Part one: record-filing practice
According to the “Regulations on the Administration of Commercial Franchising” issued by the State Council of the People’s Republic of China, enterprises engaging in commercial franchising activities within the territory of the People’s Republic of China shall file with the Chinese commercial authority within 15 days from the date of the first establishment of the franchising contract. Compared with domestic enterprises, overseas enterprises have more complex filing materials and stricter review processes. Therefore, we have collated the precautions for overseas enterprises to file for reference by overseas enterprises intending to carry out commercial franchising in China.
(I) Proof of Enterprise Legal Entity Qualification
- For overseas enterprises, depending on the specific circumstances of the country where they are located, they can submit proof documents such as the enterprise information register issued by the local enterprise information registration authority to prove the franchiser’s legal entity qualification;
- For overseas enterprises with articles of association, it is recommended to submit the articles of association simultaneously;
- For overseas enterprises with a legal representative, passport information of the legal representative should be submitted; for overseas enterprises without a legal representative, passport information of the authorized representative should be submitted, along with authorization documents indicating that the enterprise authorizes this person to be responsible for the enterprise’s commercial franchising filing business in China;
(II) Franchising business asset
- Due to the principle of territorial protection of intellectual property rights, the franchising business asset used by franchisers engaging in franchising activities within China must be registered within China. Taking trademarks as an example, the franchiser should submit the “Trademark Registration Certificate” or “Trademark File” and other rights certificates issued by the China National Trademark Bureau, and cannot only submit the international trademark registration certificate registered through the Madrid Agreement;
- The trademark owner recorded in the trademark rights certificate should be consistent with the franchiser; if the franchiser only has the right to use the trademark, it should submit the trademark license agreement signed by the trademark owner and the franchiser, specifying the scope of the license, the duration of the license, and the specific licensed trademarks;
- The registered trademark should be valid and in existence, and if the trademark has been transferred and renewed, the corresponding transfer and renewal certificates should be submitted;
- The trademark category recorded in the trademark rights certificate should be consistent with the franchising system.
(III) “Two Stores for One Year” Proof Documents
- According to the “Regulations on the Administration of Commercial Franchising,” franchisers engaging in franchising activities should have at least two directly operated stores with more than one year of operation; for overseas enterprises, these two directly operated stores can be either within or outside of China;
- The types of directly operated stores include (1) branches of the franchiser (2) subsidiaries of the franchiser (3) directly operated stores of the franchiser’s parent company (4) directly operated stores of the franchiser’s subsidiary (5) individual businesses or sole proprietorships established by the controlling shareholders of the franchiser;
- For overseas enterprises, if the wholly foreign-owned enterprise they have invested in and established in China operates the same business and brand as the franchiser, it can be considered as a directly operated store of the overseas enterprise;
- When using an affiliated company as a directly operated store, the franchiser should also submit proof of the relationship with subsidiaries, parent companies, and other affiliated companies, such as articles of association showing the proportion of shareholder investments, internal equity registration certificates, etc. For enterprises with a more complex equity structure, it is recommended to also submit an equity relationship diagram;
- To prove the actual existence of the two directly operated stores, the franchiser should submit the business licenses of the directly operated stores and actual photos of the stores;
- To further prove that the directly operated stores have been in operation for a full year, the franchiser can submit bills for water, electricity, natural gas, etc., from the directly operated stores over a period of one year, proving that the stores have been in continuous and normal operation throughout the year.
(IV) Franchise Agreements and Samples
- The franchise agreement should include a cooling-off period clause;
- In the first franchise agreement signed with the franchisee within China, attention should be paid to ensure that signatures and seals are complete; overseas enterprises without a public seal should have the agreement signed by the legal representative or authorized representative of the company;
(V) Translation
- All foreign language materials submitted by overseas enterprises should be translated by a translation company with translation qualifications and stamped with the translation company’s official seal;
- When submitting filing materials, the business license of the translation company should also be submitted simultaneously.
(VI) Notarization and Authentication
- All filing materials submitted by overseas enterprises, if formed outside the People’s Republic of China, must be notarized by the notary office of the country where they were formed (with a Chinese translation attached), and authenticated by the embassy or consulate of the People’s Republic of China in that country;
- For documents generated by overseas entities that are parties to the Hague Convention after November 7, 2023, no further authentication by the embassy or consulate of the People’s Republic of China is required; only an additional certificate from the issuing authority of the document is needed.
