Franchising in China: overview

A Q&A guide to franchising in China.

The Q&A provides an overview of the main practical issues concerning franchising, including current market activity; regulation of franchising; contractual issues relating to franchising agreements (including pre-contract disclosure requirements, formalities, parties' rights and obligations, fees and payments, term of agreement and renewal, termination, and choice of law and jurisdiction); Operations Manual; liability issues; intellectual property; real estate; competition law; employment issues; dispute resolution; exchange control and withholding; and proposals for reform.

To compare answers across multiple jurisdictions, visit the Franchising: Country Q&A tool.

This Q&A is part of the global guide to franchising law. For a full list of jurisdictional Q&As visit www.practicallaw.com/franchising-guide.

Ella Cheong, Ella Cheong & Alan Chiu, Solicitors & Notaries
Contents

Market

1. What have been the main developments in the franchising market over the past 12 months?

Registration certificates issued by China for trade marks, patents or other business operation resources related to franchise activities must be provided by a company before it applies to be a franchisor (Administrative Measures for the Record Filing of Commercial Franchises). At least one certificate is required by the Ministry of Commerce (MOFCOM), however, it is sufficient if the potential franchisor can provide a trade mark licence agreement or equivalent which indicates its authorisation to use certain trade marks. The trade mark licence did not have to be exclusive, but MOFCOM recently changed its policy and requires the trade mark licence to expressly state that only the licensor and the potential franchisor can use the licensed trade marks and then the potential franchisor can sub-license these to its China franchisees.

A potential franchisor must have at least two direct sales stores and have undertaken the business for more than one year (that is, the ''2 + 1'' agreement) (Regulation on the Administration of Commercial Franchises). MOFCOM previously allowed foreign franchisors to use affiliates when evidencing the ''2 + 1'' agreement, however, this policy was changed in 2015 and requires that only the franchisor or its direct subsidiary (and no longer a parent entity) can qualify under the ''2 + 1'' agreement.

McDonald's claimed on 31 March 2016, that in the next five years it plans to open 1,000 new franchising restaurants. The CEO Easterbrook said that the goal is to make China McDonald's second biggest market, placing it ahead of Japan and directly behind the US. The Korean biggest cosmetic brand Amore Pacific introduced more sub-brands into the Chinese market in 2015. According to Amore's 2014 annual report, their turnover increased by 44% compared to the previous financial year. As the Chinese market becomes one of the most profitable markets in the world, more famous worldwide brands and their sub-brands entered into China. Examples of world-famous brands that first entered China in 2015 include:

  • Restaurants such as:

    • Pret A Manger, which plans to open three restaurants in Shanghai and also Beijing;

    • Gucci Restaurant (Shanghai). This is Gucci's first global restaurant. Gucci first entered China in 1996 in respect of its fashion-wear; and

    • Vivienne Westwood Café (Shanghai). The café is Vivienne Westwood's first global café. Vivienne Westwood first entered China in 2011.

  • Retail such as:

    • Brookstone (Nanjing);

    • Victoria's Secret (Shanghai); and

    • Disney, which opened its world biggest flagship store in Shanghai. Disney also opened its first theme park in 2016.

  • Accessories and clothing such as:

    • Roots (Beijing);

    • Marc Rozier (Chengdu);

    • Topshop (Beijing);

    • American Rag Cie (Shanghai);

    • Chaps (Shanghai);

    • Tom Tailor (Shanghai);

    • FRED (Shanghai); and

    • GIORGIO VISCONTI (Shanghai).

  • Hotels, such as Six Senses, a luxury hotel brand from The Republic of Maldives, which opened their first Mainland China hotel in Dujiangyan (a World Cultural Heritage site located in Dujiangyan city, Sichuan province). 

 
2. What are the most commonly used methods of local and international franchising?

Local franchising

The Chinese market is huge and complex, due to the varying cultures and practices of the different cities. Every Chinese entity may have a different franchising method depending on its business type and sometimes one entity uses both direct franchising and master franchising.

