New Franchise Regulations in China

Transcription

1 APRIL 22, 2005 New Franchise Regulations in China All currently existing and future franchisors, franchisees, and franchises in China are directly affected by new regulations. The Measures for the Administration of Commercial Franchise became effective in the People s Republic of China on February 1, 2005, replacing the franchise regulations that had been governing franchises since The new Measures apply to commercial franchises in China, which are business activities with the hallmarks of (a) a franchise agreement, (b) a trademark license, (c) the payment of royalties, and (d) an obligation to conform to the franchisor s uniform system. The Measures do not provide for a transition period, so they apply to all franchises currently operating in China. The new regulations have a number of major implications, particularly for foreign franchisors seeking to commence or continue franchise operations in China. The more unusual and/or onerous provisions are: the franchisor (or its subsidiary) must have operated at least two company-owned franchises in China for more than twelve months; foreign franchisors must register and obtain approval by the Chinese governmental regulator as a pre-requisite to franchising; full disclosure about the franchised business must be made twenty days before execution of an agreement; the franchisor must disclosure any information requested by the franchisee (both pre-sale and during the term of the franchise agreement); the franchisor will be liable for certain actions of its suppliers; the franchise agreement must have a minimum three-year term; the franchisor has annual reporting requirements; and monetary and other penalties apply for infractions of the regulations. 1 of 6

2 Pre-qualifications for Franchisors Before a foreign-invested enterprise ( FIE ) starts franchising in China, it must meet a long list of requirements. First, the FIE must be registered with the relevant Chinese governmental authorities to conduct business in China. It must then obtain additional approvals to engage in franchising. To obtain approval, documents to be submitted include: a copy of the standard franchise agreement and the operations manual; copies of the business license and registration approval; amendments to the FIE s contract or articles of incorporation; and documents showing the FIE s compliance with the requirements in the Measures. The franchisor will be notified of the registration agency s decision to grant or refuse approval within thirty days of receipt of all the application materials. Additional pre-requisites to franchising for the FIE include: the FIE or a subsidiary must have a track record of directly operating at least two company-owned units in China for more than twelve months; the FIE must have the right to grant the use of trademarks and a system to others (although it is unclear whether this means that the franchisor must have its trademark or service mark registered before it grants franchises in China); the FIE must have the capability to provide long-term operational guidance and training; if the FIE will supply goods to its franchisees, it must be able to supply an ample quantity of quality goods and related services; the FIE must have no prior record of fraudulent franchising activities; and the FIE must have a good reputation. Disclosure Obligations Once properly approved to franchise in China, franchisors face pre-sale and on-going disclosure obligations. Twenty days prior to signing a franchise agreement, the franchisor must disclose to the prospective franchisee true, accurate, and basic information about the franchise, and provide a copy of the franchise agreement. This is double the previous requirement, which was a ten-day waiting period. The most onerous obligation is that franchisors must disclose any information a prospective franchisee requests. There is no apparent limit on the type or quantity of information the franchisee can demand and the franchisor must provide. Further, and even more troublesome, this disclosure obligation continues throughout the term of the franchise agreement. The Measures specify the categories of information and documents that a franchisor must disclose prior to execution of the franchise agreement, including: basic details about the franchisor s name, address, capital, scope of business; the franchisor s experience in the franchised business; identification of the franchisor s principal officers, their criminal history, and any previous personal liability for a company s bankruptcy; 2 of 6

3 any litigation the franchisor was involved in during the past five years; full details about all franchise fees, including the return of a deposit if the franchisee paid one; the amount of a franchisee s initial investment; a list of the goods or services the franchisor can supply, and the terms of supply; an indication of what training and guidance the existing franchisees receive; information about the trademarks, including registration, usage, and litigation; a demonstration of the franchisor s capabilities to provide training and guidance; statistics about existing units, including number, locations, and operational results, and the percentage of franchises that have been terminated; and an audited financial report and tax information (for an unspecified period of time). Information provided in any of the franchisor s advertising or promotional efforts about the revenues or profits of a franchise must be accurate, complete, and not misleading. The franchisor is specifically prohibited from exaggerating the franchise s profits, or concealing crucial information about the franchise. Supplier Issues Under the new Measures, a franchisor may not compel its franchisees to purchase its goods. There are exceptions for goods reserved for monopolies, and goods provided by the franchisor or its suppliers to maintain the system s quality standards. The franchisor may identify those standards and provide a choice of suppliers. The franchisor should select its suppliers extremely carefully. The Measures provide that the franchisor will be liable for the quality of goods provided by its designated suppliers to its franchisees. The Measures also state that a franchisee has the right to obtain those goods on time and for the agreed contract price. Franchisors should be aware that they may be responsible for a potentially wide range of their suppliers conduct. Pre-requisites for Franchisees Prospective franchisees must also meet certain qualifications. The franchisee must be an entity (rather than a natural person) legally established in China. It must have the combination of funds, staff and premises suitable for engaging in the franchised business. There is no indication in the Measures as to how the Chinese authorities will determine compliance with these requirements. The franchisee also has pre-sale disclosure obligations to the franchisor. At the franchisor s request, the franchisee must disclose information about its operational capabilities, and provide certificates evidencing its legal status, creditworthiness, and proof of ownership. 3 of 6

