China: Franchise & Licensing

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This country-specific Q&A provides an overview to franchise and licensing laws and regulations that may occur in China.

It will cover pre-offer, registration and other requirements; ongoing relationships; renewals and terminations; and general considerations.

This Q&A is part of the global guide to Franchise & Licensing. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/franchise-and-licensing/

  1. Is there a legal definition of a franchise and, if so, what is it?

    Yes. There is a legal definition of “commercial franchise”.

    The term “commercial franchise” (hereafter “franchise”) shall refer to the arrangement whereby a franchisor, through the conclusion of a contract, authorizes a franchisee to use the business resources its owned such as the registered trademark, trade name, patent and business model and a franchisee conducts its business under a uniform business system in accordance with the provisions of the contract and pay the franchisor franchise fees/royalties.

  2. Are there any requirements that must be met prior to the offer and/or sale of a franchise? If so, please describe and include any potential consequences for failing to comply.

    Yes. There are three pre-conditions for offering a franchise, namely (1) any organisation and individual other than an enterprise are not qualified as a franchisor under the applicable PRC laws, (2) a franchisor must possess a matured business model and have the ability to provide continual operational guidance, technical support, business training, and other service support to the franchisee; and (3) a franchisor must operate at least two self-owned stores for more than one year (namely, “2+1 Rule”).

    Where a franchisor fails to satisfy the 2nd requirement before offering a franchise, the competent commerce administration authorities (Ministry of Commerce or its local branch, as the case maybe, hereinafter referred to as “Commerce Administration Authorities”) shall order the franchisor to make correction, confiscate the illegal income, impose a fine ranging from RMB100,000 to RMB500,000 and make a public announcement. Where any organisation or individual other than an enterprise engages in franchise operations in the capacity of a franchisor, the Commerce Administration Authorities shall order such organisation or individual to cease the illegal business activities, confiscate the illegal income and impose a fine ranging from RMB100,000 to RMB500,000.

  3. Are there any registration requirements for franchisors and/or franchisees? If so, please describe them and include any potential consequences for failing to comply. Is there an obligation to update existing registrations? If so, please describe.

    Yes. Franchisors are required to be registered (in other words, file for records) with the competent Commerce Administration Authorities (Ministry of Commerce or its local branch, as the case maybe) within fifteen days.

    Consequences for failure to comply with the registration requirements: the Commerce Administration Authorities shall order the franchisor to file for records within the stipulated period and impose a fine ranging from RMB10,000 to RMB50,000; where the franchisor fails to file records within the stipulated period, a fine ranging from RMB50,000 to RMB100,000 shall be imposed and a public announcement shall be made.

    Yes, in case of change in the company registration, business resources and franchise outlet locations in China, franchisors shall update existing registrations with the authorities. In addition, a franchisor shall report to the competent Commerce Administration Authorities the information of the execution, revocation, termination and renewal of the franchise contracts during the preceding year by 31 March each year.

  4. Are there any disclosure requirements (franchise specific or in general)? If so, please describe them (i.e. when and how must disclosure be made, is there a prescribed format, must it be in the local language, do they apply to sales to sub-franchisees) and include any potential consequences for failing to comply. Is there an obligation to update and/or repeat disclosure (for example in the event that the parties enter into an amendment to the franchise agreement or on renewal)?

    Yes. It is required that the franchisor shall provide the franchisee in writing with the following information at least 30 days before the execution of the franchise contract except where the franchisor and the franchisee renew the franchise contract under the same terms:

