May, 2007

 

By BILL H. ZHANG

 

In many countries the commercial franchise business has been in existence for almost a century. In China, however, franchises have only been around for a bit longer than a decade. While the business concept may not have a long history in the PRC, many franchises have nevertheless been brokered. The growth of businesses like Starbuck, McDonalds and KFC bear witness to the fact that franchises certainly exist and are even proliferating in the PRC.

 

Regulation of the franchise market, however, has been criticized as weak. Therefore, to improve regulation of Chinese commercial franchise market, the authorities have amended the old franchise law and promulgated a series of new regulations on commercial franchising activities. In this China Legal Watch we will address the major changes in the law and how those changes might affect the future franchise market.

 

WHAT DOES THE TERM FRANCHISE MEAN IN CHINA?

 

The term franchise is often used to loosely refer to a variety of different ad hoc methods for selling goods to retail customers. Sometimes it refers to various forms of technical assistance and technology transfer arrangements as well as cooperation agreements and supply arrangements. Products and trade name franchising involve the use of a trade name in exchange for fees or royalties and may include an obligation for exclusive sale of trade name products. Business format franchising, on the other hand, involves the use of an entire business concept in exchange for fees and royalties, and may include the use of a trade name, business plan, training materials and related subordinated services.

 

HISTORY OF FRANCHISE REGULATION IN CHINA

 

In 1997 the then Ministry of Domestic Trade promulgated the Measures for the Administration of Commercial Franchising Operations, which has been the governing law for the past ten years. Owing to the growth of franchise arrangements in China and amid concerns regarding regulation of the franchise market, on February 6, 2007, the State Council promulgated the Regulation on the Administration of Commercial Franchises.Two implementing regulations followed on April 30, 2007: (1) Regulation on the Administration of Information Disclosure of Commercial Franchises and (2) Regulation on the Administration of the Recording of Commercial Franchises (collectively Regulations). These Regulations took effect on May 1, 2007, and are intended to further govern franchising activities within the PRC.

 

There are six fundamental changes in the law, each of which will be addressed in this article:

 

1. Foreign franchisors are now on an even playing field with PRC franchisors.

 

2. Only enterprises and other legal entities can be a franchisor; individuals may not.

 

3. Franchisors must have owned and operated at least two locations for a minimum of one year prior to engaging in a franchise agreement.

 

4. Franchisors must disclose sufficient information to the franchisee to allow the franchisee to make an educated decision concerning investment in the franchise.

 

5. Franchisors must register with the appropriate authorities within fifteen days of signing their first franchise agreement.

 

6. Franchisors that place false advertisements concerning their franchise can be fined up to 300,000 RMB.

 

FOREIGN FRANCHISORS ARE ON AN EVEN PLAYING FIELD WITH PRC FRANCHISORS

 

The new legislation has removed barriers to foreign franchisors entrance into the domestic franchise market. Therefore, for the first time, foreign franchisors can compete directly with PRC franchisors.

 

ONLY ENTERPRISES AND OTHER LEGAL ENTITIES CAN BE A FRANCHISOR

 

The new law restricts franchisors to enterprises (Enterprises are domestic and foreign entities in the form of corporations, joint ventures, partnerships, etc.) owning registered trademarks, enterprise marks, patents, know-how or any other business resources. Therefore, no individuals or entities, other than enterprises, may engage in the franchising business as franchisors.

FRANCHISORS MUST HAVE OWNED AND OPERATED AT LEAST TWO LOCATIONS

 

In addition to the restrictions on the types of entities that are allowed to engage in franchise activity, the franchisor is now required to possess a mature business model and the ability to provide long-term business guidance, technical support, business training and other services to the franchisee.

The franchisor shall further have at least two direct sales stores and undertaken the business for more than one year. The law backs this requirement up with a fine of up to 500,000 RMB for violation of this provision.

FRANCHISORS MUST DISCLOSE SUFFICIENT INFORMATION

 

The franchisor shall provide the franchisee with the text of the franchise contract at least thirty days prior to the conclusion of the franchise contract for which the term shall be no less than three years, unless otherwise agreed by the franchisee.

The franchisor shall also disclose sufficient information to the franchisee to allow him to make an educated decision concerning investment. In the event the franchisor fails to provide sufficient information, the franchisee may terminate the franchise contract and the franchisor may be subject to a maximum fine of 100,000 RMB. To protect his own business interests, however, the franchisor is permitted to require the franchisee to sign a confidentiality agreement.

FRANCHISORS MUST REGISTER WITHIN FIFTEEN DAYS OF SIGNING THEIR FIRST FRANCHISE AGREEMENT

 

The franchisor shall register the franchise agreement with the appropriate authorities within fifteen days from the date of the conclusion of the first franchise contract with the franchisee. In the event the franchisor has already undertaken franchising activities before May 1, 2007, it shall register the franchise agreement within one year after the implementation of the Regulations.

In addition, the franchisor shall report the conclusion, cancellation, renewal and amendment of the franchise contract in the preceding year to the appropriate authorities before March 31 of each year. In the event there are any changes to the information of the franchisor recorded at the authorities, the franchisor shall apply for registration of the changes with the appropriate authorities within thirty days from the date the changes took place. Again, this is a law with teeth -- the failure to register with the appropriate authorities opens the franchisor to liability of at least 10,000 RMB and a maximum of 50,000 RMB.

FRANCHISORS PLACING FALSE ADVERTISEMENTS COULD BE FINED UP TO 300,000 RMB

 

The new law further restricts the franchisor from engaging in fraud or misleading activities in the promotion or publicity of its franchise. Moreover, the advertisements the franchisor releases shall not contain any content regarding a franchisee profit. Violation of this provision can result in the franchisor being fined up to 300,000 RMB.

 

CONCLUSION

 

While the new law seems to provide increased protections to franchisees, the burdens on the franchisor have been increased. Those enterprises wishing to sell franchises within the PRC are urged to be cautious in all aspects of marketing and ensure that over the top promises are not made and that all materials portray the business opportunity in frank terms. In addition, close attention must be paid to the registration requirements. Nevertheless, foreign investors who wish to enter into the Chinese franchise market do so as a peer with their PRC counterparts because the new rules no longer limit foreign participation in franchises. Therefore, we believe that the new regulations provide an excellent opportunity for foreign franchisors to enter the PRC domestic franchise market.

 

 

About the Author

 

BILL H. ZHANG is the managing partner of China Sunbow & Associates with rich experience in cross-board transactions involving China with more focus on corporate and commercial matters, such as mergers and acquisitions, direct investment in China, joint venture, intellectual property, technology license and transfer, international trade, corporate governance and compliance, restructuring and reorganization, labor and employment, and dispute resolutions. He has represented many multi-national companies to merge and acquire Chinese enterprises, make investment, register and enforce various trademarks, patents and copyrights, resolve commercial disputes in China. He has also counseled many foreign invested enterprises on their daily operations in China.

 

For more information about this article and the author, please contact:

 

BILL H. ZHANG

 

F: +8621 5081 5239 (Shanghai) or

+852 2710 8266 (Hong Kong)

E: bill.zhang@chinasunbow.com

 

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