Franchising in China
In recent years, China's large population and rapid economic growth have encouraged an increasing number of foreign franchisors to expand into China. In the early years, due to the absence of comprehensive franchise laws and regulations, the development of China's franchising industry was uneven; some franchisors provided low-quality goods/services to consumers, or even swindled money out of consumers and franchisees. In order to better protect the legal rights and interests of franchisees and consumers, the Chinese government imposed registration and disclosure requirements on franchisors operating in the country.
Key Regulations on Franchising in China
Currently, the key regulations on franchising in China include: the Regulation on Administration of Commercial Franchises (Regulation), the Administrative Measures for the Registration of Commercial Franchises (Registration Measures), and the Administrative Measures for Information Disclosure of Commercial Franchise (Disclosure Measures). The Regulation was promulgated by the State Council, while both of the Measures were issued by the Ministry of Commerce (MOC).
Pursuant to the Regulation and the Measures, to be a franchisor eligible to offer franchises in China, the following requirements must be met:
- The franchisor must be a business enterprise (rather than an individual).
- The franchisor must have a registered trademark, patent, or any other business resource. (Under current practice, the franchisor may file the franchise registration with a pending IP right, but the registration, when issued, should be accompanied by at least one registered IP right.)
- The franchisor (or its parent or subsidiary) must have at least two directly-operated outlets and must have conducted business under the franchised brand for more than one year (the “2+1 Requirement”). These outlets need not be in China, but they must be operated under the franchised brand.
According to the Regulation, a franchisor must, within 15 days after signing a franchise agreement for the first franchised location in China, file an application with the appropriate commercial authority in the MOC to register its franchise. The registration requirement is an administrative measure to regulate franchise activities, and also provides potential franchisees with public access to more information regarding the franchisor and its business. Although the failure to register does not impact the effectiveness of the franchise agreement, a franchisor that fails to timely file the franchise registration could face a fine from the commercial authority ranging from 10,000 to 50,000 Chinese Yuan (CNY) (approximately US$1,600-8,000).
In connection with the franchise registration application, the following documents must be submitted:
- Business registration certificate of the franchisor.
- Registration certificate of the franchised IP right: Where the franchised trademark is not owned by, but instead is licensed to, the franchisor, the trademark license must first be recorded with the Chinese Trademark Office, and the franchisor must submit the certificate of trademark license issued by the Chinese Trademark Office with the franchise registration application.
- Franchise agreement: To comply with the requirements of the Regulation and relevant laws, the franchise agreement must include certain language regarding consumer protection, quality guarantee, and training, as well as several other matters. In addition, the agreement must also grant the franchisee a “cooling-off period” during which the franchisee can end the relationship without penalty. The term of the agreement must be at least three years; however, the franchisee can waive this requirement.
- Certification for the 2+1 Requirement: To meet this requirement, the franchisor must submit a certification from a competent commercial authority or franchising association (such as the International Franchise Association). The certification must contain information about the franchised brand; the opening date, address, and business scope of the two stores; and the relationship between the franchisor and the stores, all of which demonstrate that the franchisor (or, if applicable, its parent or subsidiary) has directly operated two stores operating the franchised concept under the franchise brand/marks for more than one year.
- Marketing plan for the franchised operation.
- Other documents required by the Regulation.
If there are any major changes to the original filing (e.g., changes concerning the business registration of the franchisor, business resource, and distribution of the Chinese franchisees), the franchisor must, within 30 days, file a notice and supporting documents with the MOC for modification of its franchise registration. An annual update regarding new franchise agreements and those terminated in the past year also must be filed with the MOC by March 31.
All certificates or documents generated outside of China must be notarized by a local notary public, legalized by a Chinese Embassy or Consulate and submitted to the MOC with a Chinese translation.
According to the Regulation, except for a renewal of the franchise agreement on the same terms, a franchisor must disclose to the franchisee in writing the following information at least 30 days prior to the execution of another franchise agreement:
- Basic information regarding the franchisor and the franchised business, and information about the franchisor and its affiliated parties (including individual shareholders) in connection with bankruptcy filings in the past two years.
- Basic information regarding the franchisor's business resources. Where the business resources are owned by affiliated parties, basic information about the owner and the contents of the licensing agreements with the owner must be disclosed, and arrangements must be made in advance for handling the franchised business if the license is suspended or terminated.
- Basic information on franchising expenses.
- Information on the prices and conditions of the products, services, and equipment provided to the franchisee.
- Information on the services to be provided to the franchisee (e.g., training and technology support).
- Guidance and supervision over the franchisee's operation, including division of responsibilities for consumer compensation, etc.
- Information on investment budgets/initial investment for franchised outlets.
- Distribution, operations, and other basic information about franchisees in China.
- Financial statements and audit reports for the franchisor for the past two years.
- Information on franchise-related litigation and arbitration involving the franchisor during the past five years.
- Records of major illegal activities committed by the franchisor and its legal representatives (e.g., records of the imposition of criminal liabilities or an administrative fine of more than CNY 300,000 (approximately US$48,000)).
- The template franchise agreement and other franchise-related contracts.
Although the franchisor is not required to submit evidentiary documents to prove it has fulfilled the disclosure obligation when it seeks to register its franchise, timely disclosure of this information is mandatory. Where a franchisor fails to fulfill the disclosure obligation, it may face a fine from the commercial authority ranging from CNY10,000-50,000 (approximately US$1,600-8,000). In addition, the franchisee may terminate the franchise agreement if the franchisor provides any false information or conceals information that may affect the performance of the franchise agreement, thereby frustrating the purposes of the agreement.
In light of the above, a franchisor should require franchisees to sign an acknowledgment regarding the information disclosed by the franchisor, as well as a confidentiality agreement.
Thanks to the MOC's online franchise registration system, information about franchisors and their franchising business in China is available to the public. Where there are any illegal activities committed by the franchisor, any party can file a complaint on the MOC's franchise system or directly before competent commercial authorities, who will make a decision following an investigation.
To see the other articles in Wiley Rein's International Franchise Development Series, please click here.
Fairy Li is a Senior Attorney-at-Law at Beijing NTD Law Office, specializing in franchise registration, trademark prosecution and enforcement, and providing IP consulting services to both domestic and foreign corporations. Robert A. Smith is a Partner and Chair of the Franchise Group at Wiley Rein LLP. Kimberly L. Sikora Panza is Special Counsel at Wiley Rein LLP.