Franchising

The Regulations on the Administration of Commercial Franchising are the main instrument governing franchising activities in mainland China (excluding Hong Kong, Macau and Taiwan). All franchising activities in China are also subject to the governance of several other laws, regulations and measures, including:

• the Commercial Franchise Administration Regulations 2007;
• the Commercial Franchise Registration Administrative Measures 2011;
• the Commercial Franchise Information Disclosure Administrative Measures 2012;
• the Administrative Measures for Foreign Investment in Commercial Fields 2004 (revised);
• the Labour Law;
• the Labour Contract Law;
• the Contract Law;
• the Anti-Unfair Competition Law;
• the Anti-Monopoly Law;
• the Trademark Law;
• the Patent Law; and
• the Copyright Law.

Franchises must register with the Ministry of Commerce (MOFCOM), industry regulatory authorities and tax and banking authorities, which in one way or another supervise franchisors and the daily operations of franchisees. Annual reports and filings are required for cross-border franchising activities. It is best to familiarise yourself with the local regulations and laws that your business will need to follow when conducting activities.

Legislative and regulatory provisions apply to all foreign franchisors. Only around 10% to 20% of franchisors are legal entities incorporated outside mainland China.

No. However, where a franchisor is a foreign party and the franchising documents are executed outside China, the party is subject to a legalisation process through the Chinese embassy. In some specific sectors – such as hotels, education, software and infrastructure – industrial regulations may apply to either the franchisor or the franchisee.

MOFCOM, the Administration for Industry and Commerce (AIC) and industrial regulatory authorities are the main bodies that supervise the franchising industry from various angles. If non-compliant practices are detected, MOFCOM, the AIC and the industrial regulatory authorities may:

• impose warnings and fines;
• suspend the business; and
• even shut down the franchising business in case of significant non-compliance.

In some situations, a franchising business may be given the opportunity to cure any wrongdoing within a reasonable period.

The regulatory bodies review annual reports and filings. They also conduct random checks and audits of franchising businesses.

Domestic franchising associations – such as China Chain Store & Franchise Association and China Franchise Expo – hold events and offer services for their members. To become a member of these associations, interested parties must submit an application form, provide the requisite supporting documents and pay the membership fee. The association will weigh up the applicant’s reputation in the global community when making its membership admission decisions. Chosen applicants are admitted only after the association has conducted a thorough background check. Typically, well-known brands, or brands that appear to be well known, are not affected by not becoming a member of an association. However, becoming a member and being recognised by a reputable local association can help a new brand to build its reputation.

In China, the maturity level of the franchise sector is intermediate. It is not as highly developed as in the United States or in some EU countries. However, as China is the world’s second-biggest consumer market, cross-border franchising activities are becoming more common.

Generally, the sectors in which franchising is common are not restricted. The new Foreign Investment Law, which came into force on 1 January 2020, has further opened up the Chinese market to foreign investment. Common sectors include:

• food and beverage;
• retail;
• car rental;
• beauty;
• health and fitness;
• catering;
• logistics;
• hospitality;
• software; and
• education (excluding compulsory school education).

However, there are a number of sectors in which foreign investment is restricted or prohibited, such as:

• banking;
• telecommunications; and
• compulsory school education.

For more information on specific sectors, refer to the Special Administrative Measures for Access of Foreign Investments (Negative List), last updated by the National Development and Reform Commission and the Ministry of Commerce in July 2020.

The most successful franchisors in China include:

• McDonald’s;
• Burger King;
• Kentucky Fried Chicken;
• Pizza Hut;
• Education First; and
• W Hotels.

The master franchising model is more popular for offshore franchisors, as the franchisor can then rely on one master franchisee for a given territory without becoming deeply entangled in operations in an area in which it has little experience. However, for domestic franchisors, the development model is definitely more popular, because of the perceived advantages of greater control and the ability to access customer data directly.

No answer submitted for this question.

Both the master franchising model and the development model are prevalent in China. However, the greatest advantage of the master franchisee model for the franchisor is the reduced administrative burden of managing multiple units, as is required in the development model. Furthermore, the delineation of territories that compete with each other is less problematic with the master franchisee model, as most master franchisees opt for a clear and well-defined geographic areas that typically reflects natural urban development. However, the franchisor is perceived to have less control in the master franchisee model; and thus where the local franchisor has the capacity to manage, many opt for the development model. Some companies prefer fast-expanding models, while others prefer more conservative growth models.