    1. basic information of the franchiser and franchise operation, including but not limited to basic information of filing by the franchisor, existing outlets and their address and phone numbers, information on bankruptcy or bankruptcy application of the franchisor or its related parties during the past two years.;
    2. basic information of business resources owned by the franchisor, including but not limited to text description of registered trademarks, corporate logos, patents, proprietary technologies and business model of the franchisor, as well as information on litigation or arbitration involving such business resources;
    3. types, amounts and methods of payment of franchise fees (including whether a security deposit is collected and its terms and methods of refund);
    4. prices and conditions for the products, services and equipment provided to the franchisee;
    5. specific contents of continual operational guidance, technical support, business training and other services to the franchisee and the method of provision and implementation plan thereof;
    6. specific measures on guidance and supervision of the franchisee's business activities;
    7. investment budget for a franchise operation network, including but not limited to franchise fee, training fee; real estate and fitting-out expenses; costs for equipment, office supplies, furniture and information sources and basis of estimation for the aforesaid expenses;
    8. quantity, geographical distribution, an evaluation of the business situation, etc. of existing franchisees in China;
    9. abstracts of the audited financial accounting reports and the auditor's report for the last two years;
    10. information on the legal and arbitration proceedings relating to franchise operations during the past five years, including cause of action, litigation (arbitration) request, jurisdiction and outcome;
    11. records of any major unlawful business operations the franchisor and its legal representative may have; and
    12. template of the franchise contract.

    In case of failure to disclose the information as required, the potential liabilities shall be that the administration of market regulation has the authority to order the franchisor to make correction and impose a fine ranging from RMB10,000 to RMB50,000; where the case is serious, a fine ranging from RMB50,000 to RMB100,000 shall be imposed and a public announcement shall be made.

    No prescribed format is required, neither is the language. However, in practice, the Chinese version is usually required to provide to the Chinese franchisees.

    There is a general requirement that where there is a significant change to the information provided by a franchisor to a franchisee, the franchisee must be notified promptly.

  5. If the franchisee intends to use a special purpose vehicle (SPV) to operate each franchised outlet, is it sufficient to make disclosure to the SPVs’ parent company or must disclosure be made to each individual SPV franchisee?

    It is required to make disclosure to the franchisee with whom the franchisor is to execute the franchise contract. In case of a framework contract between the SPVs’ parent company and franchisor and separate franchise contract between franchisor and SPVs, it may still be insufficient to make disclosure to the SPVs' parent company only since the parent company and the SPVs are legally separate entities even if they are related.

    It is required to make disclosure to the franchisee with whom the franchisor is to execute the franchise contract. In case of a framework contract between the SPVs’ parent company and franchisor and separate franchise contract between franchisor and SPVs, it may still be insufficient to make disclosure to the SPVs' parent company only since the parent company and the SPVs are legally separate entities even if they are related.

  6. What actions can a franchisee take in the event of mis-selling by the franchisor? Would these still be available if there was a disclaimer in the franchise agreement, disclosure document or sales material?

    There is no clear definition of mis-selling in the franchise legal framework. Where the so-called “mis-selling” due to concealing information by franchisor which affects the performance of the franchise contract or discloses false information and causes non-performance of the franchise contract, the franchisee may unilaterally terminate the franchise contract. The franchisee may report to the administration of market regulation and the franchisor may have the administrative punishment.

  7. Would it be legal to issue a franchise agreement on a non-negotiable, “take it or leave it” basis?

    This is an issue about the validity of standard clauses of a contract or “take it or leave it” clauses. Where such contract is concluded, the party proposing the standard clauses shall observe the principle of fairness in defining the rights and responsibilities of the parties, and the said party must take reasonable steps to draw the other party's particular attention to those clauses which eliminate or limit the said party’s liabilities, and must, where requested by the other party, explain the effect of the said clauses.

    The standard clauses will be invalid where any illegal intentions exist or the standard clauses are not compliant with any mandatory provisions of laws and administrative regulations. where the non-negotiable clause operates to exempt the liabilities of franchisor (such as personal injuries and property losses), or to increase the responsibilities of franchisee, or to exclude important rights enjoyed by franchisee, the said clause shall also be deemed as invalid clauses.

    In addition, where (1) the franchisor, through the use of fraudulent or coercive means or by taking advantage of the franchisee's difficulties, leads the franchisee to conclude a contract of standard clauses contrary to its true intentions, (2) the contract was concluded as a result of a serious misunderstanding, or (3) the contract was clearly unfair at the time it was concluded, the franchisee has the right to request that the people's court or an arbitration commission alters or nullifies the said contract.

