Issuing Body: Beijing High People's Court

Issuing Date: February 24, 2011

Effective Date: February 24, 2011

Franchise businesses are booming in China, and with that boom has come a rise in the number of franchising-related legal disputes. Beijing courts handled 343 franchising dispute cases in 2009, compared to just 83 cases in 2008. Complete statistics for 2010 are not yet available, but during the first half of the year, 211 franchising dispute cases were filed in a wide variety of industries. Local courts currently have significant discretion in franchising dispute cases. In February, the Beijing High People's Court became the first court in China to try to outline trial standards by releasing the Guiding Opinions on Some Issues Concerning the Application of Law in Hearing Cases of Commercial Franchise Contractual Disputes (Franchise Dispute Guiding Opinions). The Beijing court's opinions do not have a nationwide effect, but many commentators believe their recommendations will play an important role in unifying trial standards and improving trial practice related to franchising dispute cases throughout China.

Definition of a Franchise

The term "commercial franchise" as defined in the Franchise Dispute Guiding Opinions refers to a business activity in which an enterprise that owns registered trademarks, corporate logos, patents, and other business resources (the franchisor) licenses such business resources to another business operator (the franchisee), who operates under a uniform business model as agreed in a contract and pays franchising fees to the franchisor.

The basic features of a franchise are: 1) the franchisor owns registered trademarks, corporate logos, patents, and other business resources; 2) the franchisee uses the business resources of the franchisor under a particular business model that is authorized by the franchisor; and 3) the franchisee pays franchising fees to the franchisor.

Under the Franchise Administration Measures, business resources that may be franchised are "registered trademarks, corporate logos, patents, proprietary technology, and other business resources," but the law is unclear about what is to be considered a corporate logo and what other resources, if any, should fall within that scope. The Franchise Dispute Guiding Opinions clarify that business resources include not only registered trademarks, corporate logos, and patents, but also trade names, trade secrets, unique entire business images, unregistered trademarks with prior use rights and influential effects, and other business resources that may offer competitive advantages over the market. A franchisor may franchise business resources that are owned through original acquisition or derivative acquisition, or resources to which the franchisor enjoys exclusive rights, including the right to sub-license.

Validity of a Franchising Contract

The Franchise Dispute Guiding Opinions make it clear that a decision about whether a contact will be recognized as a franchise contract is mainly to be based on the content of the contract to which both parties agree. The title of the contract, or provisions that say things such as "the contract is not a franchise contract," generally will not affect recognition of a franchise contract as such.

Under the Franchise Administration Measures, a franchisor must file a franchise contract with the competent authority of commerce within 15 days of execution of the contract. Failure to register a contract should, according to the Franchise Administration Measures, lead to administrative penalties, but the law remains silent on the validity of the franchise contract if it is not filed with the relevant authority. The Franchise Dispute Guiding Opinions provide that if a franchisor fails to file with the competent authority in a timely fashion, the validity of the franchise contract will generally not be affected.

Also under the Franchise Administration Measures, a franchisor must have directly operated and managed at least two stores for more than a year to qualify as a franchise business, with the failure to do so leading to administrative penalties. The validity of a franchise contract signed by an unqualified franchisor, however, was again left unclear, and in practice has caused heated debate. The Franchise Dispute Guiding Opinions hold that a franchise contract will not be held invalid only for the reason that the franchisor does not satisfy the foregoing requirement.

Termination or Cancellation of a Franchising Contract

Article 12 of the Franchise Administration Measures provides franchisees with the right to unilaterally terminate a franchise contract within a specified period of time after execution of the contract. There has been a great deal of discussion in China about the nature of this termination right (for example, whether it must be specified in the contract in order for a franchisee to exercise it) and how in practice to enforce it.

The Franchise Dispute Guiding Opinions clarify that if a franchisor and franchisee make an agreement in the franchise contract or otherwise stating that the franchisee can unilaterally terminate the contract within a certain period of time after execution of the franchise contract, enforcement of the termination right shall be handled by courts in accordance with the two parties' agreement. If there is no such agreement between the franchisor and franchisee, the franchisee still has the right to unilaterally terminate the contract within a reasonable period after execution of the contract, except if the franchisee has actually used the franchisor's business resources, such as trade secrets and knowledge.

Conclusion

In practice, many franchising-related disputes in China have involved allegations of infringement of intellectual property rights and unfair competition. Contract-related disputes have generally revolved around one or more of five issues: 1) termination of the franchise contract; 2) validity of the contract; 3) non-competition clauses (franchisees are often found conducting competing business secretly and without the franchisor's authorization); 4) franchising fees; and 5) product quality and service standards.

In releasing the Franchise Dispute Guiding Opinions, the Beijing High People's Court has made an effort to address the issues and questions that underlie many of the most common types of disputes. As such, the opinions provide welcome guidance to courts in Beijing and possibly throughout the country.