It was not until the 1990s that the franchised business model was recognised in China as an official form of doing business. Now, three years after the introduction of the Commercial Franchise Administration Regulations, China is emerging as one of the fastest growing markets for franchised retail brand development.
In the last decade, the growth of franchising in China has been stimulated by the liberalisation of foreign investment, and the introduction in May 2007 of a comprehensive franchise law - the Commercial Franchise Administration Regulations - which replaced what had previously been a chaotic regulatory system.
The validity of expansion in China through franchising is highlighted by the aggressive expansion plans announced by a number of Western franchise systems for 2010.
When the Regulations were first introduced there was some uncertainty, both by the authorities in China and by foreign franchisors, as to precisely how the Regulations would apply to foreign franchisors.
The Regulations do not specifically contemplate typical business models used by foreign franchisors for network expansion, such as master franchise, area developer and sub-master franchise arrangements. Foreign franchisors face challenges applying the Regulations to these business models.
The Regulations also require extensive material to be filed, some of which does not exist, or is difficult to produce. For example the Regulations require certain company documents to be officially sealed / chopped with the company stamp / seal, which is problematic for companies that no longer hold an official company seal.
Access Key requirements
The first step for a foreign franchisor is to apply for an Access Key with the Ministry of Commerce (MOFCOM).
The Access Key (a unique verification code) will allow the franchisor to enter into the MOFCOM official filing website, to register with MOFCOM and complete the online filing requirements.
To apply for an Access Key the franchisor must file an Application for Access Key Registration with MOFCOM - in essence this operates akin to a franchisor approval process.
The Application must establish that the franchisor's system is credible. The franchisor must provide extensive supporting documents to prove that:
- The franchisor is an "enterprise" i.e. a registered trading company. Individuals, partnerships and other like entities cannot be a "franchisor".
- The franchisor has a mature business model and can provide franchisees with continuous operational guidance, technical support, training and other services
- At the time of filing, the franchisor has at least two stores each of which have been operated by the franchisor for a least one year (Two Store Rule). This requirement can be difficult to satisfy where the franchisor does not itself operate stores. However a franchisor should be able to satisfy the Two Store Rule where stores are operated by a subsidiary / affiliate of the franchisor, provided that it files sufficient evidence to prove the nexus between the franchisor and that entity. For locally appointed master franchisees, the Two Store Rule means that the master franchisee must operate at least 2 stores for more than 1 year before it can itself grant franchises.
- The franchisor must own or be licensed to use the registered trade mark, company mark, patent, know-how and other intellectual property
- The franchisor must have a sufficiently developed management system to support franchisees
Importantly, originals of all of the supporting documents must be certified by the Chinese Consulate in the local jurisdiction of the franchisor. Where documents are issued by an electronic register, a notary public will also need to certify that the electronic copy is a true and correct record. The Application and all supporting documents must also be translated.
Online filing requirements
The Regulations require a franchisor to complete the online filing procedure within 30 days of signing a franchise agreement. This includes a foreign franchisor executing a master franchise agreement and a foreign master franchisee executing a sub-franchise agreement. As a consequence of this strict timeframe, a franchisor must obtain the Access Key before it signs a franchise agreement. This can add an upfront cost to the entry into the market, a cost incurred before a signed agreement is obtained.
To register, a franchisor has to file a number of documents, including translated versions of the relevant master franchise agreement, franchise operating manual and marketing plan. These extensive filing requirements mean that commercially sensitive and confidential information needs to be filed with MOFOM. However, the filed documents are not available to the public. The Regulations require the following limited information to be available to the public on the register:
- Franchisor entity details
- Operational resources of the franchise, such as registered trade marks, logos, patents and know-how
- Date of registration with MOFCOM
- Registered address, contact information and name of legal representative of the franchisor
- Addresses of any sub-franchisees in China.
A franchisor who does not meet the qualifications to operate in China but grants franchises is at risk of having the income generated by such franchises confiscated by the authorities.
Recent clarification by MOFCOM
Over the last 6 months some of the uncertainties in relation to the application of the Regulations to foreign franchisors have been clarified by China's Ministry of Commerce. However, some uncertainties remain and careful, sometimes creative, consideration, needs to be given to explaining how the Regulations apply to foreign franchisors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.