  8. How are trademarks, know-how, trade secrets and copyright protected in your country?

    In general, trademarks and copyrights are protected in accordance with the Trademark Law and Copyright Law, which follow the TRIPs since China is a contracting country. Know-how and trade secrets are protected under the Anti-unfair Competition Law. Where a violation of the laws constitutes an administrative or criminal offence, administrative or criminal liability shall be pursued.

  9. Are there any franchise specific laws governing the ongoing relationship between franchisor and franchisee? If so, please describe them, including any terms that are required to be included within the franchise agreement.

    Yes, certain clauses of the Regulations on Commercial Franchise Operations (2007), the Administrative Measures on Filing of Commercial Franchise (2011) and the Measures on Information Disclosure of Commercial Franchise (2012) govern the ongoing relationship between franchisor and franchisee. For example, (1) the franchisor and franchisee shall include as a term of the franchise contract, the ability of the franchisee to terminate the contract unilaterally upon the lapse of a fixed term after the franchise contract is concluded; (2) the franchisor shall provide the franchisee with an operating manual for franchise operations and provide continual operational guidance, technical support, business training and other support services to the franchisee pursuant to the agreed contents and methods; (3) where a franchisor collects advertising and promotion expenses from a franchisee, the franchisor shall use the funds collected pursuant to the stipulated uses under the contract.

  10. Are there any aspects of competition law that apply to the franchise transaction (i.e. is it permissible to prohibit online sales, insist on exclusive supply or fix retail prices)? If applicable, provide an overview of the relevant competition laws.

    Yes, the Anti-unfair Competition Law and the Anti-monopoly Law apply to the franchise transaction mainly in the following aspects: (1) false advertisement, (2) commercial bribery, (3) infringement of commercial secret, (4) monopoly agreements such as fixing or altering prices of commodities and dividing sale market or procurement market of raw materials, and (5) abuse dominant market position to sell commodities at below-cost prices without a valid reason, and bundle sale of commodities without a valid reason or imposition of any other unreasonable terms of transaction during a transaction.

  11. Are in-term and post-term non-compete and non-solicitation clauses enforceable?

    The non-compete and non-solicitation clauses executed between the franchisor and franchisee are enforceable provided that the liabilities and actions are provided in a concrete manner.

  12. Are there any consumer protection laws that are relevant to franchising? Are there any circumstances in which franchisees would be treated as consumers?

    When selling goods or service to customers, the franchisee shall comply with the Law of the Protection of Rights and Interests of Consumers, Cyber-security Law and other related laws and regulations relating to customer protection and collection, disclosure, use and protection of personal information and data, etc.

    There is no legal definition of a “consumer” under the PRC laws. According to the Law of the Protection of Rights and Interests of Consumers, the rights and interests of consumers who purchase and use goods or receive services for life consumption needs will be protected by the Law of the Protection of Rights and Interests of Consumers. Considering the franchisee purchases goods or services from the franchisor for the purpose of business operation rather than life consumption, generally speaking, the franchisee would not be treated as consumer.

  13. Is there an obligation (express or implied) to deal in good faith in franchise relationships?

    Yes. It is also provided that the principles of voluntariness fairness, honesty and trustworthiness must be observed in any engagement of franchise operations.

  14. Are there any employment or labour law considerations that are relevant to the franchise relationship? Is there a risk that the staff of the franchisee could be deemed to be the employees of the franchisor? What steps can be taken to mitigate this risk?

    No. The franchisor and franchisee are two separate entity. Legally speaking, unless otherwise arranged, the employees of the franchisee are not the employees of the franchisor, and vice versa.

  15. Is there a risk that a franchisee could be deemed to be the commercial agent of the franchisor? What steps can be taken to mitigate this risk?

