Further On Down the Road: New Guidance on the Operation of Petrol Stations

The OpinionS

In accordance with the spirit of the Circular, the State Economic and Trade Commission issued the Regulating Petrol Station Franchise Several Opinions (the Opinions) on August 26 2002 as a further step to regulate and improve downstream petroleum activities in the PRC. The Opinions set out the terms and conditions that govern the relationship between specially licensed petroleum companies in various provinces, autonomous regions and municipalities (the Special Licensors) and their local licensees. While the Opinions, in a nod towards the PRC Contract Law (中华人民共和国合同法), exhort Special Licensors and licensees to memorialize their relationship in a written agreement, they also set out rights and obligations that are enforceable as a matter of administrative law.

The annex to the Opinions sets out a list of 66 subsidiaries (Local Licensors) of PetroChina and Sinopec that are specifically authorized to enter into licence agreements with local enterprises in their respective geographical areas and within the scope of activities authorized by their parent companies. The Opinions restate several existing regulatory requirements. For instance, Local Licensors are obliged to supply licensees with finished petroleum products that comply with national standards. They are also to provide materials regarding the operation of petrol stations in accordance with the standards of their parent companies along with technical guidance, training, sales support and other related services so as to ensure that their licensees provide unified and coherent services to their consumers.

The Opinions state that licensees must comply with local development plans for the petrol service business as well as with national environmental, fire prevention and construction standards. Licensees must have "definite", but as yet unspecified, administrative abilities and creditworthiness for the operation of petrol stations, along with an operational record that is free from violations of any regulations for the preceding two years.

The licensees are further required to comply with their respective Special Licensor's policies and plans for the "conscious" maintenance of a unified system of petrol stations. In this regard, they are prohibited from retailing the petroleum products of third parties, independently developing sales activities without coordination from the Local Licensor, engaging in any activities that are not included in their license agreement contract with the Special Licensors or assigning their rights without authorization.

The Opinions anticipate that the Special Licensors will use adhesion contracts. The Special Licensor is to send a sample copy of its standard agreement to the licensee no less than 10 days before the "formal signing" of the contract. The Opinions identify 10 clauses that must be included in the licence agreement: the content, scope, term, territory and exclusivity of the licence rights; generic rights and obligations of the parties; standards for the calculation of fees and payment terms; confidentiality; insurance; safety standards; liability for breach; amendments, extensions and expiration; notification and advertisements; and any other items agreed to by the parties. In those uncommon situations where a licensee attempts to negotiate additional terms to clarify the relationship between the parties, it is likely that such terms will be effected by way of an annex attached to the agreement rather than through a revision of the adhesion contract itself.

The licence agreement must be written in Chinese, a statement that perhaps reflects the fact that some of the Local Licensors are located in Tibet, Xinjiang and other regions where minority languages are widely spoken. The Opinions do not preclude a licence agreement from being written in other languages, which may be important once the downstream petroleum sector is open to foreign investment.

In addition to the sample copy of its contract, a Local Licensor must disclose the following information to the potential licensee in accordance with Article 10 of the Opinions:

• its formal name, registered capital, address, scope of business and financial information as confirmed by an accounting firm;
• the quantity, distribution area and actual circumstances for the licence agreement as well as the minimum sales level for the licence agreement and conditions triggering the termination of the agreement;
• information about the registration of trademarks, logos and other registered licence rights that can be licensed to third parties; circumstances about third party use and litigation; circumstances regarding its operational technology and service standards;
• payment terms, calculation of fees and the return of deposits;
• information about disputes and ongoing litigation;
• terms and restrictions governing petroleum products and services; and
• proof of its ability to train and supervise licensees.

Article 11 of the Opinions stipulates that licensees are obliged to supply information requested by the Local Licensor, presumably within the same 10-day period before signing. Such information may encompass proof of legal qualifications to operate a petrol station, such as those from the authorities governing local planning, fire prevention, environmental issues and taxation, a copy of Approval Certificate for Business of Retailing Finished Petroleum Products, and proof of creditworthiness and property rights.

The Opinions identify three sets of fees to be paid to the Local Licensor by the licensee: (a) a one-time admission fee for the acquisition of license rights; (b) a use fee paid during the term of the licence agreement calculated in accordance with a definite standard or ratio; and (c) stipulated fees for other products or services provided to consumers by the licensee. The Opinions do not flesh out payment procedures or the calculation of the foregoing fees, thus leaving potential licensees to face the risk of collaboration among regional franchisers in setting rigid fee structures.

The Local Licensors and licensees are to provide copies of all relevant authorizations to the local counterparts of the State Economic and Trade Commission before they begin to develop petrol station operations in their respective areas. The following information should also be supplied at that time:

• information disclosed to licensee under Article 10 of the Opinions;
• a copy of the licence agreement;
• a copy of the operational handbook for petrol stations;
• recently audited financial reports;
• approval certificates acquired by the licensee; and
• other materials required by the provincial counterpart of the State Economic and Trade Commission.

The Opinions also forbid Local Licensors from directly developing and operating petrol stations with entities that do not possess the qualifications of a licensee, and from engaging in any activity that violates national policies concerning the distribution of finished petrol products.

The local counterpart of the State Economic and Trade Commission can revoke a licensee's Approval Certificate for Business of Retailing Finished Petroleum Products in the following circumstances:

• the operation of petrol stations with the unauthorized use of a Local Licensor's trademark, trade name or logo, including marks that are substantially similar to or easily confused with a Local Licensor's marks;
• the use of a Local Licensor's marks after the expiration of the licence agreement;
• the sale of the finished petroleum products of a third party, the unauthorized increase of petroleum prices or participation in other activities outside the scope of its licensed activities;
• the assignment of rights without the agreement of the Local Licensor;
• any failure to implement safety standards; or
• other activities that violate state policies governing the distribution of finished petroleum products.

PetroChina and Sinopec are instructed to create an administrative system that will implement the objectives of the Opinions.

Significance for Foreign Investors

Traditionally, the central government has stringently regulated foreign investment in downstream petroleum activities. With very few exceptions, a Sino-foreign joint venture petrol station could only be established, on the basis of central government approval, in one of the four Special Economic Zones or in Hainan province.

Under the terms of China's accession to the World Trade Organization, foreign service suppliers will be permitted to engage in the retailing of finished petroleum products within three years of China's accession; i.e., December 11 2004. The Annex to the Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录) , promulgated on March 11 2002, indicates that upon liberalization, a foreign investor may have a majority interest in petrol stations so long as the joint venture has no more than 30 outlets. Clearly, for most foreign petroleum companies, 30 outlets are too few, and it remains to be seen whether the old game of multiple offshore investment vehicles will solve this problem.

More importantly, both the Circular and the Opinions reflect the desire of the central government to build up the downstream petroleum sector before the arrival of foreign competitors. Given that the terms of the WTO accession afford PetroChina and Sinopec as well as their subsidiaries another two years for development and refinement, foreign petroleum companies may find that potential Chinese joint venture partners have already made considerable inroads in areas such as technology and management expertise. Accordingly, foreign petroleum companies will need to tailor their expectations and strengthen their resources for entering a more mature market when liberalization of the industry takes place.