The International Hotel Law Review: China

Introduction

China is the second largest hotel market in the world by revenue, just behind the United States, with a wide gap to the third-largest market, which is Japan. All market segments are well developed as it would be expected in such a large market but there are certain aspects to the landscape of operators that are unique to China. This is partly due to regulation, such as the separation between local and international players, only the latter being subject to the foreign investment legal regime that is still relatively restrictive compared to the legal framework applicable to the local hotel industry.

Market growth has been astonishing throughout the past 20 years, and it is no surprise that all internationally operating hotel brands have flooded into China to get a piece of the huge market and the expected growth. The top end of the market has traditionally been dominated by the well-known international brands, but Chinese operators are working hard to develop new hospitality brands for the luxury segment. While room rates in particular in the luxury segment in China are comparatively low, the expansion of the market even in cities with saturated markets goes on, often as part of a branding strategy to make Chinese consumers familiar with the respective brand to benefit from future bookings in more profitable markets once people resume travel overseas. However, there is relatively little genuine outward expansion in the global hospitality sector from China so far, despite a short-lived spike of purchases of global brands and hotel properties around 2016, including the iconic Waldorf Astoria Hotel in New York City and the Club Med chain, investments often made by investment conglomerates rather than hospitality businesses.

Market entry

As a country with a strictly regulated real estate market, in its early days, China tried to limit foreign investment in domestic real estate projects. As a result, it became extremely difficult for foreign investment to directly enter the hospitality industry.

To echo the restriction, the Ministry of Construction, Ministry of Commerce, National Development and Reform Commission, People's Bank of China; State Administration for Industry and Commerce and State Administration of Foreign Exchange jointly issued opinions on the Standardization of Access to and Administration of Foreign Investment in the Real Estate Market (Jian Zhu Fang [2006] No. 171) on 11 July 2006 (Document No. 171).

Document No. 171 requires overseas institutions or individuals to establish a foreign-invested real estate enterprise when purchasing not-for-self-use real estate in China.2 However, even if a foreign-invested real estate enterprise is established, it cannot apply for any domestic or foreign loan, nor obtain approval from foreign exchange administrative departments for conversion of foreign currency into local renminbi. This applies, if such foreign-invested real estate enterprise (1) fails to pay all its registered capital, (2) fails to acquire the certificate for using state-owned land, or (3) its capital for project development does not reach 35 per cent of the total project investment amount.3

Following Document No. 171, on 1 September of the same year, the State Administration of Foreign Exchange and the Ministry of Construction jointly issued the Document Concerning the Regulation of Foreign Exchange Administration of the Real Estate Market (Hui Fa [2006] No. 47) (Document No. 47). Document No. 47 details the requirements on foreign exchange operations in the real estate industry and essentially made it very difficult in practice for foreign capital to enter the domestic real estate market.

The above restrictions of foreign investment in real estate are also reflected in the Catalogue of Guidance for Foreign Investment Industries 2007. Foreign investors' construction and operation of upscale hotels falls into the restricted category, which requires more approvals to be obtained than for domestic enterprises. The larger the total investment of the project, the higher the level of authorities' approval to be obtained for the project. This could go up to the State Council, and in practice, it would be difficult to obtain such approval.

Although the Catalogue of Guidance for Foreign Investment Industries was revised in 2011, the control of foreign investment in the real estate industry has been tightened, rather than liberalised. The construction and operation of villas that originally sat under the restricted category, were directly classified under the prohibited category. This change indicated China's conservative attitude towards foreign investment in the upscale real estate industry at that time.

Given the contemporary advances in China's domestic real estate market and the more accessible Chinese business environment, the Catalogue of Guidance for Foreign Investment Industries 2015 loosened the restriction for foreign investment. This version of the Guidance lifted the restrictions of foreign investment in construction and operation of upscale hotels so that foreign investment could legally enter the domestic hospitality industry. Since 2018, the Catalogue of Guidance for Foreign Investment Industries has been replaced by a Negative List for Foreign Investment. The current effective Negative List (2020 version) has no provisions to restrict or prohibit foreign investment in the hospitality industry.

