August 15, 2022

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Q&A: provide and sale of franchises in China

Q&A: provide and sale of franchises in China

Q&A: provide and sale of franchises in China

Supply and sale of franchises

Authorized definition

What’s the authorized definition of a franchise?

The Industrial Franchise Administration Regulation (the Franchise Regulation) defines a franchise as an association through which:

  • the franchisor by way of an settlement grants a franchisee the proper to make use of the franchisor’s enterprise working assets, together with registered emblems, logos, patents and proprietary applied sciences; 
  • the franchisee conducts enterprise beneath a uniform mode of operation; and
  • the franchisee pays franchise charges in keeping with the settlement.

 

The Chinese language definition of a franchise is sort of broad. The Chinese language time period for franchising consists of each enterprise format franchises (as in america) and product distribution preparations. Additional, licensing of non-trademark mental property rights – comparable to a commerce secret or patented know-how – can even fall beneath the definition of a franchise if a charge is paid and the licensee conducts enterprise beneath a uniform mode of operation.

Legal guidelines and businesses

What legal guidelines and authorities businesses regulate the provide and sale of franchises?

The Folks’s Republic of China (PRC) (excluding Hong Kong and Macao) is a civil regulation jurisdiction, closely primarily based on the German mannequin. All contracts within the PRC should conform to the final ideas set out within the Civil Code. Franchise relationships are ruled by the next rules and administrative measures: 

 

The Ministry of Commerce (MOFCOM) is the federal government physique that enforces franchise rules.

Different legal guidelines that will have an effect on franchisors embrace:

 

Principal necessities

What are the principal necessities governing the provide and sale of franchises beneath the related legal guidelines?

Beneath the Franchise Regulation, franchisors should meet sure eligibility necessities, provide pre-sale disclosure and adjust to obligatory content material necessities for franchise agreements. Franchise agreements should embrace, amongst others:

  • provisions concerning charges;
  • the time period of the settlement and the character of the franchise enterprise;
  • the requirements of operation;
  • particulars of the help and coaching offered by the franchisor;
  • the requirements of high quality of the services or products and high quality ensures;
  • the safety of client rights;
  • the allocation of legal responsibility for client rights violations between the franchisor and franchisee;
  • provisions concerning the promotion and promoting of the services or products; and
  • provisions concerning modification, cancellation and termination of the franchise settlement.

 

There is no such thing as a requirement to register a franchise settlement or franchise disclosure doc. Nevertheless, franchisors are required by regulation to register with MOFCOM or native MOFCOM departments inside 15 days of the primary franchise settlement being signed. The record of paperwork required for registration with MOFCOM normally consists of, however is just not restricted to:

  • the franchisor’s customary type of franchise settlement;
  • the franchise settlement signed with the primary franchisee in China;
  • the company registration certificates;
  • the market plan;
  • registration certificates for emblems or copyright (eg, emblem) used within the franchise system; and
  • proof of compliance with Article 7(2) of the Franchise Regulation (the two+1 Rule).

 

All paperwork should be translated into Chinese language. Paperwork which might be ready overseas should be notarised and both legalised on the Chinese language embassy within the nation of origin or licensed in keeping with the Hague Conference on Abolishing the Requirement of Legalisation for International Public Paperwork.

Worldwide franchisors ought to register with MOFCOM’s head workplace in Beijing, reasonably than with native MOFCOM departments. The franchisor ought to register any modifications within the info submitted to MOFCOM inside 30 days of that change happening.

Franchisor eligibility

Should franchisors fulfill any eligibility necessities so as to provide franchises? Are there any associated sensible points or tips that franchisors ought to think about earlier than providing franchises?

All franchisors in China will need to have a mature enterprise mannequin and display compliance with the necessities of article 7 of the Franchise Regulation. The two+1 Rule contained on this article requires {that a} franchisor will need to have owned and operated at the least two shops for at the least one 12 months. In accordance with the apply developed by MOFCOM officers, the shops could also be owned and operated by the franchisor’s subsidiaries or, in some circumstances, different associates; the shops might also be positioned exterior China if they’re operated beneath the identical franchise model. If the shops are positioned exterior China, franchisors could use statements issued by commerce organisations (eg, the Worldwide Franchise Affiliation) to indicate compliance with the two+1 Rule. Chinese language courts usually agree that it’s doable to have a mature system with out complying with the two+1 Rule, which in apply signifies that the franchise settlement can be legitimate (assuming non-compliance with the two+1 Rule is correctly disclosed), however registering with MOFCOM can be problematic.

Franchisee and provider choice

Are there any authorized restrictions or necessities regarding the way through which a franchisor recruits franchisees or selects its or its franchisees’ suppliers? What sensible issues are related when choosing franchisees and suppliers?