Companies should consider hiring experienced local counsel to help them develop a comprehensive understanding of the Chinese market, culture and laws.

The term ‘franchising’ refers to the practice whereby:

• the franchisor, by signing a contract, authorises a franchisee to use trademarks, trade names, business models or other business resources which the franchisee has the right to authorise others to use; and
• the franchisee conducts business activities under a unified business system in accordance with the stipulations of the contract and pays franchising fees to the franchisor.

Generally speaking, a franchise in China must cover the following elements:

• A franchisor, through an agreement, grants other operators (the franchisees) the right to use its business operating resources, including registered trademarks, logos, patents, copyright of works and proprietary technologies;
• The franchisee conducts business under a uniform mode of operation; and
• The franchisee pays franchise fees according to the agreement.

The first element is very important, so franchisors must confirm that they are entitled to the relevant business resources before they consider expanding their franchise business to China.

The key requirements that apply to franchising activities in China are as follows:

• Core documents, including the franchise agreement, must be filed with the Ministry of Commerce (MOFCOM) within 15 days of signing of the first franchise agreement.
• The franchise agreement must include a ‘cooling-off’ term, which allows the franchisee to unilaterally terminate the agreement within a pre-determined period (typically, one month) after the agreement has been signed.
• The term of the franchise agreement must be no less than three years.
• The franchisor must directly operate at least two outlet stores for at least one year.
• Pre-contractual disclosure is required.
• The franchise agreement must include clauses pertaining to fee arrangements, advertising, technical support, warranties and dispute resolution.

No answer submitted for this question.

No answer submitted for this question.

Although franchising is highly encouraged, foreign franchisors must comply with the restrictions on foreign investment set out in the Special Administrative Measures for Access of Foreign Investment (Negative List). The Negative List governs industry sectors in which foreign investment is not allowed and provides further guidance on restricted industry sectors.

China may update the Negative List periodically. The latest Negative List (Special Administrative Measures on Access to Foreign Investment (2020)) and the latest Free Trade Zone Negative List (Free Trade Zone Special Administrative Measures to Foreign Investment (2020)) were jointly issued by China’s National Development and Reform Commission (NDRC) and MOFCOM, and came into effect as of July 2020.

If the industry in which a franchise operates does not fall within the categories in which foreign investment is prohibited or restricted, foreign investors are entitled to the same treatment as domestic enterprises – that is, they can carry out franchise activity in China. Generally speaking, foreign investors are prohibited from operating in industries in China if such foreign investment would:

• threaten national security or military facilities;
• harm the public interest;
• damage the environment;
• hinder the protection and development of land resources; or
• use unique technology which is the property of China for manufacturing purposes.

For example, industries such as energy, IT and telecommunications, automotive and compulsory education are prohibited industries. Industries in which foreign investment in China is prohibited according to the Negative List may be still be accessible to foreign investors, provided that they engage in a partnership with a Chinese partner (ie, an equity or cooperative joint venture) in which the Chinese party may or may not be required to hold a controlling interest. This include franchising.

There are no specific restrictions on foreign franchisors entering China, except in industries which may materially affect the public interest and/or national safety or security. For franchising activities that involve officials, such as infrastructure, additional rules may apply.

For specific information on the industries in which franchising is prohibited in China, refer to the latest Negative List promulgated by the Ministry of Commerce (MOFCOM) and other authorities.

The most common structure adopted by foreign franchisors entering China starts with an international franchisor engaging with a Chinese corporation and assessing its qualifications and capabilities. The franchisor and franchisee then sign a confidentiality agreement before any confidential information is disclosed to the potential franchisee. Thereafter, they draft a memorandum of understanding to help the franchisor and potential franchisee to develop a mutual business model. Once a development agreement has been signed, the franchise agreement will be executed and filed with MOFCOM. Upon completion of these steps and approval by MOFCOM, both the franchisor and the franchisee can expect the grand opening of their very first franchising business established in China.

When being selected or recruited, international franchisors always expect local franchisees to have:

• recognisable experience in the relevant industry;
• profession and capability;
• a spirit of collaboration; and
• English language abilities.

Franchisees are subject to a few legal obligations when purchasing a franchise. However, there are no valid regulations that restrict a franchisee from purchasing a franchise. As the Chinese authorities impose more obligations on franchisors, franchisors are advised to specify the obligations that they wish to impose on franchisees as contractual obligations in their operating agreements.

