The Franchise Law Review: China
Retail and franchising in China developed very fast in the decade from 2001 to 2012, during which the sales volume of the top 100 chain-store retailers in China increased by 10 times. The total sales of the top 100 franchisors in China reached 504.6 billion yuan in 2019. In 2019, the total number of employees in the top 100 franchise businesses was about 4 million, and each store created an average of 16 jobs according to the China Chain Store and Franchise Association (CCFA). By 2019, 50 per cent of the top 100 franchise brands in China had been in business for more than 20 years, and 85 per cent have for more than 10 years.
There have been three remarkable trends. First, with the increasing costs on franchising (particularly premises and workforce in the first-tier and the second-tier cities) and the overwhelming competition from the rise of online retail, many franchisors tended to develop franchises in the fourth-tier cities, particularly in sectors such as supermarkets, laundry, fast food, accessories and the automotive sector. Second, both online and offline purchasing and sales have increased rapidly in recent years in China, forcing global franchisors to seek suitable approaches and strategies to address this. Third, as the power behind new consumption, discerning and trend-conscious millennial shoppers are showing diverse and fast-changing preferences for customised products and services.
Franchising in China covers a wide range of industries and sectors, such as food and beverages, retail, catering, education, beauty, health and fitness, hospitality and other services. Franchisors encompass Chinese local retailers and international brands such as KFC, McDonald's and FamilyMart with legal entities in China, most of which are members of CCFA.
CCFA, incorporated as a civil association under the Ministry of Civil Affairs in 1997, is the official industry association for the retail and franchise industry in China. Currently it has over 1,000 enterprise members with more than 427,000 outlets, including domestic and overseas retailers, franchisors, suppliers and relevant organisations. By 27 October 2020, 5,730 foreign and domestic franchisors had registered their franchises with the Ministry of Commerce (MOFCOM), the highest governmental body in charge of franchising in China, making China one of the largest franchise markets in the world.
As part of its World Trade Organization commitments, China agreed to eliminate legal restrictions on foreign investment in the area of franchising by 11 December 2004. This commitment was implemented with the enactment of Administrative Measures on Commercial Franchise Businesses on 30 December 2004 with effect from 1 February 2005.2 However, foreign franchisors are still obligated to comply with the restrictions on foreign investment set out in the Special Administrative Measures for Access of Foreign Investment (Negative List) and the various laws and regulations applicable to foreign investment in the distribution sector. For example, foreign companies are not permitted to engage directly in distribution activities (which generally covers retail, wholesale, commission agency and franchising operations) but must engage in such activities by setting up a wholly foreign-owned commercial enterprise (FICE). The types of products or services provided by the FICE must be specified in the statement of its business scope.
There are certain restrictions on granting a master franchise or development rights to a local entity (e.g., registration and other requirements) that apply to all master franchisors, foreign or domestic. Such franchises generally fall into two categories: the first is a two-level franchise, or sub-franchise, whereby the franchisor grants a franchisee the franchise rights to a specific sales region, allowing the franchisee to grant sub-franchises to others. In this instance, the franchisee would have a dual role as a franchisor as well as a franchisee. The master franchisor in this model may be either a foreign or a domestic company. The second model is an agent franchise, whereby the franchisor grants a franchisee the right to recruit other franchisees. In this instance, the franchisee would essentially act as an agent of the franchisor in handling the recruiting and would provide these sub-franchisees with guidance, training, consulting, supervision and support. In the second model, the franchisor would have to be a foreign-invested enterprise rather than a foreign company as it would essentially be conducting franchising activities in China.
Subject to obtaining the relevant governmental approvals, a foreign franchisor can own equity in a local business so long as the local business does not fall within an industry sector where foreign investment is restricted or prohibited.