International franchising

The current applicable legislation allows a foreign franchisor to either be:

  • A joint venture (or a foreign company without any presence in China).

  • A domestic subsidiary by way of a foreign invested enterprise (FIE) such as a wholly foreign owned enterprise.

The first option avoids the establishment of a domestic enterprise, but there are risks such as the absence of a local franchisor leading to lack of control over the franchisee.

The second option can be an ideal way to manage and build a franchise network in China through the use of FIEs. Having local staff and local presence will aid the:

  • Supervision of the business structure.

  • Management of business resources and brand awareness, leading to later expansion.

This may, under certain circumstances, be strongly advisable from a tax perspective too.

China has the largest population in the world with huge domestic demand. Instead of going global and bearing the risks generated from language and culture barriers and lack of knowledge of markets of target countries and regions, Chinese domestic brands are more likely to expand franchising within different areas in China.

 
3. Are there any specific reasons for an overseas franchisor to use a separate entity for entering into a franchise agreement with a franchisee in your jurisdiction?

Foreign enterprises are prohibited from carrying out franchise activities, except through foreign-funded enterprises established within China (Article 3, Measures for Administration on Foreign Investment in Commercial Fields). Therefore, the overseas franchisor can only establish a separate entity within China to carry out any franchise activity.

 

Regulation of franchising

4. What is the legal definition of franchising and/or a franchise?

''Franchise'' refers to business operations by which an enterprise owning a registered trade mark, enterprise mark, patent, know-how or any other business resource (franchisor) confers the said business resource to any other business operator (franchisee) by means of contract, and the franchisee undertakes business operations under the uniform business model as stipulated by the contract, and to pay franchising fees to the franchisor.

No entity or individual other than enterprises can engage in the franchise business as a franchisor.

 
5. What are the laws regulating franchising?

The following laws primarily regulate franchising:

  • Measures for Administration on Foreign Investment in Commercial Sector (promulgated by the Ministry of Commerce (MOFCOM) effective 1 June 2004).

  • Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007).

  • Administrative Measures for Information Disclosure of Commercial Franchises (promulgated by MOFCOM effective 1 April 2012).

  • Administrative Measures for the Record Filing of Commercial Franchises (promulgated by MOCFOM effective 1 February 2012), which govern the continuous disclosure requirements of the franchisor to the franchisee.

Currently, franchisees are not protected by other laws or regulations related to protecting local agents or distributors.

There are no specific laws affecting the ongoing relationship between franchisor and franchisee. The only applicable law is the Contract Law of the PRC (Contract Law), which states that franchisor and franchisee must abide by the principles of fairness and reasonableness. In addition to the Contract Law and the Civil Code, the parties must also comply with trade mark law, advertisement law and regulatory requirements (such as the Regulations on Prohibition of Pyramid Selling).

There is no specific law that encourages franchising in China,

 
6. What is the regulatory authority responsible for enforcing franchising laws and requirements in your jurisdiction?

The Ministry of Commerce and its local counterparts are the regulatory authorities responsible for enforcing franchising laws and requirements.

 
7. Must the franchisor be registered with a professional or regulatory body before setting up a franchise system?

A franchisor must satisfy the ''2+1'' agreement (see Question 1) (Article 7, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007) (Regulation)). If the franchisor fails to meet these requirements, the commercial administrative department will ask the franchisor to remedy its breach and confiscate all illegal income acquired by the franchise (Article 24, Regulation). In addition, the franchisor will be fined between CNY100,000 and CNY500,000 and there must be a public announcement of this decision.

Franchisors must report and register all relevant franchising materials to the Ministry of Commerce within 15 days of the franchisor entering into a franchise agreement with the franchisee (Article 8, Regulation). If the franchisor fails to meet these requirements, the commercial administrative department will ask the franchisor to remedy its breach in the time period determined by the authority, and the franchisor will be fined between CNY10,000 and CNY50,000 (Article 25, Regulation). If he fails to do so within the time limit, he can be fined between CNY50,000 and CNY100,000 and there will be a public announcement of this decision (Article 25, Regulation).

