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LEGAL: Latest Updates on PRC Franchise Rules
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altGeneral Introduction on Recent Developments of Franchise Rules in PRC


In 2007, the State Council of the People’s Republic of China (PRC) published the Regulation on the Administration of Commercial Franchises (Franchise Regulation” as the basic rules regulating the franchising business in PRC. Subsequently, more detailed rules about filing of franchising activities and information disclosure were released, including the Administrative Measures on Filing of Commercial Franchise (2007 version) and Administrative Rules on Disclosure of Commercial Franchise Information (2007 version).
By the end of 2010, there had been more than 4,500 franchisors in China which makes China rank first in the world in terms of total quantity of franchise systems1. Due to the rapid growth of commercial franchising activities in China, and in order to optimise the administration and supervision of development of commercial franchises in China, the Ministry of Commerce (MOFCOM) released the revised Administrative Measures on Filing of Commercial Franchise (Revised Filing Measures) which took effect 1 February 2012, and the revised Administrative Rules on Disclosure of Commercial Franchise Information (Revised Disclosure Rules), effective since 1 April 2012.
Though these two regulations do not make fundamental changes to the current commercial franchise regime in China, they provide detailed and updated requirements on filing of franchising activities and information disclosure by franchisors, which are consistent with the principles established by the Guiding Opinions of the Ministry of Commerce on Further Promoting the Healthy Development of Franchising during the 12th Five-Year Plan (Guiding Opinions) released in January 2012.
In addition, we could also see the endeavor made by the Chinese government on creating a friendlier environment for the franchising industry, especially for foreign invested franchisors when updating the Guideline Catalogue of Industries for Foreign Investment ( Amended Catalogue) effective since 30 January 2012. This Amended Catalogue moves commercial franchising activities from the restricted category to the permitted category. 

1. Major changes of the Revised Filing Measures

According to Franchise Regulations, any franchisor needs to file before the competent MOFCOM within 15 days after signing its first franchise agreement. Regarding the requirements on such filing, the Revised Filing Measures replace the old measures issued by MOFCOM in 2007, and the main changes are:

- Provisions on delegation of authority of MOFCOM

MOFCOM once released a circular in April 2009 on the delegation of authority to MOFCOM at the provincial level to accept filing applications for cross-province franchising made by domestic franchisors or foreign invested franchisors. On the other hand, MOFCOM at the state level is in charge of accepting a filing made by overseas franchisors.
The Revised Filing Measures once again confirm such delegation of authority, and also prohibit the further delegation of authority from the provincial MOFCOM to any local institution or individual, which clearly forbids some local practices of delegation to an unqualified entity or person.
Nevertheless, according to the Revised Filing Measures, MOFCOM at the state level can also accept the application of filing made by domestic or FIE franchisors in case the competent provincial MOFCOM fails to duly perform its duty. 

[1]According to the Guiding Opinions of the Ministry of Commerce on Further Promoting the Healthy Development of Franchising during the 12th Five-Year Plan


- Filing documents for FIE franchisor

Prior to the publishing of the Revised Filing Measures, it is unclear whether the business scope of an existing FIE was required to be expanded to include franchising activities before the filing. 
To avoid the inconsistency between different practices of local authorities, the Revised Filing Measures clearly state that if an FIE intends to make the franchise filing, its business scope should include “carrying out business activities by way of franchising”. As a consequence, in order to obtain such business scope, an existing FIE has to meet the requirement of “two directly-operated stores for more than one year”. Therefore, a newly established FIE shall first directly operate two stores for more than one year. Afterwards it shall expand its business scope to include franchising and then make the filing. For detailed requirements of “two directly-operated stores for more than one year” please refer to Section 4 below.
In this regard, in case the foreign investor intends to start a commercial franchising programme through its Chinese subsidiary instead of the parent company abroad, the longer time framework as required shall be considered.

alt2. Major changes of the Revised Disclosure Rules

According to the Franchise Regulation, the franchisor shall disclose the required information to the franchisee at least 30 days before signing a franchise agreement. In this regard, the main changes introduced by the Revised Disclosure Rules compared with the old rules issued by MOFCOM in 2007 include:

Disclosure obligation exemption

The franchisor is exempted from the disclosure obligation when renewing the franchise agreement without change of the original terms and conditions.

- Confidentiality

Franchisees are obliged to keep the franchisors’ business secrets confidential no matter whether it is in the process of negotiation of the franchise agreement or after the termination of the franchise agreement, even though there is no Non-Disclosure Agreement signed between the parties. The franchisee shall be responsible for the damage arising from the disclosure or improper use of the business secrets of the franchisor.

- Some adjusted requirements to the information to be disclosed

● In case of bankruptcy or application of bankruptcy of the franchisor or its affiliates within the past two years (reduced from five years as previously provided), the relevant information shall be disclosed;
● Any liquidation or arbitration involving the franchisor in relation to the franchise during the previous five years shall be disclosed. In the past, such obligation only covers the liquidation or arbitration with a claimed value equivalent to or higher than CNY 500,000;

3. Pending Issues of “two-store, one year” requirementalt

Based on the Franchise Regulation, a franchisor who intends to carry out franchising activities shall already have  at least two directly-operated stores, which have been in operation for more than a year. However, there is no further interpretation to the definition of “directly-operated stores”. Currently, there are several uncertainties related to the requirements of directly-operated stores, such as, whether the stores operated by the affiliates of the franchisor could be qualified as directly-operated stores or not.
According to the MOFCOM website, directly-operated stores of affiliates of the franchisor could also be deemed as the directly-operated stores of the franchisor, provided that, the business scope of such stores shall be identical with the business to be operated by the franchisor under the same brand and system. The term “affiliates” here refers to the definition specified in Article 3 of the Revised Disclosure rules, which includes the parent company or individual shareholder of the franchisor, subsidiaries, of which the franchisor directly or indirectly owns all or most of the equity, and companies, of which all or most of the equity is directly or indirectly owned by a same party that directly or indirectly owns all or most of the equity of the franchisor. In such circumstance, the problem encountered by newly established FIE franchisors as above analysed in Section 2, will no longer exist. However, as such interpretation is not in the form of laws or regulations, it is not accepted by all the local MOFCOMs yet.alt
Further, in relation to the form of directly-operated stores, it is still not clear whether the forms are limited to the subsidiary or branch of the franchisor. For instance, whether the stores in the form of a joint operation with commercial malls could be deemed as directly-operated stores? According to the practices of some local MOFCOMs, it will be accepted as long as the business license of the counter or the store can be provided.

4. Conclusion

China is making continuous efforts to update and optimise its legal framework regulating commercial franchising activities. Although, with the latest revision on relevant regulations, there are still some uncertainties such as the different explanations of the “two-store, one year” requirements, etc. Therefore, it is expected that further clarifications and/or provisions will be provided in future regulations or rules to address these unclear issues. We would like to suggest that foreign investors who are carrying out or intend to carry out franchising business in China  keep an eye on the on-going evolution of PRC laws and regulations on commercial franchising and the practices of ocal authorities as well.
 

 By Manuel Torres and Julian Yu
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