Owning real property is restricted under Chinese law. A foreign-invested enterprise that does not specialise in real estate may only purchase real estate in China for its own use. If the franchisor's overall strategy includes provision of premises to franchisees, one solution may be for the franchisor (or an affiliate) to set up a foreign-invested real estate company in China (which would trigger conditional approvals by several Chinese governmental bodies) to make the relevant real estate purchases and to provide premises for franchises to the franchisees. This, however, is subject to another set of relatively restrictive procedures that the investor must complete prior to any applications made for these approvals.
ii Foreign exchange and tax
The yuan, China's official currency, is not a freely convertible currency; offshore remittances are generally subject to the regulation of the State Administration for Foreign Exchange (SAFE). From the perspective of a foreign master licensor, it would be prudent to insist that the master franchise contract provide for payments to be made in a foreign currency and into an offshore bank account so that the responsibility for making offshore remittances rests with the domestic master franchisee. Transactions involving remittances of current account payments can usually be handled at banks designated by SAFE to handle such transactions upon presentation of the contract and shipping documents. Since 2016, reports have confirmed that SAFE is again tightening the supervision of outbound payments for both capital and current account items. It will mean, therefore, that SAFE may require the submission of an application for approval. In addition to what would normally be presented to a bank, the application submitted to SAFE shall contain additional documents and information, including without limitation the detailed reasons for the parties' agreement to the terms. Payments may therefore be rejected repeatedly. In the (unlikely) event that the payment cannot be remitted offshore, the parties may consider adding a provision setting out an alternative arrangement for payment of yuan to an onshore bank account or agent. It would also be prudent to stipulate that failure to pay for any reason (including those relating to government actions) cannot be excused under force majeure. However, on 23 October 2019, SAFE issued the Circular on Further Promoting the Facilitation of Cross-border Trade and Investment (Hui Fa  No. 28) (Circular 28). Circular 28 aims to further liberalise and streamline foreign exchange control over cross-border investments and trades through measures such as (1) simplification of the documentary and reporting requirements in relation to payments made in cross-border trade; and (2) relaxation of the domestic equity investment restriction imposed on foreign-invested enterprises. Notwithstanding these aims, the implementation of the Circular 28 has yet to be tested in practice.
i Brand search
Brands of foreign franchisors would usually enjoy protection by operation of their respective trademark registrations in the relevant countries. Such registrations are generally made in the brand's original language and writing. To market products under such a brand to consumers in China, the franchisor would need to create a recognisable Chinese brand based on Chinese language characters and protect the brand locally in China. The selection of Chinese characters for each transliteration is very important as the choice of characters may flatter or detract from the brand image. To avoid future disputes, the franchisor should conduct all necessary trademark searches to ascertain that the selected Chinese name is not already being used by another entity, or if it is being used, that its use can easily be discontinued; for example, by having an intermediary purchase any existing rights on behalf of the franchisor. It is essential, as mentioned, to conduct the requisite market research to ensure that the name appeals to the Chinese general public, taking into account the visual effect of the Chinese characters in both simplified and classical format as well as its auditory effect in various major Chinese dialects. Once the franchisor determines the Chinese name under which it wishes to be officially known to the Chinese public, if it chooses to do so trademark applications to register the Chinese mark in all relevant trademark classes may be filed with the Chinese Trademark Office.3
Once the franchisor has determined what marks it plans to use to identify the goods or services that are intended to be offered under the franchise, it should conduct a search of the official database of the Chinese Trademark Office to ensure that there are no records of trademark registrations or pending applications for marks identical or similar to its own in the trademark classes covering the goods or services to be offered. If there are registered trademarks or pending applications for marks similar or identical to the marks that the franchisor intends to use in the Chinese market, the franchisor will need to decide whether to try to acquire the relevant rights from the prior rights holders, or to identify alternative marks for use in the Chinese market.
The Chinese brand name may then be used for Chinese domain names and also as part of the name of any entity to be established in China. For the registration of China domain names, searches should also be conducted to determine whether the desired domain names in the relevant domains (.cn, .com.cn, .net.cn, etc.) are available. The same applies for company names, as regards company name searches with the relevant Administration of Industry and Commerce to ensure that these names are available for use as part of a company name in the jurisdictions where the franchisor intends to establish its affiliates.
