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FRANCHISING IN CHINA

17 March, 2008

Franchising in China started in the 1990s. Reflecting its vast geographical coverage, China now has more franchisors than any country in the world.
Does this coveted market also open its arms to foreign franchisors? Are the regulations as restrictive as those under the Doubin Law in France?
In other words, is the legal structure for franchising in China propitious for foreign franchisors, or not?


This question is all the more pertinent as Chinese franchise law continues to provide increased protection to franchisees.
The Chinese Ministry of Commerce published on 30 December 2004, in the context of its WTO membership since 2001, Administrative Measures concerning commercial franchises, applicable from 1 February 2005.
These Measures supplement regulations for foreign investment distribution companies passed in December 2004, which permit franchising.


More recently, the 30 December 2004 law was expanded on 1 May 2007, the application date for the Regulations governing franchises, by Measures controlling registration of franchises and by Measures to supervise the commercial franchise obligation of information.


Under these new measures, franchisors and franchisees, whether Chinese or foreign, will receive equal treatment.


Scope of regulations
Foreign franchisors are now no longer obliged to prove direct operation of two stores in China for a year  before being able to develop franchises in that country. (Article 7, Franchise Regulations)
This obligation may be fulfilled in another country, but must be proved to the Chinese authorities.
In addition to having operated two stores, the franchisor must fulfil the following conditions to acquire legal standing as a franchisor in China :
-    be registered as a trading company, as individuals and other entities may not be franchisors (Individuals could not be a franchisor) ;
-    own a registered trademark, company mark, patent, know-how or any other business resource ;
-    have a sufficiently developed management system to support franchisees via technical support and professional training ;
-    shall possess a mature business model and the ability to provide long-term business guidance, technical support, business training and other services to the franchisee.
Furthermore, under the former regulations, foreign franchisors were required to obtain the prior approval  of the Chinese authorities before commencing any franchise operation.

The franchisor is no longer subject to this obligation, and need only register the franchise contract with the appropriate Chinese local authority within 15 days of its signature.
It must nevertheless produce a certain number of documents, such as its marketing plan, the original franchise contract, franchisee manual and, in fine, any information required by the Ministry of Commerce. (Article 8, Franchise Regulations)


Needless to say it will be difficult therefore for a franchisor to keep back certain information - protected by trade secrecy in France - if it wishes to develop its franchise network in China.
Obligatory information in franchise contract


Under the Franchise Regulations, the franchise contract must be in writing and for a term of not less than three years, unless the franchisee decides otherwise. (Articles 11 and  13, Franchise Regulations)
This provision is advantageous to the franchisee who may unilaterally terminate the contract within a contractually-agreed period without financial compensation being payable to the franchisor.
The franchise contract must also incorporate a certain number of obligatory clauses and provide a minimum of information: (Article 11, Franchise Regulations)
-    basic information concerning franchisor and franchisee;
-    the contract term;
-    franchisor remuneration procedures;
-    assistance and services provided by the franchisor to the franchisee;
-    respective obligations as to liability for product quality and consumer guarantees; franchisors will therefore have to be particularly careful with their network franchisees, by continuously ensuring that product quality is maintained by franchisees, to ensure that their brand image is not substantially affected;
-    promotion and advertising methods used by the franchisor;
-    procedures for terminating the contract;
-    resolution of disputes.


Moreover, mirroring French regulation, article 16 of the Franchise Regulations states that payments by the franchisee to the franchisor made before signature of the franchise contract must be evidenced and the repayment methods contractually agreed.


However, in the absence of provision in the Franchise Regulations, the parties should define in their franchise contract the geographical territory concerned, its exclusiveness or otherwise for the franchisee, whether there is a non-competition obligation on expiry of the contract and the pricing policy applied by the franchisor.


Obligation to inform the franchisee
The Franchise Regulations are supplemented by a Ministry of Commerce order ("Administration Rules on Commercial Franchise Information Disclosure ") which details all obligatory information which   franchisors must give to franchisees before signature of the principal contract.
The franchisor must provide the information to the franchisee at least 30 days before signature of the contract, as opposed to a minimum of 20 days under the French system. (Article 4 of the Order).

Just as the Doubin Law may require, the franchisor must provide an estimate of the franchisee’s  investment budget, its profitability outlook, a list of its franchisees and a financial statement concerning their respective situations. (Article 22, Franchise Regulations)


It must also provide its last two balance sheets and details of any disputes affecting the franchise operation within the 5 years prior to contract signature. (Article 22 (10), Franchise Regulations)


Franchisors should therefore ensure that all the obligatory information is clearly set out in the franchise contract to avoid any non-disclosure complaint by franchisees.


Such non-disclosure, or provision of false information, entitles the franchisee to terminate the contract unilaterally and claim damages if appropriate.
It seems clear that the new Chinese regulations, which closely follow existing franchise legislation, have decided to be both more flexible and more restrictive with a view to reinforcing the protection of franchisees and attracting foreign investors.


Trade secrecy protection and other sanctions
The Chinese Ministry of Commerce, aware of the importance of protecting the  franchisor’s commercial secrets obtained by the franchisee before and during execution of the franchise, has expressly provided (Article 18, Franchise Regulations) that the franchisee must not disclose, or allow others to use, commercial secrets obtained during franchise operations.
Breach of this provision exposes franchisees to the risk of an order for substantial damages.


Elsewhere, the law provides that companies engaged in franchising which do not fulfil the franchisor pre-qualification conditions above may have the incume generated by such business confiscated by the authorities.
Other pecuniary sanctions are also provided in the Chinese regulations.


To dissuade breaches of the law, the regulations provide for publication of all potential sanctions against franchisors and franchisees.
The new Franchise Regulations have therefore been considerably tightened in 2007, producing a legal structure closer to that under the Doubin Law.
This may reassure French businesses considering extending their franchise networks to China.


Apart from the tightening of this detailed regulation, the legal structure for business and trade in China is organized. For example, Lease Contract is stipulated in the Contract Law of PRC, and there are other regulations concerning commercial lease.  Goodwill is an important policy of Civil Law of PRC, which is embodies in many civil and commercial laws and regulations.

 

By Jean-Gratien Blondel,                       By YU Jingyan
Attorney at Law - Paris Bar                    Lawyer/Partner

SELARL du Manoir de Juaye                 Beijing Hongren Law Firm

juaye@france-lex.com                           jingyan_yu@yahoo.com

 

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