There are not any such rules particularly concentrating on franchising.

Pre-contractual disclosure – procedures and formalities

What procedures and formalities for pre-contractual disclosure are required or suggested in your jurisdiction? How typically should the disclosures be up to date?

Franchisors ought to present potential franchisees with a franchise disclosure doc at the least 30 days earlier than signing the franchise settlement. There is no such thing as a prescribed format; franchisors could select to comply with the format of the disclosure paperwork ready for different jurisdictions or comply with the order set out in article 5 of the Data Disclosure Measures. There is no such thing as a requirement to register a franchise settlement or franchise disclosure doc; nevertheless, franchisors ought to register with MOFCOM inside 15 days of the primary franchise settlement being signed.

There is no such thing as a obligation to make persevering with disclosure, however disclosure should be up to date earlier than signing the franchise settlement if there’s a vital change within the info offered by the franchisor.

Pre-sale disclosure to sub-franchisees

Within the case of a sub-franchising construction, who should make pre-sale disclosures to sub-franchisees? If the sub-franchisor should present disclosure, what should be disclosed in regards to the franchisor and the contractual or different relationship between the franchisor and the sub-franchisor?

The duty to supply pre-sale disclosure to the sub-franchisee rests with the sub-franchisor. 

Following the precept of excellent religion in negotiating and performing contracts, the sub-franchisor ought to disclose all materials details concerning the franchisor and the connection between the franchisor and sub-franchisor, for instance:

  • the possession of any mental property rights used within the franchise system;
  • the time period of the grasp franchise settlement;
  • if the franchisor is the provider of merchandise, providers or gear, the phrases and circumstances of the provision association;
  • an outline of providers (coaching, advertising and marketing, operational assist) offered by the franchisor, if any, and franchisor’s oversight rights; and
  • an outline of lawsuits and arbitral proceedings associated to the franchise system.

 

Due diligence

What due diligence ought to each the franchisor and the franchisee undertake earlier than getting into a franchise relationship?

Conducting due diligence on a potential franchisee is a necessary step in a franchise transaction in China. In main city centres, a variety of details about an organization could be obtained on-line (in Chinese language), together with:

  • its shareholders;
  • its registered capital;
  • its administration;
  • its associates; and
  • any previous litigation.

 

On the very least, a franchisor ought to begin by acquiring a duplicate of the person’s passport or id card. If the possible franchisee is a home firm, the franchisor’s legal professionals ought to acquire a duplicate of the enterprise licence. Enterprise licences disclose the Chinese language character identify of the company that should be used within the contract (even when the contract is in English) to make sure that the contract could also be enforced towards the franchisee. The enterprise licence additionally discloses the identify of the authorized consultant, who’s the one one who can signal for the corporate except she or he points an influence of legal professional to a different particular person to signal the settlement.

Alternatively, it is usually advisable for the potential franchisee to conduct needed due diligence checks on the franchisor and the franchise enterprise. Along with the franchise disclosure doc offered by the franchisor to the potential franchisee, the potential franchisee ought to think about checking the standing of the franchisor firm and its franchise enterprise, previous and ongoing litigations and administrative penalties and the standing of its operational assets, comparable to emblems.

Failure to reveal – enforcement and cures

What actions could franchisees or any related authorities businesses absorb response to a franchisor’s failure to make required disclosures? What authorized cures can be found? What penalties could apply?

MOFCOM has the authority to cost an administrative penalty of as much as 100,000 yuan for failure to adjust to disclosure obligations, however hardly ever workouts this authority.

If a franchisor conceals related info, fails to supply disclosure or offers false info, the franchisee could rescind the franchise settlement. 

Damages could be claimed beneath the Civil Code; nevertheless, damages awards are usually low in franchise circumstances.

Basic authorized ideas and codes of conduct

Along with any legal guidelines or authorities businesses that particularly regulate providing and promoting franchises, what normal ideas of regulation have an effect on the provide and sale of franchises? What trade codes of conduct could have an effect on the provide and sale of franchises?

The regulation within the PRC relies on the precept of excellent religion in negotiating and performing contracts (culpa in contrahendo), which is the other of the widespread regulation doctrine of caveat emptor (‘purchaser beware’). Additional, article 500 of the Civil Code prohibits a celebration from deliberately concealing key details regarding contract creation. These provisions assist the pre-sale disclosure obligation (together with all materials details disclosure) and the duty to carry out a franchise settlement in good religion, which is a part of PRC regulation.

Fraudulent sale

What actions could franchisees take if a franchisor engages in fraudulent or misleading practices in reference to the provide and sale of franchises?

Franchisees can apply to court docket to revoke a franchise settlement that was concluded on account of fraud or complain to the authorities of fraud. Article 224 of the Legal Regulation offers a particular cost for fraud in reference to contracts.