A franchisor must explain the purpose and the use of the preliminary payment if it requires the franchisee to make this payment before signing the agreement and also specify in writing to the franchisee, all conditions and methods of the franchise (Article 16, Regulation). If the franchisor fails to meet these requirements, the commercial administrative department will ask the franchisor to remedy its breach in the time period determined by the authority and the franchisor will be fined between CNY10,000 and CNY50,000 (Article 26, Regulation). In addition, if the breach is serious, he will be fined between CNY50,000 and CNY100,000 and there will be a public announcement of this decision.

A foreign franchisor must register its trade mark with the China Trademark Office before entering into commercial franchise agreements with local franchisees. In a well-known case between Apple Inc. and Shenzhen Weiguan Technology Corp., Apple was unable to successfully register the trade mark IPAD within China. Ultimately, Apple paid US$60 million to Weiguan to secure the right to use the trade mark IPAD.

 
8. Is there a code of ethics or other means of promoting ethical franchising in your jurisdiction?

At present, there is no code of ethics or other means of promoting ethical franchising in China.

 
9. Do franchisees benefit from any laws designed to protect consumers or small businesses?

The Consumer Protection Law defines a consumer as someone who purchases goods or services for his own consumption. A franchisee will not be deemed as a consumer because he purchases materials or services from the franchisor for business purposes (not for its own consumption). Different Chinese cities have different business protection policies, so franchisees must consult the local administrative commercial departments to ascertain whether they are protected under regulations designed to protect small businesses.

 
10. Are there any other requirements which must be met before a business can sell a franchise?

Before engaging in franchise activities, a franchisor must (Article 7, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)):

  • Have a mature business model.

  • Provide long-term business guidance, technical support, business training and other services to the franchisee.

  • Meet the ''2+1'' agreement (see Question 1).

Foreign franchisors are treated similarly to domestic franchisors. However, from a regulatory perspective, there are some minor differences (for example, domestic franchisors must file with the local Ministry of Commerce (MOFCOM) counterpart, whereas foreign franchisors must file with MOFCOM. In addition, application and filing documents submitted by foreign franchisors must be notarised and certified.

 

Franchise agreement

Pre-contract disclosure requirements

11. Is the franchisor subject to any general or formal pre-contract disclosure requirements?

The franchisor must provide the following information in writing to the franchisee at least 30 days before entering into a franchise agreement (Articles 21 and 22, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007) (Regulation)):   

  • The franchisor's name, domicile, legal representative, registered capital, business scope and the basic situation of franchising activities.  

  • Basic information of the franchisor's registered trade marks, corporate logos, patents, proprietary technology and business model. 

  • The type, amount and method of payment of franchise fees (including whether margin deposit is required and the repayment details of the margin deposit).

  • Prices and conditions for the provision of products, services, or equipment to the franchisee.

  • The content and implementation plan for the provision of continuous business guidance, technical support and operation training to the franchisee.

  • Specific methods of supervising and guiding the operation activities of the franchisee.

  • The estimate budget of investment for franchise outlets.

  • The number, geographical distribution and business conditions assessment of existing franchisees.   

  • The last two years' briefs of financial accounting report and auditing report as audited by an accounting firm.

  • The last five years litigation and arbitration results related to franchising. 

  • Any serious illegal business records of the franchisor or its legal representative.   

  • Any other information prescribed by the commercial administrative department.

There are no exemptions or differences in treatment for a large or sophisticated franchisee or investor. If the franchisee or investor is based outside the country, they must comply with the laws of the country in which they are operating their businesses.

If the franchisor fails to comply with disclosure requirements, the commercial administrative department will order the franchisor to make a correction and impose a fine between CNY10,000 and CNY50,000. In addition, the franchisor may be fined between CNY10,000 and CNY50,000. If the franchisor does not take steps to correct this non-compliance, it may be fined CNY50,000 to CNY100,000, with public announcement (Article 28, Regulation).