4 Franchisor/Franchisee Relationship Issues Both parties are bound to conduct themselves according to the principles of fair dealing, reasonableness, honesty, and trustworthiness during the course of their relationship. Although the Measures state that the parties will determine the contents of their franchise agreement, they mandate some of the specifics: the term of the agreement must be at least three years; the franchisee may not transfer the agreement without the franchisor s prior approval; when the contract expires, the parties may negotiate an extension; the franchisee s confidentiality obligations continue indefinitely after termination or expiration of the franchise agreement; if the franchisee has paid a deposit to the franchisor, it must be refunded on termination of the franchise agreement; and upon termination, the franchisee is prohibited from continuing to use the franchisor s marks. Reports to Chinese Authorities Each January, the franchisor must report to its local commercial authority (and to the authorities where its franchisees are located, if different) information about the franchise agreements executed in the prior year. The Measures do not specify what details must be reported, or whether signed agreements must be filed or registered with any government authority. FIEs must report this information each January also to the original registration agency and to their local commerce regulatory authority. Penalties There were no penalties for violations of the previous regulations. The new Measures impose penalties on a party if it does not meet its qualifications or fails to disclose information as required by the Measures. The offending party may be subject to orders to comply and/or a fine of not more than CNY 30,000 (approximately US $3,600). Its business license may be cancelled for serious violations. The franchisor must compensate a franchisee for its losses suffered as a consequence of any inadequate disclosure or false information it provided. Violations of the Measures for advertising and promotion matters are also punishable under other existing Chinese laws. The Measures do not state whether there is any private right of action for a franchisee against a franchisor. Conclusion Barriers to entry into the Chinese franchise market are considerable. The new Measures present a variety of compliance issues for franchisors. Most significantly, the franchisor (or its subsidiary) must have operated at least two company-owned franchises in China for more than twelve months. Before and after becoming properly established in China, a franchisor 4 of 6

5 may be required to disclose virtually any information demanded by a prospective or current franchisee. In addition, franchisors are also liable for the third-party conduct of their suppliers. Because of these and other onerous and sometimes uncertain new obligations in the Measures, franchisors should carefully consider their present or future plans for franchising in China. 5 of 6

6 Franchise and Distribution Team Please feel free to call or your usual contact or any of the partners or counsel in our Franchise and Distribution Team listed below. ATTORNEY NAME PHONE BOSTON Arthur L. Pressman apressman (617) Amy R. George ageorge (617) MANCHESTER, NH Jamie N. Hage jhage (603) NEW YORK CITY Roger M. Quinland rquinland (212) Frank W. Ryan fryan (212) Stacey B. Slater sslater (212) PHILADELPHIA Craig R. Tractenberg ctractenberg (215) Reneé Bergmann rbergmann (215) ROCHESTER Robert B. Calihan rcalihan (585) Peter H. Durant pdurant (585) Carolyn G. Nussbaum cnussbaum (585) Andrew P. Zappia azappia (585) SAN FRANCISCO Emily S. Chang echang (415) Glenn E. Westreich gwestreich (415) WASHINGTON, DC Andrew P. Loewinger aloewinger (202) Kendal H. Tyre ktyre (202) Shannon Haaf shaaf (202) Valerie S. Johnson vsjohnson (202) Christopher J. Wallace cwallace (202) Albany, NY Omni Plaza 30 South Pearl Street Albany, NY Boston, MA 100 Summer Street Boston, MA Buffalo, NY 40 Fountain Plaza, Suite 500 Buffalo, NY Garden City, NY 990 Stewart Avenue Garden City, NY Hartford, CT CityPlace 185 Asylum Street Hartford, CT Los Angeles Gas Company Tower 555 West Fifth Street, 30th Floor Los Angeles, CA Manchester, NH 889 Elm Street Manchester, NH McLean, VA 2010 Corporate Ridge, Suite 700 McLean, VA New York, NY 437 Madison Avenue New York, NY Orange County, CA 2040 Main Street, Suite 850 Irvine, CA Philadelphia, PA 1818 Market Street Philadelphia, PA Providence, RI One Citizens Plaza Providence, RI Rochester, NY Clinton Square Post Office Box Rochester, NY San Francisco, CA Two Embarcadero Center San Francisco, CA Washington, DC 401 9th Street, N.W., Suite 900 Washington, DC