If franchisors are to be allowed to use this name in China, the granting of the relevant use rights would need to be made part of the legal franchise documentation. Franchisors, however, are advised not to license the brand to the franchisee for use as part of the franchisee's company name as it will be difficult to reclaim the rights for its use in the event that the franchise relationship terminates.
ii Brand protection
A franchisor that wishes to do business in the domestic Chinese market is strongly advised to register its key marks in China. The Chinese registrations can be done as part of an international application under the Madrid Convention or by filing separate applications with the Chinese Trademark Office. Although filing applications under the Madrid system is a simpler process, in-country applications filed with the Chinese Trademark Office will provide the applicant with greater flexibility as it will be able to craft its own specification of goods and services, tailored to accommodate local requirements, and to the needs of the domestic market.
China is a first-to-file jurisdiction and trademarks are protected in China upon registration with the Chinese Trademark Office in accordance with the procedures set out by relevant laws and regulations. That is to say, even though a trademark has been registered in the home country, it is not protected in China until the registration application is approved. Therefore, it is very important for foreign companies to ascertain whether its specific mark is still available in China as it makes plans to enter the Chinese market.
In respect of what can be registered as a trademark, Chinese law recognises three-dimensional symbols and combinations of colours as well as any visual sign if it can be used to distinguish the goods or service of a natural person, legal entity or any other organisation from that of others, including any word, design, letters of an alphabet, numerals, etc. Under the Trademark Law, non-visual trademarks such as sound trademarks are registrable in China.
A trademark registration is valid for 10 years, starting from the date the registration receives approval, and may be renewed for subsequent 10-year terms. Renewal applications should generally be made 12 months prior to the expiration date, although, subject to a related application, the application may still be accepted up to six months before the expiry date.
In China, trademarks are not only categorised in the international trademark classes but are further categorised into subclasses. It is possible that the Chinese Trademark Office may allow a registration for the same mark from another applicant if it covers goods or services that are not in the same subclass as the goods and services listed in the franchisor's registrations.
Therefore, as a defensive measure to prevent others from registering a certain mark for other related goods, the franchisor may also consider whether it wishes to include additional goods or services in each subclass or register its mark in other classes. As a matter of first priority, the franchisor should register any and all marks in the relevant classes of goods and services that it will be using in China or to promote its products to Chinese customers.
The franchisor should monitor, whether on its own or through a designated intermediary, the domestic market on an ongoing basis so that possible problems may be addressed as they arise or as early as possible; for example, any unauthorised use of its trademarks and trade dress in China. This may entail working with law firms, investigation firms and agents as necessary to monitor use of any intellectual property (IP) of the franchisor, identify infringers and collect evidence. If the franchisor is considering sending cease-and-desist letters to infringers, it must be prepared to follow through on any threats made therein, if only to maintain its credibility as a company that is serious about protecting and enforcing its intellectual property. Pursuit of an aggressive enforcement strategy is key to discouraging potential infringers.
In addition to IP litigation in Chinese courts, companies may also file for administrative protection with the State Administration for Industry and Commerce (SAIC) or its local counterparts for trademark infringement matters. However, the SAIC's authority is limited: it can issue an order to halt the infringement, impose fines, conduct raids or seize counterfeit goods, materials or equipment, but it cannot award compensation.