(VII) Other
- If an overseas enterprise commissions a service institution within China to handle franchise filing, the corresponding power of attorney, designated handler’s identity proof documents, etc., should be submitted simultaneously.
Part two: Some hot questions about the franchise dispute litigations in China
Q: Does “Two Stores One Year” rule affect the validity of contract?
A: According to the statistical result of this note, cases involving the “two stores one year” rule account for about 30% of the total cases, of which about 64% claiming the rescission of contract for the franchisers failed to meet the requirement of “Two Stores One Year” rule.
For the issue whether the validity of the contract is affected if the franchiser fails to meet the requirement of “Two Stores One Year” rule, opinions from the court decisions have been relatively unified, that the franchiser not meeting the “Two Stores One Year” rule shall not directly resulting in the invalidity of the franchise agreement.
Q: What would result results in rescission or revocation of contract if Failure in information disclosure
A: According to the case statistics, for the performance of the franchiser’s obligation to disclose information, the primary claim from the franchisee is the rescission or revocation of the contract on the basis of three statutory rules: article 94 of the Contract Law, article 54 of the Contract Law and article 23 of Regulation on the Administration of Commercial Franchises (2007 Regulation).
Q: Is there any case about the information disclose about the Rescission of the franchise agreement under article 23 of Regulation on the Administration of Commercial Franchises (2007 Regulation)?
A: In Zeng Qianqian v. Chengju Baishan Food & Beverage (Nanjing) Co., Ltd. et al. [2019] Nanjing Railway Transport Court (Su 8602 Min Chu Zi No. 479), the court found the franchiser failed to disclose the facts in written form including the quantity of the stores, distribution areas, evaluation of business status and other information of the franchised business operators, constituting substantial influences in the franchisee’s decision making, and thus decided to support the franchisee’s claim for rescission of the contract.
In Huang Fenghua v. Suiyu Corperation Management (Shanghai) Co. Ltd. [2018] Shanghai Xuhui District Court (Hu 0104 Min Chu Zi No.20939), the court found that the franchiser failed to disclose the information on the Archival Filing of Commercial Franchises and “Two Stores One Year” will result in doubting of the franchisee about the franchiser’s operating resources, and additionally the claim for rescission was raised within the cooling-off period. The court consequently decided to support the franchisee’s claim.
Q: What is the judical practice of the franchisee unilaterally rescinds the contract as per agreement by cooling-off period?
A: According to the statistics of the judicial decisions, it is generally considered that the Regulation on the Administration of Commercial Franchises has clearly stipulated a cooling-off period, which shall be regarded as the legal right granted to the franchisee. Even if the parties do not agree on a cooling-off period, the franchisee still has the right to rescind the contract unilaterally within a reasonable period, which shall be considered as an implied clause approved by both parties. Only when the franchisee expressly renounces, can the franchisee no longer enjoy the unilateral rescission right during the cooling-off period.
Q: What is the reasonable limits for cooling-off period?
A: As the Regulation on the Administration of Commercial Franchises does not specify the limitations of the reasonable period, the determination of “reasonable period” becomes an issue in judicial practice. In the dispute between Shen Fei v. Chengju Food & Beverage (Nanjing) Co., Ltd. (franchise agreement dispute), the court found that the contractual agreement for 3-day cooling-off period was obviously too short, however the franchisee’s claim to rescind the contract was five months after signing the contract, which obviously exceeded the reasonable limit of the cooling-off period.
Q: What are the restrictions on rescission within the cooling-off period?
A: The limitations of cooling-off period are not defined by legislation, and thus the purpose of the cooling-off period shall be taken into account for considering whether to allow the rescission of the contract within a reasonable cooling-off period. Therefore, when deciding whether the franchisee can unilaterally rescind the contract in accordance with the cooling-off period clause, the court commonly consider the backgrounds of the franchisee and the franchisee, combining with the facts of the content, the term and the performance of the contract, and also the business experience of the franchisee, etc.. The decision for rescission of contract in individual case is depending on comprehensive judgement based on the establishing purpose for the rule of “cooling-off period”.
Q: What are the Judicial Standards in the Franchisee claiming rescission of the contract within cooling-off period?