In 2015, the Ministry of Housing and Urban-rural Development and Other Authorities issued the Notice on Adjusting Policies on the Market Access and Administration of Foreign Investment in the Real Estate Market (Jian Fang [2015] No. 122), which amended some of the provisions in Document No. 171. For example, the ratio of registered capital to total investment of foreign invested real estate companies was amended. Consequently, such a ratio could be set with reference to the ratios applicable to general foreign-funded enterprises. Also, it lifted the requirement that foreign invested real-estate enterprises must fully pay its registered capital before handling domestic loans, foreign loans and settlement of foreign exchange loans.4 These measures have further relaxed the requirements for foreign investment into the real estate industry in China.

Although China no longer excludes foreign-funded enterprise investment, management and construction in the hospitality sector, in practice, foreign-invested real estate or hotel management companies are still having difficulties with foreign exchange settlement. This is to a greater extent compared to general foreign-funded enterprises based on Document No. 171 and Document No. 47, which are still effective.

Regarding the process of company establishment, the Interim Administrative Measures for the Record-filing of the Incorporation and Change of Foreign-invested Enterprises issued by Ministry of Commerce in 2018, requires the competent commercial authorities to adopt a filing mechanism,5 instead of the prior review and approval mechanism, for most foreign-funded enterprises. In terms of the process, foreign-funded enterprises can complete the filing through online management systems of the commerce department. The competent authorities will need to conduct a formal examination of the materials submitted by foreign-funded enterprises online. This simplifies the establishment procedures compared to the previous approval mechanism to a great extent.

At present, there are no special restrictions set by the Chinese government on legal forms to be adopted by foreign investors for the development or management of hotels. Therefore, wholly foreign-owned enterprises (WFOE), joint ventures or cooperative enterprises with Chinese partner(s) (EJV or CJV), or branches of WFOE/CJV/EJV are all feasible legal forms.

With regard to tax, domestic enterprises established by foreign investors, as resident enterprises, shall pay 25 per cent enterprise income tax in accordance with the Enterprise Income Tax Law. In addition to enterprise income tax, the tax regulations of the real estate industry were also adjusted, replacing business tax with value added tax (VAT) from 1 May 2016.

Legal structures

An important aspect of the legal structures used for operating hotels is the form of real estate ownership. In China, ownership of land can only be held by the state or rural collectives. All other entities or individuals can only acquire land use rights on such state or collectively owned land. State-owned land can only be used by legal and other persons who hold a land use right over the land. Land use rights are generally conveyed by the state through a bid, auction and listing or grant.

Depending on the approved land use purpose, owners of a real estate property can only enjoy the land use right for a limited period of time. For example, the term of use for residential purposes is 70 years, whereas the term of use for commercial, tourism and entertainment purposes is 40 years. For the rest (i.e., industrial, education, science technology, culture, public health, sports purposes and so forth) the term is 50 years.

In China, there are two popular types of hotels, one is the traditional hotel model, the other is the condominium hotel model. A condominium is an apartment building in which each apartment is owned by the person who lives there. Condominium hotels, deemed as commercial real estate, exist in almost all major cities in China beside the traditional hotels.

The term of use for residential real estate and commercial real estate is different. Taxes levied on commercial real estate, public utility costs, construction standards and property management fee standards are higher for commercial real estate than for residential real estate. A major driver of this has been the categorisation of condominium hotels as residential real estate.

With more and more condominium hotel developers trying to sell their hotels as residential real estate, in May 2010, the Beijing municipality issued a local regulation under which the development of condominium hotels were no longer permissible for hotel-related land use right purchases approved after 30 May 2010. This effectively meant that smaller property titles on a guest room by guest room basis could no longer be granted to individual owners in Beijing. Since then, governmental authorities in other first and second-tier cities issued similar local regulations to close the door on new condominium hotel projects.

