Franchising is the practice of the right to use a firm's business model and brand for a prescribed period of time. The word "franchise" is of Anglo-French derivation—from franc, meaning free — and is used both as a noun and as a (transitive) verb. For the franchisor, the franchise is an alternative to building "chain stores" to distribute goods that avoids the investments and liability of a chain. The franchisor's success depends on the success of the franchisees. The franchisee is said to have a greater incentive than a direct employee because they have a direct stake in the business.
1) 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).
2) Eligible Franchisor
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.
3) Franchise Registration
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).
4) Disclosure
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).
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. 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.
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