    Usually, it is provided that the franchisee shall advertise itself as a franchisee of the franchisor instead of an agent or representative of the franchisor, and that the franchisee shall be responsible for its own management decisions, profits and losses.

  16. Are there any laws and regulations that affect the nature and payment of royalties to a foreign franchisor and/or how much interest can be charged?

    It is provided by the Supreme Court of PRC that if the interest is not provided in the agreement, the creditor can charge the interest at the lending rate of the people's bank of China in the same period.

  17. Is it possible to impose contractual penalties on franchisees for breaches of restrictive covenants etc.? If so, what requirements must be met in order for such penalties to be enforceable?

    Yes. The parties have the right to apply for adjustment of the amount of penalties agreed in the contract by asserting that the penalties are too high or too low. Where a party claims to increase the penalties, it shall prove the actual losses it has suffered and the increased penalties shall not exceed the actual losses it has suffered. Where a party claims to decrease the penalties, the court will rule on the basis of the actual losses, taking into consideration comprehensive factors such as the performance of the contract, the extent of culpability of the relevant party, and the anticipated benefits etc., and adjust in accordance with the principles of justice and integrity and good faith. Where the penalties agreed exceeds the actual losses by 30%, then in general it may be found that the penalties are “excessively higher than the actual losses”.

  18. What tax considerations are relevant to franchisors and franchisees? Are franchise royalties subject to withholding tax?

    The value-added-tax is applied to franchise royalties and prices of goods paid by the franchisee to the franchisor. The franchise royalties and prices of goods shall be the taxable income of the franchisor. When the franchisee pays royalties or other related service fees to any franchisor or third party registered outside mainland China, the payment will also be subject to withholding tax in China.

  19. Does a franchisee have a right to request a renewal on expiration of the initial term? In what circumstances can a franchisor refuse to renew a franchise agreement? If the franchise agreement is not renewed or it if it terminates or expires, is the franchisee entitled to compensation? If so, under what circumstances and how is the compensation payment calculated?

    The franchisee may request so provided that such right is agreed by the parties. There are no mandatory requirements for the franchisor in refusing to renew the franchise agreement, and the circumstances depend fully upon agreed terms by the parties. The franchisor can even not give the franchisee the right of renewal on expiration of the initial term. The franchisee shall be entitled to compensation provided that such compensation clause is properly stipulated in the agreement which has been satisfied when the agreement is not renewed or terminates or expires, and this means the franchisee will not automatically be entitled compensation where there is no clear provision when the agreement is terminated. The circumstances and method in compensation payment also depends on the agreed terms by the parties, and there is no mandatory laws or guideline yet in China.

  20. Are there any mandatory termination rights which may override any contractual termination rights? Is there a minimum notice period that the parties must adhere to?

    Yes. For example, the franchisee has the right to unilaterally terminate the agreement upon the lapses of a fixed term after the agreement is concluded, and the franchisee may terminate the franchise agreement where the franchisor has concealed any relevant information or provided false information. There is no mandatory minimum notice period for the parties.

  21. Are there any intangible assets in the franchisee’s business which the franchisee can claim ownership of on expiry or termination, e.g. customer data, local goodwill, etc.

    There is no mandatory laws or regulations in China stipulating the ownership of the intangible assets (including customer data and local goodwill) on expiry or termination of the franchise agreement , and the ownership of such assets in the franchisor’s business shall not automatically be transferred to the franchisee where no such assets transfer or assignment arrangement is agreed upon by the parties in the franchise agreement.

  22. Is there a national franchising association? Is membership required? If not, is membership commercially advisable? What are the additional obligations of the national franchising association?

    Yes, e.g. China Chain Store & Franchise Association (CCFA). Yes, membership is required and online application need to be approved. CCFA shall publish the industry standards (e.g. specifications/economic/management standard) based on its market analysis and investigation, make industry regulations and guidelines for the specific industry, update the association journals, websites and books for members, and conduct various industry related activities, etc.