According to the Circular of the Ministry of Housing and Urban-rural Development and Other Authorities on Adjusting Policies on the Market Access and Administration of Foreign Investment in the Real Estate Market, a branch or a representative office of a foreign institution established in China (except for the companies that are approved to operate real estate businesses) and a foreign individual that works or studies in China may purchase commercial property for the purpose of self-use or living. In the cities that implement such restrictive policies on property purchasing, foreign individuals shall satisfy such local policies before purchasing a property.

An overseas institution or individual that purchases real estate in China that is not for self-use must follow the principal of commercial presence. It means a foreign investment enterprise relating to foreign investment in real estate needs to be established. When applying to establish a real estate company, land use rights and ownership over relevant structures shall first be obtained. Alternatively, a preliminary agreement for transfer or purchase of land use rights or building ownership rights signed with the land administration department, the land developer, or the owner of said buildings shall be obtained. Where an already established foreign-invested enterprise expands their business to include real estate development or management, or a foreign-invested real estate enterprise engages in the development or management of a new real estate project, an application for an increase in business scope shall be filed with the examination and approval authorities.

Popular business models include management and franchising models, which mainly focus on high-end and low-end to mid-level hotel brands respectively and are discussed below.

Leases

In principle, parties are free to negotiate and agree on the terms of hotel leases. However, a typical lease may contain the following provisions:

  1. details of the parties and leased premises;
  2. rental, deposit and payment term (including payment of property management and utility);
  3. usage;
  4. lease term;
  5. liabilities on repair and maintenance;
  6. liabilities of breach;
  7. termination and indemnification; and
  8. dispute resolution.

Longer lease term is generally preferred for hotel leases; however, the term of a lease cannot exceed 20 years for all types of leases. In general, tenants are not guaranteed right of renewal at the end of the contractual lease term under the prevailing Chinese law. In China, many hotel leases adopt fixed and tired rent, meaning rent payable remains the same during certain period of time, for instance, three years but is typically subject to an increase and reach next tier of rent rate. Turnover rent is not a prevailing market practice in China for hotel leases. Development clauses are very common and normally included in many hotel leases, which gives the landlord the right to redevelop the building over the course of a typically long-term hotel lease. Many hotel leases provide the landlord with a right to terminate and re-enter the leased premises in the event that the tenant breaches the lease agreement and fails to rectify such breach within a stipulated period of time upon notice. With regard to insurance under hotel leases, in practice, the landlord usually purchase insurance policy for the property and meanwhile require the tenant to purchase insurance covering damages caused to the leased premises or third parties and require its name to be added as additional insured.

Intellectual property and branding

Foreign hotels, whether or not entering the Chinese market, may face various challenges on intellectual property rights in China. Infringers and free riders can usually be found after the brands are known by Chinese customers. It is much easier and quicker now, thanks to the development of social media, for tourists to share their overseas travelling experience.

With respect to trade names, a hotel's unauthorised use of another business' corporate name (including its shortened name or trade name) or the name of an individual (including his or her pen name, stage name, translated name, etc.), which has influence to a certain extent in society, violates Article 6 of the Anti-Unfair Competition Law. Such hotels shall, in a timely manner, undergo name modification registration. Before its name is modified, the original enterprise registration authority shall substitute its unified social credit code by its real name.6

In China, company registration is handled by municipal level governmental departments separately. The officers will only check whether there is a hotel using a same or similar name in the same city. Therefore, one can register a local company using a name identical or similar to other brands to operate a hospitality business in China, unless the brand has a well-known Chinese name. In this case, the infringer may create a 'legitimate' ground of using the brand. The brand owner may push them to change their trade names based on the prior registered trademarks, reputation, and fame in China. However, such complaints need to be filed and tried case by case. The procedures will be costly and sometimes the outcome will be unfavourable. Failure to change the company names will be a setback but there are other available options. If the brand owner can prove a prior right and a reasonable reputation, it will have the right to forbid the infringer from prominently using the trade name. Therefore, it is important to conduct trademark registrations as a very first step, keep good records or evidence of promotions in China and regularly monitor the market even before the brand formally enters China.