According to the Measures for the Administration of Information Disclosure of Commercial Franchises, franchisors must disclose the following information 30 days prior to the execution of franchise agreements:

• basic information on the franchisor and franchise activities;
• basic information on the business resources of the franchisor;
• basic information on the franchise charges;
• information on the prices and conditions of the products, services and equipment provided to the franchisee;
• information on the provision of continuous services to the franchisee;
• the methods and content of guidance and supervision over the franchise activities of the franchisee;
• information on the franchise network investment budget;
• information on the franchisee within the territory of China;
• abstracts of the franchisor’s financial and accounting reports and of the audit reports as audited by accounting firms or auditing firms in the last two years;
• information on any major litigation and arbitration concerning franchises of the franchisor in the last five years, including the cause of action, the litigation (or arbitration) claim, the jurisdiction and the result;
• information on any record of major illegal operation(s) involving the franchisor or its legal representatives; and
• the text of the franchise agreement.

The disclosure document must include all of the financial and accounting reports prepared by a third-party accounting firm. A statement to the franchisee warranting the truthfulness and accuracy of the disclosed information is also required.

No pre-contractual disclosure requirements apply to franchisees in China. However, it is recommended that all franchise information be disclosed. This includes a very detailed description of the business model, expertise, know-how, technical support, business training and any other relevant information. Some franchisees may also need to know more about the franchisor to assist in the decision-making process and help them decide whether to continue the negotiations for the franchise. After an assessment, if the prospective franchisee does not think that the franchisor will be profitable, it may look for more promising franchisors.

There are consequences if the franchisor conceals any information that should be disclosed or discloses false information. In such case, the franchisee may terminate the franchise contract if the undisclosed information adversely affects the performance of the contract or precludes it from realising the purpose of the contract.

No other explicit due diligence is required before entering into a franchise agreement. The purpose of franchise due diligence is to find the right franchisees. In order to franchise smoothly, it is advisable to conduct an investigation or due diligence on the background of all prospective franchisees. This is an essential step to help the franchisor find the right franchisees and to enter into successful franchise agreements.

Referring to the Market Supervision Administration and other competent authorities will help the franchisor to obtain exact and specific information about each franchisee, including its shareholders, registered capital, management, affiliates and pending or settled litigation or disputes.

No restrictions are imposed on franchise brokers in China. Franchise brokers provide business consulting services in China.

No answer submitted for this question.

Franchisors and franchisees conducting franchising activities must sign a written franchising agreement. The content of this agreement must include the following:

• basic information about the franchisor and franchisee;
• the content and term of the franchising agreement;
• the type, amount and payment method for the franchising fee;
• a substantive enumeration of the operational guidance, technical support and service training to be provided, as well as the means by which this will be provided;
• the requirements for product or service quality, and the methods for assurance thereof;
• publicity or promotion relating to the products or services;
• consumer rights protection and acceptance of responsibility to provide indemnification;
• modification or termination of the contract;
• relevant liabilities if the agreement is violated;
• the methods for resolving disputes; and
• other items as agreed by the franchisor and franchisee.

No specific requirements apply regarding the governing law or jurisdiction of the franchise agreement. However, where laws other than Chinese law govern, this may cause concern for the Ministry of Commerce.

The franchisor has no mandatory rights and obligations under the franchise agreement.

The only mandatory right or obligation under the franchise agreement to which the franchisee is entitled is unilateral termination of the franchise agreement within a period (typically, one month) of signing of the franchise agreement.

To the extent that Chinese law allows, purchasing requirements, non-compete obligations, exclusivity and price control are allowed. Price control should be subject to an antitrust check by local counsel.

There are no default provisions requiring a duty of good faith under Chinese law. However, the parties may include this as a contractual obligation in their franchise agreement.

There are no mandatory regulations requiring renewal of the franchise agreement. All of these are contractual obligations mutually agreed to by the parties.

There are no requirements that apply to termination of the franchise agreement. All of these are contractual obligations mutually agreed to by the parties.

There are restrictions on the repatriation of moneys out of China. A franchise agreement or any other document which contains fee arrangements must be filed with the banking/tax authorities as supporting documents for the purpose of foreign exchange settlement/tax clearance and cross-border money transfers.

Taxes are withheld in franchise activities. A franchise agreement or any other document which contains fee arrangements must be filed with the banking/tax authorities as supporting documents for the purpose of foreign exchange settlement/tax clearance and cross-border money transfers.

The operations manual is not a contract, but rather only guidance. If the franchise agreement or other document sets out consequences or indemnification for non-compliance with the guidance, this is feasible and enforceable.