iv Data protection, cybercrime, social media and e-commerce
The laws and regulations relating to cybercrime, e-commerce and other internet-related activities that are applicable to general commercial transactions under Chinese law would also apply to franchising activities in China. Though there are no e-commerce provisions specifically applicable to franchising, the increasing regulatory trend to protect personal data is noteworthy. In particular, the Chinese Consumer Protection Law, amended in October 2013 and effective from 15 March 2014, newly included provisions on personal data protection with a specific focus on consumer rights; the State Council of the People's Republic of China (the State Council) and the Ministry of Industry and Information Technology, one by one, enacted new rules between 2012 and 2013 protecting online personal data or personal data related to other means of telecommunication. The revised Chinese Consumer Protection Law came into effect in March 2014, provisions of which re-emphasised the protection of consumers' personal data, online and offline. The Cybersecurity Law, issued by the Standing Committee of the National People's Congress (SCNPC), entered into effect on 1 June 2017 and has had a profound influence on personal data protection. This new Law regulates, for the first time at national level, how information is collected, stored, transmitted, exchanged and processed. 'Operators' will bear additional security protection responsibilities, such as formulating internal security management systems, adopting technological measures to prevent computer viruses, and monitoring and recording the operational status of networks. However, whether these obligations will apply to all enterprises, or only to e-commerce companies, is not clearly stipulated.
The Chinese E-Commerce Law, effective as of 1 January 2019, is the first fundamental law addressing e-commerce in China, and it is likely to have a significant impact on prevailing e-commerce practice. The E-Commerce Law stipulates specific requirements for platform operators' liability, the protection of intellectual property rights, and data protection. Following the rules for protection of personal information mentioned above, the E-Commerce Law provides clear details about the use, collection and processing of customer information, enquiry, correction and requests. The Law also covers rules on how to disclose information about goods or services in a comprehensive, truthful and accurate manner. As regards the protection of intellectual property rights, the E-Commerce Law stipulates that the platform operator should bear joint and several liability with the online retailer if it fails to adopt necessary measures when the platform operator knows or should have known that the online retailer is infringing a third party's intellectual property rights. The platform operator should adopt appropriate measures for deleting, screening, disconnecting and ending transactions and services in cases where there is a potential intellectual property claim.
v Advertising Law
The most recent influential amendment to the Advertising Law, issued by the Standing Committee of the National People's Congress, entered into effect on 1 September 2015, and the Interim Measures for the Administration of Internet Advertising issued by the State Administration of Industry and Commerce entered into effect on 1 September 2016. Changes introduced by these amendments included: (1) more restrictions on advertising-related matters, with explicit penalties for non-compliance; (2) claims containing superlative words or the advertising of off-limits products or services are generally restricted; (3) the use of 'technical/digital methods' to fabricate or 'improve' the real effect of the product or service in advertisements is punishable as false advertising; (4) further regulation of electronic advertising by defining internet advertising; (5) tighter regulation of endorsements; and (6) changes regarding the advertising of specific products and services. On 26 October 2019, the Standing Committee of the National People's Congress promulgated the latest amendment to the Advertising Law, although without any significant changes to the 2015 amendment. The franchisors, by making advertisements to promote their brands, are subject to the amended Advertising Law.
Under Chinese law, there are specific commercial franchising regulations that stipulate among other items, franchise-specific pre-contractual disclosure and franchise requirements. These regulations apply to both foreign-invested and local Chinese franchisors.
Commercial franchising operations are generally defined under Chinese law as:
arrangements whereby a franchisor, by contract, authorises a franchisee to use its relevant operational resources, such as its trademark, trade name, logo, patent, proprietary know-how and the franchisee conducts the business in accordance with the franchisor's standardised business model (i.e., uniform visual image, business concept, management model, etc.) and pays fees for participating in the franchise in accordance with the franchise agreement.
However, simply not charging fees does not automatically mean that an entity is not running a franchising operation, as other factors will also be taken into consideration.
The two types of franchising arrangements most commonly seen in the Chinese market are arrangements whereby the franchisor authorises the relevant franchisees to (1) open and operate stores in a specific territory, without any right to grant further sub-franchises; or (2) act as the master franchisor for a specific territory, with the right to grant further sub-franchises to other downstream sub-franchisees as well as directly operate its own franchises as a franchisee. However, the relevant laws and regulations address only franchising as a direct relationship between two parties, and do not distinguish between the different types of franchising arrangements.