With respect to trademarks, even if a hotel does not register a trademark similar to another hotel's pre-registered trademark within the same industry, its prominent use of other pre-registered trademarks (shape or text) in its trade name, service, decoration that could cause confusion in the market would infringe the exclusive right of pre-registered trademarks.

Brand owners need to choose a formal Chinese name or mark as early as possible and build a connection between the Chinese name and the original brand. Trademark hijackers may try to expand the scope of the goods (i.e., besides the goods most relevant to the hospitality industry (Classes 35 and 43)), they will also register the marks in the potentially linked classes (e.g., towels or bedding (Class 24), shampoo/soap (Class 3) and cabinets (Class 20)). Therefore, defensive trademark registrations are always useful to block the attempts of infringers and can secure own rights to use the hotel brand and logo on accessories. In the new Trademark Law, which took effect on 1 November 2019, 'registration not for the purpose of use'7 is added as a reason to invalidate the trademarks. It is deemed as a signal that the administration will not tolerate the abuse of registered trademarks by hijackers.

Establishing a fake website is cheap but useful to attract guests to the wrong hotel. Such copycat hotels are usually of low quality and price, which harms the reputation of the copied brand. Taking quick action (e.g., domain name dispute complaint) to shut down the infringing website should in these cases be a priority. More serious action can be taken against repeated infringers, including a civil action or an administrative action. A fraudulent website usually includes pictures copied directly from the original website, which is a straightforward case of copyright infringement. It is also possible that the counterfeiters take photos themselves in the genuine hotel and then use them to promote the copycat hotel. In theory, a person who takes a photo owns the copyright of the photo and it will be hard to claim copyright infringement. However, a competitor of the hotel who makes use of such pictures to promote their own hotel will be deemed to have falsely advertised and committed 'other acts of confusion sufficient to mislead a person into believing that a commodity is one of another person or has a particular connection with another person',8 therefore violating the Anti-Unfair Competition Law of China.

Some risks may be experienced during cooperation with different vendors.

For the interior decoration, it is a common practice that international hotels will provide a unified style or internal standard for a local construction team to follow. The same construction team may serve other hotels and use its previous work as a template. When the decoration style is recognisable, it may be used to confuse guests. Besides setting a reasonable fine in the decoration agreement to forbid the construction team from using the materials in other projects, it is generally a good idea to clarify that any intellectual property rights generated during the construction shall be owned by the hotel. Similarly, the hotel shall seek to own and register all relevant intellectual property (e.g., design patents) of any customised furniture, ornaments and daily necessities. If there is any violation of the exclusive right to use these materials, the hotel may not only claim a breach of contract by the construction team, but also obtain an injunction for the use of the same materials.

All the hotels display artwork such as sculptures, photographs or paintings, in their public areas. For valuable artwork, international hotels usually engage sourcing agents or artwork consultants to search relevant artwork, either domestically or globally. This may lead to issues with third-party intellectual property rights in such artwork. Hotels often defend themselves with a legitimate source, proven by the agreement, statement and warranty signed by the sourcing agent, the artwork consultant, or the artist. Such a defence may help to avoid paying compensation if the hotel can present good evidence to prove that it is the liability of the sourcing agent, the artwork consultant or the artist. However, the hotel may still be obliged to cease further infringement by destroying or removing the alleged artwork if the third party is seeking such an injunction, causing losses to the hotels. Therefore it is reasonable to ask for an indemnity from the contracted sourcing agent, artwork consultant or artist if the final artwork infringes any other party's intellectual property right.

In China, the Music Copyright Society of China acts as a centrally authorised party for all the music copyright owners. They deal with music licensing issues between the owners and the users. There is usually a certain term for the licence and, therefore, the hotels need to pay attention to renew the contract in a timely manner, avoiding any infringement due to the expiration of the licence.