The sub-franchisor must provide the pre-sale disclosure under a sub-franchising structure by disclosing to the sub-franchisee that it has obtained the necessary operational authorities from the original franchisor to grant sub-franchises. The disclosure must also contain some information disclosed by the original franchisor, such as the ownership of the trade marks.

 
12. Must the franchisor disclose fairly and in good faith all facts material to the prospective franchisee's decision to enter into the arrangement, or must the prospective franchisee rely on its own due diligence?

The franchisor must disclose fairly and in good faith all facts material to the prospective franchisee's decision to enter into the arrangement (Article 23, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)).

Formalities

13. What are the formal contractual requirements to create a valid and binding franchise agreement?

Chinese law does not require the franchise documents to be in Chinese. However, to avoid potential disputes with local franchisees and for the purposes of registration with local authorities, it is advisable to do so or ensure that a translation is available. In addition, the Chinese version of the franchise agreement must be prepared and submitted to the Ministry of Commerce (MOFCOM). The franchisor must ensure that he retains the copyright of the translation.

Franchisors must report and register the following relevant franchising materials to MOFCOM within 15 days of the franchisor entering into a franchise agreement with a franchisee (Article 8, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007) (Regulation)):

  • A photocopy of the business licence or enterprise registration certificate.

  • A sample franchise agreement.

  • A brochure for franchised operations.

  • A market plan.

  • A written commitment and relevant certification materials as specified under Article 7 of the Regulation.

  • Other documents and materials prescribed by the commercial administrative department.

If the product or service of a franchise cannot be dealt with until approval, the franchisor must also submit a relevant approval document.

There are no different categories of franchise agreements.

Parties' rights and obligations

14. Is there a general obligation to behave fairly, reasonably or in good faith to the other party during the term of the franchise agreement?

Obligations of the franchisee

A franchisee must not transfer the franchise to others without the consent of the franchisor or divulge any of franchisor's trade secrets to others. There is no applicable law that specifies that the above provisions can be overridden.

Obligations of the franchisor

The franchisor has an extensive information disclosure obligation towards a prospective franchisee. It must provide, among others, the following:

  • A sample franchise agreement.

  • Information on its business.

  • Business resources, including its registered IP, investment, budget plan and business model.

The failure to disclose this information, or the providing of inaccurate information, provides the franchisee with legal grounds to terminate the franchise agreement and to claim for damages. There is no applicable law that specifies that the above provisions can be overridden.

Overseas franchisors may be liable for the failures of a local sub-franchisor to meet the disclosure obligation as the disclosure will normally specify that some information must be disclosed by the original franchisor.

 
15. Does local law require that particular provisions must be expressly included in a franchise agreement?

The franchise agreement must include (Article 11, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007):

  • Basic information about the franchisor and franchisee.

  • Contents and terms of the franchise.

  • The type, amount and payment method of franchising fees.

  • The content of and the methods for providing business guidance and technical support.

  • Business training and other services.

  • Quality provisions, standards and guarantees for the product or service.

  • Sales promotion, advertising and publicity about the product or service.

  • Protection of rights and interests of consumers and assumption of compensation liabilities.

  • Change, rescission and termination of the franchise agreement.

  • Breach of agreement provisions and liabilities.

  • Dispute resolution methods.

  • Other agreements between franchisor and franchisee.

No law specifies that any of the above provisions can be overridden.

 
16. Are exclusion and entire agreement clauses enforceable in your jurisdiction? If so, are they effective to protect the franchisor?

There is no expressed provision in Chinese law dealing with this issue. However, under a sub-franchising structure, a local sub-franchisor must take most of the responsibility for its own misbehaviours.

 
17. Can the franchisor impose product tying or other purchasing restrictions and non-compete obligations on the franchisee during the term of the agreement?

Restrictions on purchasing and product tying

The disclosure of information provided by a franchisor (see Question 14, Obligations of the franchisor) must include whether the franchisee must buy products, services or facilities from the franchisor or its nominated supplier. If so, the related prices and conditions must also be described. A franchisor can impose this requirement in the franchise agreement, if agreed by the franchisee. However, if this results in an abuse of dominant market position by the parties, they might be caught by the Anti-Monopoly Law. (Article 3, Anti-Monopoly Law).

