China's New Franchising Regime

Now, however, it is no longer a requirement that the "two directly operated outlets" be in mainland China; furthermore, the Filing Rules explicitly state that the two stores may be located outside of China. Also, amnesty treatment is offered under the new law to franchisors selling and operating franchises in mainland China before May 1 2007, no matter whether they complied with the "2+1 Rule" or not.

Another relaxation in favour of the franchisors under the new law is that, unlike under the MOFCOM Measures, the franchisor is not now required to bear joint and several liability for the quality of products provided by its designated suppliers. This means that the Franchise Regulations recognize the independent relationship between the franchisor and the suppliers that it designates to the franchisee.

The new law also imposes a filing requirement on franchisors. A franchisor must file a record with MOFCOM or its provincial level counterparts (depending upon whether the franchising takes place in more than one province) within 15 days of the execution of the initial franchise contract. "Filing" in theory means that the government should grant the filing as long as the documents submitted by the franchisor are complete and true.

On the other hand, the new law also provides some one-sided protection to the franchisees. For example, the new law requires that the franchisor and the franchisee stipulate a certain time period in the franchise agreement during which the franchisee can unilaterally rescind the franchise agreement. The law is silent on how long such a period must be, however.

Another example of the protection to franchisee is the disclosure requirements. While the disclosure obligations under the new law are substantially similar to the MOFCOM Measures, the new law imposes some new obligations, for example the opportunity for the franchisee to rescind the franchise contract if the franchisor conceals relevant information or provides false information. The new law also explicitly prohibits a franchisor from disclosing the revenues earned by its franchisees in advertisements. The timeframe for disclosure is also moved to an earlier stage, i.e., 30 days (vis a vis 20 days under the MOFCOM Measures) before the franchise agreement is signed.

THE FILING RULES

The Filing Rules mainly address the requirements and formalities for franchisors to make a "franchise filing" with MOFCOM. A franchisor is required to file with MOFCOM or its provincial level counterpart. The filing should be made within 15 days after the initial franchise agreement is signed; or, for franchisors which began franchising in China before May 1 2007, they can perform the filing before May 1 2008. Failure to file will lead to such consequences as being ordered to rectify within a certain time period, monetary sanctions up to an amount of Rmb100,000 (approximately US$13,000), and/or publicly circulated official criticism.

For the purpose of filing, a franchisor needs to submit the following

documents to the government authority:

i) basic information of the franchisor's franchise business;

ii) the locations of all the franchisees' stores in mainland China;

iii) the market plan of the franchisor;

iv) a photocopy of the franchisor's business license, or if the franchisor is a foreign company, it should be a copy of its certification of incorporation or a similar type of document;

v) photocopies of the registration certificate(s) of the trademark(s), patent, and other operation resources that are relevant to the concerned franchise activities;

vi) samples of the franchise agreement;

vii) table of contents of the franchise operation manual (the pages of each chapter and the total pages of the whole manual should be noted; where such manual is provided on the internal website of the franchise system, the approximate number of print-out pages should be noted);

viii) an undertaking signed by the legal representative or authorized representative of the franchisor in which the franchisor undertakes that it will abide by the franchise laws of China, and submit all of the documents and materials in relation to its operation in a timely manner;

ix) if the franchisor started its franchise business in China before May 1 2007, it must provide the franchise agreement that it signed with its franchisee before May 1 2007. Otherwise, it must provide documents to evidence that it has two outlets that have operated under the franchise brands for at least one year. If the outlets are within China, the evidential document should be the one issued by MOFCOM or its local counterpart at the place where the outlets are located; if the outlets are outside mainland China, the franchisor should provide documents which evidence the operation of such outlets and such documents should be consularized by the Chinese embassy or consulate of the concerned foreign country.

So long as the franchisor submits all the required documents, the registration should be granted within 10 days, and it remains effective indefinitely. MOFCOM will publicize the relevant filing of a franchisor on its official website, upon its acceptance of the filing by the relevant franchisor.

The filing may be revoked by MOFCOM (or its provincial level counterpart) under certain circumstances stipulated by the Filing Rules, including two basic situations. One is that the franchisor loses its legal capacity to operate as a franchisor (if, for example, its business license is revoked by the government, or judicial institutions suggest that MOFCOM revoke the filing as a result of the illegal operation of the franchisor, or the franchisor applies to discontinue its existence). The other is that the franchisor concealed relevant information upon filing with MOFCOM (or its provincial level of counterpart), or the information that it filed turns out to be false upon verification.

The franchisor is obliged to update MOFCOM or its provincial-level counterpart of the status of its franchise agreements on an annual basis, reporting by March 31 of every year, specifically, how many franchise agreements were signed, rescinded, extended or amended in the preceding year. Additionally, if there are any changes to the filed information, the franchisor should update MOFCOM (or its provincial level counterpart) within 30 days.

THE DISCLOSURE RULES

The Disclosure Rules set out detailed disclosure requirements that a franchisor must follow.

At least 30 days before the franchise agreement is signed, the franchisor must provide the following 12 types of information to the prospective franchisee:

i) basic information on the franchisor and the franchise activities;

ii) basic information on the franchisor's operational resources;

iii) basic information regarding franchise fees;

iv) prices and conditions of products, services and equipment to be supplied to the franchisee;

v) continuous services to be provided to the franchisee;

vi) specific methods and details of guidance and supervision of franchisee's operation;

vii) investment estimate of franchise stores/outlets;

viii) relevant information of the franchisee(s) within China;

ix) abstract of financial accounting reports and abstract of auditing reports of the past two years that have been audited by an accounting firm or an auditing firm;

x) any material litigation and arbitration in the past five years related to the franchise activities;

xi) record(s) of material illegal operation of the franchisor or its legal representative (a record of material illegal operation refers to (1) the imposition of a fine by the relevant authority in charge of administrative enforcement of law in an amount no less than Rmb300,000 and no more than Rmb500,000; and (2) the imposition of criminal liability); and xii) franchise contract text.

In some instances, the Disclosure Rules specify the reach of the Franchise Regulations by limiting disclosure to information that is within China or meets certain materiality standards.

Those familiar with the disclosure requirements under US franchise laws will find many of the requirements quite acceptable.

OUTSTANDING QUESTIONS

The new legal regime for franchising has clarified some issues, for example that the new regime governs cross-border franchise business, while on the other hand, it does not address all outstanding questions. For example, will a franchisor be able to satisfy the "2+1 Rule" requirement based on operations owned by its affiliates? Does an FIE franchisor have to have franchise business included in its "business scope"?

On the other hand, this new legal regime does provide a solid legal framework for foreign franchisors selling franchises in China. The message is clear - the time is right for international franchisors to enter mainland China.

About the Authors

Janet Jie Tang is a partner and Lu Ning is a senior associate at the Beijing office of DLA Piper UK LLP. The authors have represented the International Franchise Association, together with Phillip Zeidman, a partner of DLA Piper US office, to work with the Chinese government in relaxing the franchise regulations. This article reflects the views of the authors only and does not reflect the views of DLA Piper UK LLP. The authors would like to thank Edward Hillier for his assistance in preparing this article.