Data and hotel tech

Companies operating in the hospitality sector are currently facing significant challenges in reviewing their data collection and processing systems, particularly, if they are adopting new technologies to help them with room reservations, check-in and check-out, and payments as is currently the trend not only for luxury brands. In the normal course of business hotels are collecting highly sensitive data such as guests' identification numbers or passport numbers, medical health and credit card details.

The coming into force of the EU General Data Protection Regulation (GDPR) – the EU's cornerstone data protection law – has not only changed the data privacy landscape in Europe, but also served as the global reference point for privacy and data protection laws, shaping legislation worldwide, including in China. China has been taking significant steps to develop its data protection laws. The Cyber Security Law (CSL), the newly passed Data Security Law (DSL) and the newly passed Personal Information Protection Law (PIPL), together form the troika of the regulatory framework related to data management in China (together as the China Data Protection Legislation). Meanwhile, data protection provisions are also scattered in different sectoral laws and regulations, including, for example, the Civil Code, Criminal Law, Tort Law, Consumer Rights Law, telecommunications regulations and so forth. Regarding enforcement, China also does not have a independent authority responsible for enforcing provisions in relation to the personal data protection. The enforcement responsibilities are mainly shared, among others, by three government organs, namely the Cyberspace Administration of China (the CAC), the Ministry of Industry and Information Technology and the Ministry of Public Security.

The CSL came into effect on 1 June 2017, together with a few other regulations and measures (some are still in draft status as of September 2021) broadly regulating the collection, storage, transmission and use of personal information by critical information infrastructure operators (CIIOs) and network operators, which hotels are very likely to be. Before the adoption of the PIPL and in the absence of a dedicated personal information protection law, the recommended National Standards on Information Security Technology – Personal Information Security Specification (GB/T 35273–2020) (the PI Specification), has played an important role in providing guidance for compliance in personal information processing. The PI Specification is also called the China GDPR, as the GDPR has served as the primary model during the drafting of this set of national standards. This non-binding guideline contains detailed requirements on data handling and data protection (i.e., excessive collection of users' personal information, forced collection) and bundled authorisation is not allowed. Chinese government authorities are known to apply the PI Specification as an important measure of compliance coupled with binding data protection laws and regulations.

The long-awaited PIPL was officially adopted on 20 August 2021 and will take effect on 1 November 2021. The PIPL is a significant milestone on China's road to personal information protection. The PIPL echoes not only the existing data protection provisions under the CSL, the Civil Code and the newly released DSL, but it also enhances data protection by introducing new concepts and codifying the accumulated best practices from home (e.g., the PI Specification) and abroad (e.g., the EU GDPR) into law. Companies operating in the hospitality sector will be required to comply with data protection requirements of the PIPL upon its effectiveness, such as

  1. following principles of lawfulness, legitimacy, necessity and good faith, legitimate purpose and data minimisation, transparency, accuracy, accountability, security and storage minimisation;
  2. relying on the appropriate legal basis for data processing;
  3. where consent is required, ensuring satisfying consent standards including being fully informed, freely given and unambiguous, and obtaining separate consent in specific circumstances stipulated in the PIPL;
  4. complying with personal data transfer rules;
  5. responding to data subject right requests such as requests to access, correction, erasure, portability, objection and restriction, etc., where appliable; and
  6. adopting data accountability and data governance measures such as conducting a personal information protection impact assessment and keeping records of processing, assessing the need for a data protection officer, responding to data breach notification, etc.

