisee’s operation activities.

g. Budget for the investment to the franchising outlets.

h. Relevant information of the franchisees within China.

i. Summary of the audited financial statements and summary of the audit report of the franchisor in the most recent two fiscal years.

j. Information of the material litigation and arbitration concerning the franchising business of the franchisor in the most recent five years.

k. Material illegal or irregular operation record of the franchisor and its legal representative. 

l. Franchises contract.

After the above information is disclosed by the franchisor, the franchisee shall provide two original written receipts with regard to the understanding of the contents of the information.15 Much harsher penalties are imposed on violations of information disclosure obligation by the franchisor. If the franchisor holds back any relevant information or supplies false information, the franchisee is entitled to terminate the contract.16 The franchisor’s violation of the information disclosure obligation will be subject to rectification required by the competent commercial authority and will be imposed a fine of more than RMB10,000 but less than RMB50,000, or a fine of more than RMB50,000 but less than RMB100,000 and a public announcement in case of serious violation.17

To protect the confidentiality of the information the franchisor disclosed, the franchisor is entitled to request the franchisee to sign the confidentiality agreement before the information is disclosed.18

3. Relaxation of the “2+1”Requirement

Prior to the issuance of the Administration Regulations, it is required that a franchisor (or its subsidiary) shall own at least two directly-operated outlets which have been in operation for more than one year within China before it can franchise in China.19 It is widely known as the “2+1” requirement.

However, the Administration Regulations now provide that a franchisor shall own at least two directly-operated outlets which have been in operation for more than one year. 20 Careful readers will note that there is no explicit requirement that the outlets being “within China”, a silence that is clearly of potential benefit to foreign franchisors.

It is further provided in the Administration Regulations that the new “2+1” requirement will not apply to the franchisor engaging in franchising operation before May 1, 2007.21 In accordance with the provision, such franchisor will not need to provide the document issued by the commercial authority at city level certifying that the franchisor owns at least two directly-operated outlets which have been in operation for more than one year, but the first franchise contract it signed with the franchisee within China, when filing with the competent commercial authority.22

4. Cross-border Franchising

In breaking the silence of an international franchisor operating its franchise system in China without its business establishment (“Cross-border Franchising”), the Filing Measures have provided that for those overseas franchisors operating in China, the Filing Measure shall be applied with reference, 23which is an express acknowledgement and recognition of Cross-border Franchising in China. This has essentially clarified and cleared the confusion caused by separate rules — the Measures on the Administration of Foreign Investment in Commercial Sectors issued by MOFCOM on April 16, 2004.24

5. Importance Attached to the Protection of Franchisees

The nature of franchising presupposes that the franchisee is an independently run business. The presumption, however, is not borne by reality. The franchisor necessarily imposes significant controls in a franchise system. Franchising involves a careful balancing of rights and responsibilities between the franchisor and the franchisee. It is a reality of franchising that the franchisor exercises extensive controls over the operation of the franchisee's business. The Commercial Franchising Regulations noticed the unbalanced controlling power between the franchisor and the franchisee and attached importance to the protection of franchisees. In addition to the information disclosure obligation and the much harsher penalties imposed on violations of information disclosure obligation by the franchisor as stated above, a mandatory “cooling-off” period for the franchisee has been introduced. According to the Administration Regulations, it is required to be agreed in the franchise contract that the franchisee may unilaterally terminate the contract within a certain period of time after the execution of the contract.25 However, as is widely criticized, the “certain period” has not been clearly defined in the Administration Regulations, which will surely make uncertainties of the implementation of this article.