Non-compete obligations and transfer restrictions

There is no law that places a limitation on a franchisor's ability to impose non-compete obligations during the term of the agreement. However, he should insert the relevant non-compete clauses into the franchise agreement.

A franchisee must not transfer the franchise to a third party, without the consent of the franchisor (Article 18, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)).

Fees and payments

18. What fees are usually payable by the franchisee? Are there any restrictions on the parties' freedom to set the fees and payments, or any other payment requirements?

Promotions and advertising expenses must be promptly disclosed to a franchisee and be used in accordance with the terms of the franchise agreement (Article 17, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)). 

The parties can negotiate the methods of payment of all related fees.

The current related regulations do not contain any restrictions on the amount of interest that can be charged on overdue payments. In practice, the franchisor can charge interest, as long as the interest charged is reasonable and not punitive.

Term of agreement and renewal

19. Are parties free to agree on the term of the franchise agreement? What is the typical term of a franchise agreement in your jurisdiction?

There is no statutory maximum term for the franchise agreement. However, the initial term of franchise agreement must not be less than three years unless it is otherwise agreed on by the franchisee (Article 13, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)).

 
20. What rights of renewal are usually included in the franchise agreement? Are fees paid on renewal?

Commercial practice

At the end of the term, the franchisor can refuse to renew the agreement. The law is silent as to what circumstances permit renewal and the fees payable on renewal. These should be the subject of negotiations.

Local law

The law is silent as to what circumstances permit renewal, the fees payable on renewal and the remedies if a franchisor does not renew the agreement. Parties can stipulate the renewal terms of the agreement after negotiation under the Contract Law of the PRC.

Termination

21. Are there any limitations on the right of a franchisor to terminate the agreement?

A franchisor must maintain the contractual relationship with the franchisee for three years, unless otherwise agreed by the franchisee.

Early termination of an agreement by a franchisor is only allowed if there is strong evidential support that there is a breach or a violation of good faith. A franchisor must be fair and reasonable when deciding to terminate the agreement. In the absence of contractual provisions, a franchisor can only terminate the franchise agreement in one of the following circumstances (Contract Law of the PRC (Contract Law)):

  • The franchisee delayed performance of its main obligation after the performance was demanded and failed to perform within a reasonable period.

  • It is impossible to achieve the purpose of the agreement due to an event of force majeure.

  • The franchisee delays performance of its obligations, or breaches the agreement in some other manner, rendering it impossible to achieve the purpose of the agreement.

  • Prior to the expiration of the period of performance, the franchisee expressly states, or indicates through its conduct, that it will not perform its main obligation.

Therefore, it is advisable for the parties to clearly state any other occurrence of breach that will entitle the franchisor to terminate, instead of relying only on the Contract Law.

A franchisee can unilaterally terminate the agreement without cause after an agreed cooling period (Article 12, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007) (Regulation)). A franchisee can also terminate the franchise relationship in accordance with the Contract Law (see above). In addition, if a franchisor conceals relevant information or provides false information, the franchisee can rescind the franchise agreement (Article 23, Regulation ).

Contractual penalties and liquidated damages (as opposed to or in addition to damages for breach) are enforceable under the Contract Law.

 
22. Are post-term restrictive covenants enforceable?

A franchisee must not divulge or allow any other persons to use confidential information regarding the business secrets of the franchisor and franchise (Article 18, Regulation on Administration of Commercial Franchises).

Before disclosing the information to the franchisee, the franchisor can require the franchisee to sign a confidentiality agreement (Article 7, Administrative Measures for Information Disclosure of Commercial Franchise). Therefore, for better protection of the disclosed information, it is advisable for the parties to enter into restrictive covenants under Article 7.

In relation to the enforceability of post-term restrictive covenants, Article 7 also provides that the franchisee must keep confidential any information that is disclosed during the course of the contractual relationship between the franchisor and franchisee.