  23. Are foreign franchisors treated differently to domestic franchisors?

    Generally, there is no difference in treating foreign franchisors and domestic franchisors according to the existing laws and regulations, but tax burdens shall be different. For example, in terms of corporate income tax, the withholding tax rate for the foreign franchisors which has no office or premises established in China or the income derived or accrued without de facto relationship with the office or premises established, shall be 10% in general cases, and the corporate income tax for the domestic franchisors shall be 25% usually.

  24. Are there any requirements for payments in connection with the franchise agreement to be made in the local currency?

    It depends on whether cross-border payment is involved. The payment currency shall be local currency only if made to the domestic franchisor, In the event that the franchisor is foreign company and cross-border payment is necessary, the franchisee may purchase relevant foreign currency in compliance with the PRC foreign exchange laws and regulations, and then make payments for the agreed franchise fees, royalty fees, commodities purchase fees, etc.

  25. Must the franchise agreement be governed by local law?

    No, unless there are purely domestic factors For instance, if both parties are domestic companies (including FIE), but they choose to be governed by foreign law as agreed in the franchise agreement, such clause shall be invalid since it will be decided that the application of law in this case has no connection point with the foreign law.

  26. What dispute resolution procedures are available to franchisors and franchisees? Are there any advantages to out of court procedures such as arbitration, in particular if the franchise agreement is subject to a foreign governing law?

    Reconciliation, mediation, arbitration and litigation. Usually, most arbitration proceedings and decisions are kept completely confidential.

  27. Does local law allow class actions by multiple franchisees?

    There is no mandatory restriction upon class actions by multiple franchisees.

  28. Must the franchise agreement and disclosure documents be in the local language?

    The franchise agreement can be executed in a different language, and the disclosure information provided to the franchisee can also be different from Chinese (if the franchisee agrees so), however, the Chinese translation version of the filing documents (including franchise agreement) submitted with the Commerce Administration Authorities must be provided.

  29. Is it possible to sign the franchise agreement using an electronic signature (rather than a wet ink signature)?

    Yes. The electronic signature in compliance with the legitimate form signed by parties in franchise agreement is legally recognized under the laws in China.

    According to Article 13 of the Electronic Signature Law of the People's Republic of China (“ESL”), an electronic signature shall be deemed as reliable electronic signature if it satisfies all the following criteria: (1) when the electronic signature creation data is used for electronic signature, it is exclusively proprietary to the electronic signatory; (2) the electronic signature creation data is exclusively controlled by the electronic signatory at the time of signing; (3) any subsequent alteration to the electronic signature after the signature can be detectable; and (4) any subsequent alteration to the content and form of the data message after the signature can be detectable.

  30. Can franchise agreements be stored electronically and the paper version be destroyed?

    Yes, in the event that the franchise agreements are validly signed electronically. However, the electronic signatures need to comply with the legitimate form as stipulated in the relevant PRC laws and regulations.

    According to Article 13 of the Electronic Signature Law of the People's Republic of China (“ESL”), an electronic signature shall be deemed as reliable electronic signature if it satisfies all the following criteria: (1) when the electronic signature creation data is used for electronic signature, it is exclusively proprietary to the electronic signatory; (2) the electronic signature creation data is exclusively controlled by the electronic signatory at the time of signing; (3) any subsequent alteration to the electronic signature after the signature can be detectable; and (4) any subsequent alteration to the content and form of the data message after the signature can be detectable.

  31. Please provide a brief overview of current legal developments in your country that are likely to have an impact on franchising in your country.

    In terms of the market access, foreign franchisors are obligated to comply with the restrictions on foreign investment set out in the foreign investment industry guidance catalogue. As the new foreign Investment Law shall take effect in 2020, which is a landmark legislation with the aim of improving the business environment for foreign investors and ensure that foreign invested enterprises participate in market competition on an equal basis, the China’s franchising market will also enter into a new era. The current disclosure and filing requirements under PRC franchise laws are becoming more complete and enforceable. Besides, more specific industry rules shall come out through detailed acts and administrative regulations.