An entity must satisfy the following requirements to be eligible to conduct a franchising business in China:
- it must be an enterprise;
- it must own or have the right to use the relevant operational resources, such as the relevant trademark, trade name, logo or well-established operational model, etc.;
- it is capable of providing long-term operational guidance and training support to franchisees;
- it (or any of its subsidiaries or its controlling shareholder) must have established at least two directly operated stores and have operated those stores for a period of no less than one year;
- it must have established a stable supply system that can ensure sound product quality and render relevant services where the franchising arrangement requires the franchisor to supply the relevant goods; and
- it must be of good repute and does not have any record of fraudulent operational activities.
ii Pre-contractual disclosure
A franchisor should positively disclose in writing to the franchisee, at least 30 days before signing the franchising contract, certain information about itself:
- basic information on the franchisor and franchise activities (e.g., full name, registered address, registered capital, business scope);
- basic information on the business resources of the franchisor (e.g., trademarks, proprietary technologies, business models);
- basic information on the franchising expenditures (e.g., franchising fees, deposit, payment, refund);
- information on prices and conditions of the products, services and equipment provided to the franchisee;
- plans on continued provision of support or training services to the franchisee;
- the methods and content of guidance or supervision over the franchise activities of the franchisee;
- investment budget for the network of franchises;
- information on the franchisees within the territory of China (e.g., number, regional distribution, operational status);
- abstracts of the franchisor's financial and accounting reports and audit reports for the past two years audited by accounting firms or auditing firms;
- information on major litigation and arbitrations concerning franchises of the franchisor in the past five years, including the cause of action, litigation and arbitration claims, jurisdiction and results;
- information on the records of gross violations (i.e., above a certain threshold of fines or amounting to criminal offences) of the franchisor and its legal representative; and
- the franchise contract:
- a sample franchise contract; and
- a sample of other contracts relating to the franchise if the franchisor requires the franchisee to sign any with the franchisor (or its affiliate).
A franchisor is obligated to provide its franchisees with authentic, accurate and complete information, and keep the franchisees informed of updated information in a timely manner. If a franchisor hides any related information or provides false information to a franchisee, the franchisee will be entitled to terminate the franchise contract and the franchisor may also be ordered to rectify the matter and be punished by a fine of up to 100,000 yuan, with a public announcement if the responsible governmental body (MOFCOM) thinks the franchisor's violation is severe.
Pursuant to the Beijing Appellate Court's Interpretation on Several Issues regarding Adjudication on Franchise Agreement Disputes (effective as of 23 February 2011), the franchise agreement may be invalid when undisclosed false information is material to the operation of the franchise and the franchisee entered into the franchise agreement on the basis of that information. The courts shall also consider the adverse impact of undisclosed or false information in relation to the performance and purpose of a franchise agreement so as to adjudicate whether the franchise agreement is valid. This interpretation suggests that violation of the disclosure obligation does not necessarily render the contract invalid in every instance.
If any of the information provided constitutes trade secrets, the franchisor may ask the franchisee to enter into a non-disclosure agreement.
Within 15 days of entering into a first franchising contract in China, the franchisor is required to make a filing with the Ministry of Commerce. The franchise contract template, operational manual, business plan for the proposed franchising arrangement and the documents evidencing that it has satisfied the relevant requirements to serve as a franchisor must be submitted as part of the filing.
