Commercial Franchising is a successful business model around the world. It is also a fast growing business trend in China. It is estimated that there are more than 2,600 franchise operations in China (ranking number one in the world) involving more than 168,000 franchise outlets in more than 60 industries in 2006. The legal framework was however based on the Measures on Administration of Commercial Franchising issued in 2004 ("2004 Measures") which did not have adequate administrative penalty, civil compensation or criminal liability and are very restrictive to foreign franchisors.
On 6 February 2007, the State Council promulgated the Regulations on Administration of Commercial Franchise ("Regulations") which replaced the old 2004 Measures and set out a stronger legal framework for commercial franchising in China. The Regulations apply to franchisors that have been engaging in franchising activities within the boundaries of China before and after the Regulations and are effective from 1 May 2007. To implement the Regulations, the Ministry of Commerce, Ministry of Commerce issued the Measures on the Administration of Filing of Commercial Franchising and the Measures on the Administration of Information Disclosure of Commercial Franchising on 30 April 2007, also effective 1 May 2007.
Basics of a Commercial Franchise
Article 3 of the Regulations provides the four basic fundamental elements in a franchise. To begin with, a franchisor must have its own operational resources such as registered trademarks, logos, patents or specific techniques etc. Secondly, the relationship between the franchisor and the franchisee should be governed by a contract and the rights and obligations of the parties are specified in the franchise agreement. Thirdly, as operating in a highly organizational and systematic manner is the core value of a franchise, all franchisees will conduct their operations in a consistent manner ranging from their management, promotional activities and quality control to decoration and location of the logo. Lastly, the franchisee shall pay a fee to the franchisor as specified under the franchise agreement.
Qualifications of Franchisor - the "Two Outlets + One Year" Rule
The 2004 Measures require the franchisor to have at least 2 direct-operated outlets which have been in operation for more than one year before it can franchise in China. Article 7 of The Regulations now do not explicitly state that the outlets must be within China. This is a welcome change for international franchisors.
It is expressly stated in the Regulations that only corporate entities are entitled to be franchisors, whilst other entities or individuals are prohibited to conduct such business. The Regulations also require the franchisor to possess a mature operational mode and provide continuing operation guidelines, technical support and training to the franchisee.
Terms of Franchise Agreement
Article 11 of the Regulations set out the standard terms to be included in a franchise agreement :- category of payments, amount of fees to be paid and the format of payment, guidance and technical support provided, quality and standard required, promotional activities, consumer protection in relation to the franchise operation and the relevant obligations, termination and amendments of contract and dispute resolutions.
Under Article 12 of the Regulations, a franchisee is entitled to unilaterally terminate a franchise agreement after a certain period of time. The Regulations also set out that the term of the franchise shall not be less than 3 years.
A franchisee is also prohibited by the Regulations to transfer or assign its franchised rights without the consent of the franchisor. Franchisee is also forbidden to disclose the business secrets relating the franchise in its possession to any other third parties.
Disclosure of Information by Franchisor
The franchisor shall disclose the substantial information to the franchisee at least 30 days prior to the execution of the franchise agreement including information on the franchisor intellectual property rights, budget for the franchise outlet, quantity, distribution and evaluation of current franchisees in China, information on major legal action or arbitrations in the last 5 years and whether the franchisor was ever prosecuted for illegal business activities or fined more than Rmb300,000.
Filing of Franchise Agreement
Article 8 of the Regulations provides that within 15 days of the signing of the franchise agreement between the franchisor and its first franchisee, the franchisor shall file the franchise agreement with the Department of Commerce in the relevant province. For franchise operating in more than one province, the franchisor shall file the franchise agreement to the Ministry of Commerce of the State Council. The filing shall include documents and information including its business license, sample contract, operational guideline, marketing plan, a declaration of compliance of the qualifications under Article 7 of the Regulations. If the goods or services involved in the franchise require special approval by relevant authorities, the relevant approval documents shall also be filed by the franchisor. The Department/Ministry shall complete the filing within 10 days after the receipt of all relevant documents and publish a list of filed franchisors in the website of MOC.
The franchisor is required to file with the competent authorities within the first 3 months of each year the status of all of franchise agreements in the previous year and within 30 days, any change to filed information.
To better protect the potential franchisees, the authorities will publish a list of franchisors in the government’s websites after the relevant filing is completed for verification by the public.
As the Regulations are applicable to those franchisors who were already operating commercial franchising in China before the effective date of the Regulations, such existing franchisors are required to file their application in accordance with the Regulations within one year of the effective date of the Regulations (i.e. on or before 1 May 2008).
Lawyers in our China Business Practice Group regularly advise clients on foreign direct investments, mergers and acquisitions and China investment issues. For more information on the Regulations, please contact us.
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.