A franchisor may ensure compliance with its operation standards through the ‘secret shopper/consumer’ approach. This is a good method for quality control purposes.

Yes, the franchisor can make unilateral changes to the operational standards during the term of the franchise agreement.

Brands are protected in China through registration. China is not a common law country and a lack of registration will inevitably lead to a lack of protection or even denial of use. Before the franchisor commences franchising activities in China, it should ensure that the intellectual property intended to be used in China covers trademarks, patents and copyright. The use of IP rights is governed by the Trademark Law, the Patent Law and the Copyright Law, and other relevant laws and regulations. A number of laws govern the registration, use and licensing of IP rights and the foreign owner should take note of the registration requirements.

In the case of copyright for literary works and artistic works and relevant works registered (or generated) in jurisdictions other than mainland China, there is automatic protection in member countries under the Berne Convention for the Protection of Literary and Artistic Works, including China. However, the registration of other IP rights – such as trademarks or patents – in other jurisdictions does not automatically provide clients with protection in China. Thus, in the absence of registration of such other IP rights, according to the related laws and regulations in China, little can be done to protect the rights of the franchisor in China.

IP rights – such as trademarks, patents, copyright and know-how – are a crucial franchise resource and are interconnected. It is imperative to ensure that the franchisor is legally entitled to such IP rights in China; otherwise, it or their master franchisee may be precluded from using those rights in the jurisdictions in which they are active.

A franchisor must legally own all its IP rights to use them in China, or have the right to use them in China, in order to enter the Chinese market. The IP rights must also conform to the relevant laws that govern IP rights in China, such as the Trademark Law, the Patent Law, the Copyright Law and the Anti-Unfair Competition Law, along with other applicable implementing rules and procedures. An ill-prepared franchisor may face difficulties with regard to business development in China.

The provisions on the protection of trade secrets, the Civil Code and the Criminal Code apply in this regard. There are no specific regulations that protect trade secrets or know-how in terms of franchise activities. However, the Chinese authorities and legislative branch have introduced a series of measures (e.g, the promulgation of new laws) to strengthen the protection of trade secrets and know-how owned by foreign parties.

The applicable instruments are the General Labour Law and the Labour Contract Law and their corresponding regulations (interpretations apply). There are no implications specific to franchise activities under the current laws and regulations.

No, a franchisee may not be deemed an employee of the franchisor, unless hired by the franchisor.

A non-compete clause is allowed, unless it contravenes Chinese antitrust regulations and fair competition regulations. However, the antitrust and fair competition laws of the franchisor’s home country may also be applicable.

Franchisees can use e-commerce in their business. E-commerce is well developed in China. Platforms such as Alibaba and Tencent offer excellent e-commerce services for franchisees and are permitted as long as the franchisor allows this practice.

The Law on the Protection of Consumer Rights and Interests generally governs consumer protection, with no specific implications for franchising activities. The franchisor is unlikely to be held liable for any damage to consumers by default. However, it may be held liable if the guidance from the franchisor directly or indirectly causes damage to consumers.

Yes, franchisees are covered under these consumer protection measures as the sellers of products or the providers of services.

The Data Security Law and its corresponding interpretations and regulations govern this issue, with no specific implications for franchising activities. Cross-border data transmission may be subject to the authorities’ review if the data is deemed important or sensitive, which may raise public safety and/or national security concerns. Internal data protection measures are necessary for information providers, holders and receivers.

The Cybersecurity Security Law and its corresponding interpretations and regulations govern this topic, with no specific implications for franchising activities. However, for franchisors in the technology, media and telecommunications industry, a cybersecurity compliance check is required before entering the Chinese market.

The most common forums for franchising disputes in China are:

• the China International Economic and Trade Arbitration Commission; and
• the Shanghai International Arbitration Centre.

The main topics of dispute include:

• determination of the nature of the commercial franchise contract;
• terminating the franchise agreement during cooling-off period;
• whether the franchisee may terminate the franchise contract if the franchisor conceals relevant information or provides false information; and
• whether, in a commercial franchise, the failure of the franchisor to meet the requirement of "two stores and one year" or complete filing formalities with the franchisor during the commercial franchise may cause the commercial franchise contract to be identified as invalid.

Mediation is mandatory in Chinese court/arbitration proceedings, unless one party explicitly refuses to mediate. Arbitration is commonly used where a foreign party is involved and a properly drafted arbitration clause exists.