Regulations are not clear on what constitutes a 'first franchise agreement'. It may be interpreted that the franchisor should only file the franchise agreement concluded with their first franchisee but not every franchise agreement it enters into. According to informal enquiries to the Ministry of Commerce, the franchisor should record as a template the franchise agreement entered into with its first franchisee. After this filing, the franchisor is required to make an online renewal of this filing at the MOFCOM website each year in March to be able to register any new franchisees. This confirms that the franchisor does not need to record every franchise agreement entered into with new franchisees.
iv Mandatory clauses
The franchisor and the franchisee must enter into a written franchise contract; and the main content of the franchise contract shall include the following:
- basic information in respect of the franchisor and the franchisee;
- content and term of the franchise;
- type, amount and payment method for the franchising fees;
- specific content and methods for providing business guidance, technical support, business training and other services;
- quality requirements and standards for the product or service and methods for assurance thereof;
- sales promotion, advertising and publicity in respect of the product or service;
- protection of consumers' rights and interests and the assumption of compensation liabilities in the franchise;
- alteration, annulment and termination of the franchise contract;
- liabilities for breach of the contract; and
- methods for dispute resolution.
The franchisor and the franchisee may stipulate in the contract any other matters as they like.
The qualification and validity of a franchise agreement would depend upon the nature of the actual commercial arrangement as set out in the relevant agreement among the parties, even if the agreement itself was not identified as a franchise agreement. This question has been confirmed by the Supreme People's Court recently. The Supreme People's Court also decided on whether a franchise agreement should be invalidated where the franchisor does not comply with the above franchise-related requirements. The question of the non-compliance of the franchisor appears to depend upon whether the non-compliance is remediable; for example, failure on the part of the franchisor to comply with the requirement of directly operating at least two stores will not affect the validity of its agreements with franchisees, whereas franchise agreements entered into by any non-enterprise entity or individual (which by law is not permitted to enter into franchise agreements) will be deemed as invalid.
v Guarantees and protection
The laws and regulations relating to guarantees and protection under Chinese law that are applicable to general commercial transactions would also apply to franchising activities in China, but there are no provisions specifically applicable to franchising.
i Franchisor tax liabilities
There are no specific tax duties for franchise operations. Any company incorporated in China shall pay corporate income tax on its profits. Unlike most business operators, franchisors as such do not have to file consolidated tax returns covering consumption tax, corporate income tax, etc. However, franchisors must pay taxes on fees received under the franchise agreement, which are generally all subject to value added tax.
ii Franchisee tax liabilities
As business operators, franchisees would have to file consolidated tax returns covering value added tax, consumption tax, corporate income tax, surcharges, etc.
iii Tax-efficient structures
Whether a structure is tax efficient will depend on specific aspects of the franchise.
Impact of general law
i Good faith and guarantees
The duty of good faith is one of the key principles set out in Chinese contract law. A party that breaches its duty of good faith may find itself liable for the damages incurred by the other party as a result of the breach.
ii Employment law
The courts are unlikely to treat the franchisees as employees of the franchisor, but the franchisor should provide clear statements with respect to the independent nature of the relationship between the contracting parties stated in the relevant franchise agreements, and make clear that the franchisee is responsible for bearing the responsibility as an employer of the individuals employed in the franchise, and that those individuals are not employees of the franchisor.
iii Consumer protection
In the event of consumer claims in relation to franchise operations, Chinese law gives consumers the choice of claiming against either the franchisee or the franchisor. A franchisor may consider indemnifications by franchisees individually in the franchise agreements. In addition, MOFCOM requires franchisors and franchisees to clarify and disclose to MOFCOM in advance each party's responsibilities for consumers in the franchise agreement.
We are not aware of any specific circumstances under Chinese law whereby franchisees would be treated as consumers.
iv Competition law
The laws and regulations relating to competition and antitrust under Chinese law that are applicable to general commercial transactions would also apply to franchising activities in China, although there are no antitrust cases currently involving franchising. It is permissible for a franchisor to exercise control over the franchisee business. Given the increasing enforcement activities by the Chinese competition law authorities, however, it is important to bear in mind that restrictions imposed on the franchisee should not go beyond what is necessary and proportionate to the aims of protecting know-how, brand unity and licensed IP rights. Specific attention has been paid in recent years to fixed-price clauses in retail and distribution agreements; such clauses are prohibited under Chinese competition law since it is difficult to justify them in relation to franchise networks.
v Restrictive covenants
There should be no problem with imposing non-compete or other restrictive covenants so long as they do not violate any competition rules or obviously break the principle of fairness. Any non-compete or other restrictive covenants should be set out in the franchise agreement or other agreement to be enforceable. The Chinese laws and regulations applicable to general commercial transactions would also apply to franchising activities in China.