One of the challenges faced or will be faced by companies in the hospitality sector is the requirements for the transfer of personal data. Under the CSL, to obtain the informed consent of data subjects for transferring or disclosing any of their personal data to a third party is necessary, though it lacks detailed requirements as to the nature of the consent. However, consent to an overseas data transfer may be implied by a person's actions, for example, when sending international emails or instant messages, making international phone calls or conducting international transactions over the internet in accordance with the draft Guidelines for Cross-Border Data Transfer Security Assessment released by The National Information Security Standardisation Technical Committee in May 2017. In addition, the latest revisions in the draft Security Assessment Measures issued by the CAC require all network operators to obtain regulatory approval for transfers of personal data outside of China. This burden is more onerous than the self-assessment procedure under the previous draft and would have significant implications for companies in the hospitality sector as network operators. However, regulatory approval for repeat or continuous transfers of personal data to the same recipient would not be required unless there is a change to the type of data being transferred, the purpose of the transfer, or the permitted retention period. It is also worth noting that the PIPL introduces a new personal information transfer framework (i.e., data export by CIIOs and organisations processing a certain amount of personal information to be designated by the authority will be subject to the security assessment requirement), while other types of data export can be achieved by entering into a standard contract (which is to be formulated by the authority) with data recipients, obtaining data protection certification, etc. On top of the above, the PIPL also provides that information notice is required to be provided to, and 'separate consent' collected from, data subjects whose personal information will be transferred.9

In light of these new regulations to be subsequently adopted, the PIPL to be effective, and further implementation rules to be released, companies are required to carefully review their IT structure, internal processes and internal data protection or privacy policies and develop new governance procedures or revise the existing ones to safeguard guests' privacy rights. The China Data Protection Legislation imposes a mandatory obligation on companies to promptly inform relevant authorities and data subjects in the event a data incident has occurred, or is likely to occur, and to take immediate remedial action. Draft Regulations on the Multi-Level Protection Scheme (MLPS) of Cyber Security require network operators to report cyber incidents to the local branch of the Ministry of Public Security within 24 hours. In addition, under the National Contingency Plans for Cyber Security Incidents effective on January 2017, cyber incidents are required to be reported to the Cyber Security Coordination Office of the CAC under several circumstances.

In terms of data security, the DSL, promulgated on 10 June 2021 and taking effect from 1 September 2021, is now adopted to further enhance data security by establishing a fundamental and categorised data security system applying to data processing carried out within the territory of China, and to entities and persons located outside China if their data processing activities impair the national security, public interest and people's legitimate interest in China. Unlike the CSL, which contains provisions applicable to personal information and certain other data, the DSL focuses simply on 'data' and has wider application. Companies in the hospitality sector should take active and prompt action – if not done already – to assess whether and how the DSL applies to their data processing activities within and outside China, and what data security governing measures they should further put in place.

For multinational companies operating in the hospitality sector or multinational companies doing business in China in general, it is necessary to know about the China-specific add-on to its global data protection and cybersecurity compliance programme. This includes data localisation and security assessments where applicable prior to cross-border data transfer, personal information security impact assessments, and a multiple-level protection system.

Hospitality was the third-most targeted industry after retail and finance in an onslaught that has left few corners of the industry untouched, according to a 2018 report from information-security firm Trustwave Holdings. Hilton Worldwide Holdings Inc., Hyatt Hotels Corp. and InterContinental Hotels Group have all been targeted in past attacks, as well as Trump Hotels, Radisson Hotel Group and Mandarin Oriental. The most recent investigation of a large industry player was Marriott International, which announced that it had taken a US$126 million charge in the second quarter, primarily as a result of the data breach it announced in 2018. Coincidentally, on 9 July 2019, the UK Information Commissioners Office, which enforces the GDPR in the UK, announced that it intended to impose a fine of £99,200,396 on Marriott for its data breach. The stakes are only getting higher. Hotel companies are experimenting with voice-operated technology and internet-connected rooms that could mean storing an increased amount of personal information, such as biometric data or what time guests go to sleep. Although cost-sensitive investors see more immediate returns from money spent on new carpeting rather than intangible security measures, ignoring compliance with new regulation, in particular around technology, may come at a very high cost.