A: From the case statistics in this note, 62% cases claiming rescission of contract in accordance with cooling-off period clause are supported by the court. From the opinions of the court decisions, the main points of view are as follows:
- If there is any agreement for cooling-off period, the agreement shall be followed;
- If the agreed cooling-off period is too short, which has substantially restricted the legal right of the franchisee, it is regarded as not agreeing on the cooling-off period;
- If there is no agreement for cooling-off period, the franchisee may exercise the right to unilaterally rescind before actually obtaining the operating resources.
when determining the reasonable limitations of the cooling-off period, in order to reach comprehensive analysis and judgment, whether the franchisee actually occupy and take advantage of the franchise business assets shall be considered also with the aspects of the fair principle and the interests balance between the franchiser and the franchisee.
Q: What is the boundary of information disclosure for franchiser?
A: In the cases we collected if the franchisee’s claim of rescission or revocation of the contract is solely on the basis of the franchiser’s lacking or insufficient fulfillment for the obligation of information disclosure, the court’s approval rate is not high. We believe that the court should fully consider the following three factors. First, whether the undisclosed information is substantially affecting the franchisee’s acceptance, the performance and the purpose of the contract; second, whether the undisclosed information is related to the factors that directly affect the franchisee’s income, such as the franchise resources, the quality of the franchiser’s products and services or the price; and third, whether the undisclosed information affects the franchisee’s evaluation of the franchise resources, the franchiser’s operating ability, and the judgment of the income prospect of the franchise project. Only when the information concealed or falsely provided by the franchiser is related to the essence of the franchise agreement and has a substantial impact on the franchisee, can the franchisee’s claim be supported.
Q: What is the effect on contract validity for violating legislations?
A: In the cases of franchise disputes, the most common controversial topics are involving the effective and administrative compulsory provisions, specifically regarding the provisions of article 3,7 and 8 of the Regulation on the Administration of Commercial Franchises. According to the court decisions and legislative status, we believe that the provision of article 3 of the franchiser’s qualifications in the Regulation on the Administration of Commercial Franchises are mandatory. Generally, if the franchiser fail to meet the requirement of this provision, the franchisee may claim the rescission of contract.
In addition, with regard to the qualification requirements of “two stores for one year” stipulated in Article 7 of the Regulation on the Administration of Commercial Franchises and the archival filing stipulated in Article 8, a unified judicial standard has been established in practice, that fail of filing or to fulfill the requirement do not necessarily constitute the contract to be invalid.
Q: Please offer the suggestions and Tips for the Franchiser who run the franchise business in China.
A: (I) .Before engaging: the content of franchise agreement and information disclosure
Articles 11 to 13 of the Regulation on the Administration of Commercial Franchises provide detailed provisions on the main and essential terms of the franchise agreement, which is one of the essential materials for the Archival Filing of Commercial Franchises. Therefore, in the formulation of the franchise agreement, the franchiser should pay attention to clarify the terms and conditions of the parties, the duration of the contract, the collection of the franchise fee, the specific contents and methods of the service, the quality assurance of the product and service, the dispute settlement method and the agreement of the cooling-off period.
Before signing the contract with the franchisee, the franchiser should also fulfil the obligation of information disclosure, establish a template and procedural documents and a disclosure mechanism for the important business management information with regular updating management, in order to form a complete information disclosure mechanism.
(II) .Legal qualification and archival filing
In accordance with the relevant provisions of the Regulation on the Administration of Commercial Franchises, a qualified franchiser is required to meet at least the following requirements in order to carry out a commercial franchise activity: 1. Franchiser is an enterprise; 2. Franchiser owns at least two direct sales stores and have undertaken the business for more than one year.
In addition, the completion of the Archival Filing of Commercial Franchises is also one of the important compliance topic before the franchiser carries out the franchise operations. According to the relevant regulations, the archival filing here includes not only the first filing of the franchiser, but also the filing of information change and the annual filing.
(III) .Timely and proper measures for violation of the legal rights
Although the proportion of disputes brought by the franchiser is not big, it also reflects that the franchiser is not always “safeguarded” in the franchise operations, and the protection of the franchiser’s rights mainly focus on the paying back of franchise fees, breaching of contract to operate other products or provide other services, and requiring the franchisee to stop using the franchise business assets after the termination of the contract.
For the above issues, we recommend the franchiser to establish a penalty mechanism or default measures. In case of contract breaching, the franchiser shall timely claim the rights to the franchisee in with company letter or lawyer’s letter, and pursue judicial or arbitral remedies as appropriate.
In view of the franchisee’s post-contractual obligations stipulated in the franchise agreement, we suggest that when the contract is rescinded or terminated, the franchisees shall be clearly notified for the post-contract obligations by means of written letter, or request the franchisee to sign a written agreement with regularly tracking and verifying of the performance.