Other kinds of restrictive covenants that prohibit competition, may violate Article 13 of the Anti-Monopoly Law. If the franchise agreement with post-term restrictive covenants is considered as a monopoly agreement, the Anti-Monopoly Authority can (Article 46, Anti-Monopoly Law):

  • Order the parties to cease continuing the agreement.

  • Confiscate the parties' illegal gains.

  • Impose a fine of 1% up to 10% of the parties' sales revenue in the previous year.

 
23. Can the franchisor or a replacement franchisee continue to sell to the former franchisee's customers?

The parties can negotiate the replacement of a franchisee and compensation issues.

Choice of law and jurisdiction

24. Will local courts recognise a choice of foreign law in a franchise agreement for a business operating in your jurisdiction?

Foreign law is not applicable to a franchise agreement for a business operating in China (Article 2, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)). The mandatory local rules apply to any franchise agreement.

 
25. Will local courts recognise a choice of foreign jurisdiction in a franchise agreement for a business operating in your jurisdiction?

Chinese courts will not recognise a choice of foreign jurisdiction in a franchise agreement for businesses operating in China. These businesses must comply with the Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007) (Regulation) (Article 2, Regulation).

 

Operations Manual

26. How does the franchisor ensure that the franchisee complies with the business standards, systems and requirements?

A franchisor must provide a franchise operation manual to the franchisee and periodically provide business guidance, technical support, business training and other services to the franchisee in accordance with the franchise agreement (Article 14, Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007) (Regulation)). The quality and standards of a franchise product or service must comply with the laws, administrative regulations and the relevant requirements (Article 15, Regulation).

 
27. Can the franchisor change the Operations Manual unilaterally, as is usually required?

If there is a major change to the information provided by a franchisor, he must promptly notify the franchisee of these changes (Article 23(2), Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)).

 

Liability issues

28. What are the franchisee's remedies against the franchisor for deceptive or fraudulent selling practices?

If a franchisor conceals relevant information or provides false information, the franchisee can rescind the franchise agreement (Article 23(3), Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007) (Regulation)). Under Article 28 of the Regulation, if Article 23 is violated, the franchisee can report the violation to the commercial administrative department and if the violation is inspected and proved, the department must:

  • Order the franchisor to rectify his violation.

  • Fine the franchisor between CNY10,000 and CNY50,000.

In the case of a serious violation, the franchisor can be fined between CNY50,000 to CNY100,000 and the decision will be announced publicly.

 
29. How can third-party claims against the franchisee be brought successfully against the franchisor?

A franchise agreement must include clauses regarding the protection of rights and interests of consumers and the assumption of compensation liabilities in the franchise and liabilities for breach of the contract (Article 11, Regulation on the Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)). If the franchisor includes clauses exempting its own liability against any third-party claims and the franchisee agrees, it may not be possible for any third party to claim against the franchisor successfully.

 

Intellectual property

30. What provisions are usually made in relation to intellectual property rights (IPRs), including know-how?

Franchisors must ensure that their IP is established under Chinese law and that the franchise agreement contains clear clauses on how their brand name, designs and trade secrets, (such as production techniques) must be applied. Breaches of these clauses are punishable by penalties and the immediate termination of the franchise by the franchisor.

Under current practice, a franchisor can file the franchise application with a pending IP right (because the registration of an IP right can take a long time). Before the franchise registration is issued, it must be accompanied by at least one registered IP right (such as a trade mark, patent or design).

Know-how is usually protected as a contractual obligation of the receiving party. Unlike trade marks or patents, there is no registration regime for know-how. Some know-how, such as software, can be protected under the copyright regime. However, the registration of know-how with authorities is not a mandatory requirement for copyright protection, but necessary before legal action is undertaken.

A franchisee must not divulge or allow any other persons to use the franchisor's business secrets (Article 18(2), Regulation on the Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007)).