No answer submitted for this question.

Yes, class actions may be brought in China.

Yes, the highest courts of Beijing/Shanghai regularly release summaries of franchising-related cases within their jurisdiction. Each provides data such as the number of cases, the focus of the disputes and so on.

This is a good time for international brands to enter the China market, for several reasons:

• China’s national policy of ‘openness and reform’ has been implemented for decades and will be sustained for the foreseeable future. Foreign enterprises with good products and services are warmly welcomed.
• China is the world’s second-largest consumer market.
• Over the past decade, international franchisors (eg, Burger King, Shake Shack, Education First) have succeeded in China and they should become even more successful in the foreseeable future.
• The regulatory environment is improving, as is the respect that market participants have for agreements, laws and regulations.

• Double check and ensure that you legally own all operation resources (including IP rights) in China, as these are the basis for the operation of franchises in this jurisdiction.
• Conduct due diligence on prospective franchisees and try to obtain and confirm details of their shareholders, registered capital, management, affiliates, past litigation and so on. This is a vital step in any franchise transaction in China.
• Set a long-term goal for the franchise business in China and cultivate the confidence and trust of target consumers. Instead of aiming to make a quick buck from consumers, buyers, vendors and the relevant public and then disappear into the sunset with your profits, you should prove to them that you have a long-term business plan in China. Consumers, buyers, vendors and the relevant public may be very wary at the beginning, as they don’t know you or trust you. In fact, this is similar for every new company in the market. Bear in mind that Rome was not built in a day; the same is true of earning money in China through franchising.
• Respect how the Chinese view the world. As one of the four ancient civilisations, Chinese culture places high value on its own views, even after many years of opening up to the world. Put another way, it is hard to change Chinese culture. As a foreign franchisor, you will need to respect this influence and understand that Chinese consumers, vendors, customers, partners and even the relevant public may not share the same values as foreigners or Westerners. For example, although Chinese culture has been influenced to some degree by certain elements of Western-style individualism, for many Chinese people, individual accomplishments or desires still remain secondary to societal, familial or organisational obligations.
• Be aware of cultural differences, cultural preferences and norms. Linguistic translations and interpretations may yield a literal meaning only. When doing business in a different country, in addition to understanding the language, it is also vital to understand the different cultures and norms at play. As more and more foreign businesses commence operations in China, they are discovering the major differences that distinguish Chinese culture from other cultures. For instance, colours have very specific meanings for the Chinese. Red is associated with good fortune; and white symbolises purity, it is also the colour most associated with death. Although the Gregorian calendar is widely used in the world, specific dates in the Chinese Lunar calendar are considered more auspicious or prosperous, so many Chinese will schedule business meetings or events around these dates. The Chinese Lunar New Year is also a major holiday that may last for a full week (sometimes longer) in many different economic sectors. These facts can be crucial for branding considerations in China. Understanding these differences may be crucial to the success of a franchise (or other business) in China.
• Customise the sales pitch of the franchise and speak to Chinese values. It is vital to tailor the pitch to specific audiences, including consumers, vendors, partners and the like. As the Chinese market for luxury goods has boomed in recent years, it may seem incongruous to Westerners that Chinese culture still values austerity and saving. For modern upper-class and upper-middle class Chinese citizens, Western luxury brands represent part of a new global future and a commitment to buying quality, rather than a frivolous purchase that will haunt them down the road. Successful sales leaders can address this by selling the aspiration that customers can solve their problems and improve their lives by buying the solutions they offer. You can draw on this concept when preparing your presentations for the Chinese market.
• Work with and learn from local partners. If you are planning on expanding into China, you will likely be more successful if you rely on local partners who can guide you through the cultural and logistical hurdles that await. This is especially true given that Chinese values and systems are still largely misunderstood by most casual Western observers. Those franchisors that hire local legal counsel with experience and expertise in terms of franchising activities are the most successful at starting and maintaining healthy business relations in China. The franchising industry is different in every country, so it is advisable to set a specific strategy for individual countries and then include all rights, obligations, warranties and arrangements in a written contract and have it signed by both parties. Finding experienced franchise counsel who can deal effectively with these issues is thus of utmost importance. The ability to speak from experience is an invaluable resource, as there is no need to keep reinventing the wheel. In China, learning from the mistakes of others is a valuable lesson – and what better way to learn of these mistakes than from those who toil on these matters day in, day out?

Co-Authors: Jenny Zeng and John Tan