The latest catalog on foreign investment in China, the most important policy document in the field of China foreign investments (entered into force on 31 January 2012), removed franchising from the category of investments subject to restrictions. Franchising is now a “permitted” investment.
This new legislation is certainly a further sign of openness to foreign investors in the sector, including multinational companies, as well as small and medium-sized enterprises.
Definition of Franchising
In China, the current regulatory framework of franchising is not collected under a single law but is made up of various regulations issued by the Government and the Ministry of Commerce (mainly in 2007). The same regulatory regime is applicable to both foreign and Chinese investors.
According to Chinese law, franchising consists of a company (the franchisor), which is the holder of certain resources that can generate business, such as intellectual property rights and business know-how. The franchisor grants the use of these resources, through a licensing contract, to another company (the franchisee). The franchisee will pay a fee to the franchisor as consideration for the use of the intellectual property rights, know-how and, in certain situations, training.
The intellectual property rights may include trademarks (registered in China), signs, patents, and know-how. In practice, through the licensing of these intellectual property rights, the franchisee acquires the right to use them in conjunction with a business model and the opportunity to benefit from the reputation among the public that goes (or should go) with this model.
Requirements of franchising
The current law provides for two main requirements to conduct business in the form of franchising:
- The franchisor already manages at least two stores. The law does not require that these stores are in China or that they are even stores of the franchisor itself. They could also be stores opened through an associate company either domestically or abroad. In practice, however, the simplest solution is to open two stores in China, and possibly in the same city. This makes easier for the franchisor to prove the fulfillment of the condition in question.
- The two stores have been in operation for a period longer than one year.
If these two conditions are fulfilled, the Company may add, subject to approval by the authority, “to conduct economic activities in the manner of franchising” to its business scope and actually engage in franchising activities.
Registering a franchising agreement
The franchisor must submit an application for the registration of the franchising agreement to the relevant department of the Ministry of Commerce within 15 days of the signing of the first franchising agreement.
The most important documents that the franchisor must submit are:
- status of all its franchising activities in China;
- certificates of registration of the relevant trademarks, patents, etc.;
- copy of the first franchising agreement;
- model franchising agreement;
- operation manual (the table of contents is enough);
- market development plan;
- evidence of the effectiveness of the franchising model adopted and the ability to provide the franchisee with direction, technological support and training.
The franchisor has several obligations to inform the franchisee in respect to, among other things:
- its intellectual property rights and their situation;
- the number of franchisees and their locations;
- an assessment of the current franchising operations;
- specific procedures for carrying out direction and supervision of franchising activities.
The franchisee has the right to terminate the franchising agreement in the event that the information provided by the franchisor is incomplete or false.
- The regulation of franchising in China has been conceived primarily with the domestic operators in mind. In particular, the legislation is intended to protect, the franchisees against fraud or imposition by the franchisor. (It is not uncommon that franchisees are required to offer guarantees or pay fees to the franchisor although the franchisor does not provide any services, technical assistance or training.)
- In this context, the authorities are not interested in the examination of all the documents of the franchising arrangement, but mainly those concerning the training and supervision to be carried out by the franchisor. The purpose is also to protect consumers.
- The franchising legislation only marginally covers certain aspects of primary interest to the franchisors, especially foreign franchisors, such as the obligations of the franchisee to:
- meet the quality standards set by the franchisor;
- exclusively sell the products or services of the franchisor;
- protect the rights of intellectual property of the franchisor.
All these points need to be covered more extensively in a franchising agreement.
(Alexander Martin has contributed to this post)