 
31. What are the registration requirements for licensing IPRs?

China has a ''first-to-register'' trade mark system, which means that popular foreign trade marks can be registered easily by anyone. Therefore, a foreign franchisor who considers establishing a franchise in China must take immediate steps to register its trade marks and trade names with the relevant authorities. Franchisors should also register their trade marks and trade names as domain names.

Without a proactive IP registration plan in China, problems may also emerge after a franchisor terminates a relationship with its franchisee. For example, a franchisee may continue using the franchisor's proprietary trade marks by registering the trade mark for its own business and offering similar services or products, either directly or indirectly. This can occur because China has two separate systems for the registration of trade marks and trade names. Trade mark registration with the Chinese Trademark Office is valid across the whole country. Trade names, however, must be registered locally and applies only to jurisdiction of the local registry office. Therefore, the agreement must ensure that all IP rights belong to franchisor.

The franchisor must register its trade mark licence before franchising operations commence. If the franchise business utilises patents, the franchisor must enter into and register a patent licence in China.

Apart from the franchise agreement, a separate foreign investment licence is required and the procedure involved varies from city to city. Foreign entities must consult the local administrative commercial department. A business without this licence will be an illegal business.

 

Real estate

32. Are consents from landlords difficult to obtain when transferring leases or granting subleases from a franchisor to a franchisee?

The commercial real estate market in China is competitive and in major cities rent can be expensive. The terms of the lease arrangement depends on both the landlord and the city. Franchisors must consult a local real estate company for an accurate assessment of the city in which they decide to set up operations.

 
33. How can a franchisor prevent the franchisee from occupying the premises after the franchise agreement has ended?

The typical term for a commercial lease is three to five years with one renewal term. International franchisors cannot lease or sublease property to franchisees in China unless they set up an onshore legal entity with the required business licence. A franchisor must have a legal entity in China to lease real or moveable property (Article 3, Administrative Measures for Foreign Investment of Leasing Property). It is advisable for the parties to sign a separate commercial leasing agreement with the landlord (whether it is the franchisor or any other party). If the franchisee occupies the premises after the leasing agreement has ended, the landlord can call the police to evict the franchisee from the premises, by providing evidence of ownership or legal possession of the premises.

 
34. How can the franchisor effectively acquire the franchisee's premises at the end of the franchise relationship?

The law is silent as to whether the franchisor can effectively acquire the franchisee's premises at the end of the franchise relationship. However, if the franchisor has no legal entity in China, it cannot own or lease real or movable property in China. If the franchisor has a legal entity in China, the franchisor can own or lease real or movable property and the franchisor's right as a property owner will be protected by the local land registry.

 
35. If the franchisor leases or subleases its own site to its franchisee, can it pass on all related costs to the franchisee? Can the franchisor charge its franchisee tenant a rent expressed as a percentage of the franchisee's sales?

The parties can negotiate on these issues. A franchisor that has a legal entity in China can own its own site.

 

Competition law

36. What is the effect of competition law rules on franchising agreements? Are there any available exemptions?

Competition law

The legal regime for competition law is primarily covered by the Anti-Unfair Competition Law and the Anti-Monopoly Law. These two laws provide the following use of IP and restrictions on price, which are related to typical franchise transactions:

  • IP. The Anti-Unfair Competition Law prevents:

    • inducing confusion by using the same or a similar name, packaging or distinctive characteristics of a well-known product;

    • using another party's registered trade mark;

    • using the certificate of another business on merchandise; and

    • using the name of another business to confuse consumers.

  • Price. The Anti-Monopoly Law prevents:

    • a monopoly agreement, which fixes prices for resale;

    • limits on the developments of new products or new technology; and

    • limits on the output or sale of products.

Exemptions

A franchisor will not be in violation of the Anti-Monopoly Law and the Anti-Unfair Competition Law unless there is:

  • An abuse of market position.

  • Interference with a franchisee's lawful business activities.

  • An impairment of public interest.

Online/e-commerce restrictions

Parties can negotiate freely on online/e-commerce restrictions.

 

Employment issues

37. Can a franchisee be regarded as an employee of the franchisor?

A franchisee will generally not be considered as an employee of the franchisor. The risk can be mitigated by including a well-drafted clause in the franchise agreement to clarify the relationship between the two parties.