Chinese laws and regulations that are applicable to general commercial transactions, including termination and transfer of businesses, would also apply to franchising activities in China.
Regarding post-contractual obligations of franchisees, some are stipulated by laws. For instance, a franchisee has contractual and post-contractual obligations to keep the franchisor's trade secrets confidential, whether or not this is agreed by the franchising parties in writing. As to any other post-contractual obligations, franchisors may impose them on franchisees by contractual agreement.
vii Anti-corruption and anti-terrorism regulation
The laws and regulations relating to fraud, anti-corruption and money laundering under Chinese law that are applicable to general commercial transactions would also apply to franchising activities in China, but there are no provisions specifically applicable to franchising. Corrupt and fraudulent behaviour in retail operations are generally widespread, however, so franchisors should implement protective measures against related legal non-compliance and financial risks.
viii Dispute resolution
Contracting parties may elect to settle disputes by arbitration or litigation, and with respect to contracts with a foreign element (i.e., involving one or more foreign parties), arbitration or litigation may take place offshore. At this time, mediation is still not commonly used as a dispute resolution mechanism in China.
Parties that choose to settle disputes by litigation may stipulate that disputes be settled in a Chinese or foreign court with jurisdiction (e.g., located where the contract is signed or performed). However, because it is difficult to enforce a foreign court judgment in China, a foreign party to an agreement should not choose to resolve disputes by means of litigation in a foreign court unless the Chinese party has assets under the jurisdiction of that foreign court. In the absence of these circumstances, it would be prudent to stipulate that disputes be settled by binding arbitration in a neutral location. The arbitration clause must be drafted to expressly provide final and binding arbitration as the sole and exclusive means for resolving any and all disputes arising under or in connection with the agreement, and the arbitration tribunal designated for this purpose should be named in a clearly identifiable manner. Any ambiguity or other flaws in the arbitration clause may result in invalidation of the clause itself, which would allow a party to refuse to submit to arbitration and leave litigation in a Chinese court as the only viable alternative, or render an award obtained by arbitration under that arbitration clause unenforceable.
The parties may elect to submit their dispute to arbitration before any internationally recognised arbitration commission. As a signatory to the New York Convention, China's courts are obligated to recognise and enforce arbitral awards issued by arbitration tribunals in the country of other signatories to the Convention.
Notwithstanding the above, it may be prudent to carve out an exception so as to give a party the right to seek injunctive relief from any competent court with jurisdiction over the subject matter. This may be useful in cases involving infringement where damage control is necessary, as it is faster to obtain and enforce injunctive relief from a court where the activity at issue takes place. While a case is pending, injunctive relief (preservation of property or evidence and other specific injunctions) may also be sought in urgent circumstances (e.g., instances involving IP infringement), and China's IP laws provide an efficient mechanism for seeking these interim remedies. An applicant that submits an application for injunctive relief must post a bond or provide another form of guarantee. Within 48 hours of an application for injunctive relief, the court must respond with a written decision and must notify the applicant of its decision within five days. Within 15 days of the order for injunctive relief being issued, the applicant must file a complaint with the court, otherwise the injunctive order will be vacated. However, Chinese courts are not bound to follow the agreement of the parties with respect to a party's right to injunctive relief, notwithstanding the fact that it is expressly set out in the agreement. The court is at liberty to review the circumstances to determine whether to order specific performance, or to grant injunctive or equitable relief, and may still require the party seeking relief to prove damages and post a bond or other security. But notwithstanding the above, the provision should not be deleted from the agreement as its inclusion in the agreement may have a persuasive effect on the judge and a deterrent effect on the other party.