 

Dispute resolution

38. How are franchising disputes typically dealt with? What provisions for handling disputes are usually included in domestic franchise agreements?

Most cases in China are rarely litigated in the courts but are settled through administrative agencies or party negotiations. Arbitration is common for franchising claims as it is considered a practical and quick approach for dispute resolution. Court proceedings can be lengthy and more expensive.

The law is silent as to whether mediation is mandatory but the State encourages and supports mediation (Article 6, People's Mediation Law). The law is also silent as to what governing law should be used in mediation.

Parties can apply to the People's Court jointly for judicial confirmation after the mediation agreement has been concluded by the People's Mediation Committee (Article 33, People's Mediation Law). Therefore, if the mediation has not taken place before the People's Mediation Committee, parties may not be able to apply for judicial confirmation.

 
39. How are foreign judgments or foreign arbitral awards enforced locally?

It is very difficult to enforce foreign judgments or foreign arbitral awards in China. It is therefore advisable for parties to negotiate the settlement of their disputes.

 

Exchange control and withholding

40. Are any exchange control or currency regulations applicable to payments to an overseas franchisor?

China adopts a foreign exchange control system, which states that all outbound payments (except for settlements with Hong Kong, Macao and Association of Southeast Asian Nations countries, which can be made in renminbi) must be made in a foreign currency. To satisfy the payment requirements to an overseas franchisor, a franchisee must provide the:

  • Agreements (such as franchise agreements, licence agreement and so on) that have been filed with the Ministry of Commerce or its local counterpart.

  • Tax certificate evidencing that the franchisee has fulfilled its obligation in respect of withholding tax (if any).

  • All other documents that are required by the payer bank in accordance with foreign exchange control regulations.

 
41. Is there a withholding obligation on payments made to an overseas franchisor?

Parties can negotiate whether a withholding obligations applies.

 

Reform

42. Are there any proposals to reform the laws affecting franchising?

In September 2014, the Ministry of Commerce (MOFCOM) posted an online questionnaire on China's Commercial Franchise website, to gather opinions on amending the Regulation on Administration of Commercial Franchises (promulgated by the State Council effective 1 May 2007). The online questionnaire was intended to help MOFCOM prepare an amendment to the 2007 Regulation. In May 2015, the Supreme People's Court organised a conference for the discussion of the amendment to the 2007 Regulation, but there has been no announcement of the outcome. In the meantime, MOFCOM has not yet made an announcement concluding the reform. Therefore, there is no proposal to introduce voluntary self-regulation in relation to franchising in China.

 

Online resources

The Central People's Government of the People's Republic of China

W www.gov.cn/zwgk/2007-02/14/content_527207.htm, www.mofcom.gov.cn/article/b/c/201204/20120408089230.shtml, www.gov.cn/flfg/2011-12/21/content_2025612.htm, http://english.mofcom.gov.cn/aarticle/policyrelease/domesticpolicy/200412/20041200315836.html, www.mofcom.gov.cn/aarticle/b/c/200502/20050200354809.html

Description. This website contains legislation such as the Administrative Measures for Information Disclosure of Commercial Franchises (promulgated by the Ministry of Commerce (MOFCOM) effective 1 April 2012), Administrative Measures for the Record Filing of Commercial Franchises (promulgated by MOCFOM effective 1 February 2012), the English version of the Measures for Administration on Foreign Investment in Commercial Sector (promulgated by MOFCOM effective 1 June 2004) and the Administrative Measures for Foreign Investment of Leasing Property. All legislation is official, up-to-date and binding. The translations are for guidance, except for the Measures for Administration on Foreign Investment in Commercial Sector (promulgated by MOFCOM effective 1 June 2004), which is binding.



Contributor profile

Ella Cheong

Ella Cheong & Alan Chiu, Solicitors & Notaries

T +852 3752 3859
F +852 3752 3850
E peggy.ng@ellalan.com
W www.ellalan.com


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