There have been various cases involving franchise arrangements in the courts over the years, some of which have been identified by the Supreme People's Court as being noteworthy cases. One of those cases, decided in 2012 by Shandong Province High Court, addressed the issue of an implied obligation on the part of franchisors to avoid competing with their franchisees in the same geographical territory. In that particular case, the franchisor opened a branch company within 200 metres of its franchisee, and both were offering similar real estate agency services. The court held that because of the nature of a franchise arrangement and based on the principle of good faith, a franchisor should reasonably avoid operating in the business territory of its franchisee so as not to threaten or affect the normal operation of the franchisee. The franchisor was ordered to immediately cease the business operations of its branch company.
Since the amended Commercial Franchise Operations Registration Administrative Measures took effect on 1 February 2012, the government has made a significant effort to regulate and monitor franchising activities in China. However, the barriers to market entry in the franchising business have risen with the increasing costs of real estate, equipment, goods and labour, and made it more challenging to make sustainable profits in these businesses. As an example, to cut down on costs, fast-food outlets have sought to reduce their labour costs by trying to automate many of their work processes and by centralising goods production.
Franchising in China has long focused on many industries relating to retail, food and beverages, and services. The education sector has been booming with high growth rates since around 2005, but reports in late 2013 suggested that certain subsectors in the Chinese education market have become saturated and appear to have slowed down. In particular, the Chinese Private Education Promotion Law, which was passed in 2003 to encourage private funding of non-profit schools and amended in 2013, 2016 and 2018, provides that dual-curriculum schools may only be organised as non-profit entities for the nine-year compulsory education phase of the curriculum. It also provides that the sponsors of non-profit schools cannot obtain profits from running these schools. When the Ministry of Justice published a circular seeking public comments on the Implementing Regulations of the Law of the People's Republic of China on the Promotion of Private Education (Revised Draft) (Draft for Review) (the Draft) on 10 August 2018, there were substantial concerns that the rules may be further tightened for the education business and its foreign investors. The Draft proposes a number of amendments to the prevailing version of the Implementing Regulations. In short, the proposed changes are yet again trying to prevent operators in the educational sector avoiding the need to comply with existing regulations. Additionally, the State Council issued the 'Opinions on Deepening Education and Teaching Reform and Comprehensively Improving the Quality of Compulsory Education' in June 2019, which reiterates that a core Chinese curriculum should be taught and that overseas curricula shall not be taught in the compulsory years, which may make it more difficult for dual-curriculum schools to cooperate with overseas schools, by franchising or other means. Apart from the aforementioned restrictions on the nine-year compulsory education phase, the pre-school education phase is also restricted by another policy issued by the State Council in December 2018, entitled 'Several Opinions on Deepening Reform and Standardising Development of Preschool Education'. This policy prohibits the control of state-owned or non-profit kindergartens through merger and acquisition, franchise or variable interest entity structures.
One of the fast-growing and most promising market areas is currently the baby-and-mother market. However, the traditional franchising models in this market have suffered largely from e-commerce and parallel import competition, but, on the other hand, e-commerce itself is a fast-changing area and one closely supervised by the Chinese authorities. Another area showing optimistic signs is the technology sector, while some other industries have been suffering slow or even negative growth. The government is working through a 10-year plan called 'Made in China 2025', to accelerate the development of high-tech industries and aiming to spearhead in telecommunications, robotics, new-energy vehicles and high-end automation research and development.
1 Sven-Michael Werner is a partner at Bird & Bird.
2 The Franchise Measures are no longer valid; they have essentially been replaced by the Administration Rules on Commercial Franchise Businesses enacted on 6 February 2007 with effect from 1 May 2007.
3 Trademark Office of the State Administration for Industry and Commerce of the People's Republic of China.