Franchising of hotels

For various reasons, international hotel chains have been using the franchise business model to quickly enter the Chinese market in the past decades, as it is an asset-light model from the franchisor's perspective. The hotel sector has traditionally been one of the key sectors for using the franchise business model worldwide as it offers the franchisors opportunities for quickly entering a new market by employing the local connections and resources of franchisees while themselves enjoying wide flexibility.

In China, franchise laws require that franchise agreements are in writing and include several provisions, including:

  1. basic information about the franchisor and franchisee;
  2. the content and term of the franchise agreement;
  3. the type, amount and payment method for franchise fees;
  4. standards of operation for the franchised business, including the technical support, operational guidance and service training to be provided by the franchisor;
  5. the quality standards for the products or services and methods for assurance thereof;
  6. allocation of responsibility for the promotion and advertising of the business;
  7. allocation of responsibilities and liabilities for the protection of consumer rights;
  8. provisions regarding modification or termination of the franchise agreement;
  9. relevant liabilities when the franchise agreement is violated; and
  10. dispute resolution mechanisms.10

Furthermore, franchise agreements must contain a cooling-off period in which the franchisee may unilaterally terminate the agreement.11 The length of the cooling-off period is not prescribed by the franchise regulations and should be negotiated by the parties in good faith.

International franchisors should follow certain formalities of executing a contract in China to ensure that it can be enforced against the franchisee (i.e., the franchisee's official name in Chinese must be used). If the franchisee is a legal entity, the contract must be signed by a legal representative or a person with a valid power of attorney from the legal representative and must be sealed with the company's official seal.

Within 15 days of entering into the first franchise agreement in China, the franchisor must make a filing with the Ministry of Commerce (MOFCOM),12 including all information required to evidence that the franchisor satisfies these requirements. This generally includes providing a copy of the franchise agreement template, registration certificates for trademarks or copyright (e.g., logo) used in the franchise system, evidence of compliance with the 2+1 rule, the corporate registration certificate, the operations manual and business plans for China.

The above-mentioned documents to be filed with MOFCOM must be translated into Chinese. Documents that are prepared abroad must be notarised and legalised at the Chinese embassy in the country of origin.

The franchisor must renew this filing online via the MOFCOM website in March each year to be able to enter into new franchise agreements. Provided the franchisor complies with this, there is no need to register each agreement entered into after the first agreement.

China has modified the regulatory framework governing franchise activities several times in the past. Before 2007, foreign franchisors were required to operate at least two self-owned stores within China for more than one year (known as '2+1' rule) before they were permitted to franchise their brands or services to local Chinese franchisees. New franchise regulations issued in 2007 eased the above requirement by stipulating that a foreign franchisor would satisfy the 'two stores, one year' requirement provided it had operated two self-owned stores in its home country or other jurisdiction, not necessarily in China.

A guideline concerning the self-owned and self-operated stores for record filing of commercial franchises purpose published on MOFCOM's website provided clearer guidance for hotel management companies seeking to determine whether they meet the 'two stores, one year' requirement. Hotels under direct management of the hotel management company can be deemed self-owned stores. This means that once the hotel franchisor has directly managed two hotels in China or other jurisdictions for more than one year, it is entitled to conduct franchise business in China. However, when an applicant submits the documentation for MOFCOM filing it would need to submit the management agreement entered into between the franchisor and the hotel. The rationale behind this was that the hospitality sector requires large investments and does not always provide for self-owned and self-operated stores. In principle, the business model is pure exporting management services in the form of franchising.

Apart from the contractual requirements for franchise agreements in China, a franchisor also needs to satisfy the pre-contractual disclosure requirements through providing a disclosure document to each franchisee, at least 30 days before signing the franchise agreement. There is a prescribed list of information the disclosure document must contain, including:

  1. information about the franchisor and franchise activities, business resources (IP, technology, business model, etc.);
  2. information about the franchising expenditure – fees, deposits, etc.
  3. details of continuous services to be provided (i.e., operating guidance, training and technical support);
  4. details of the existing franchisees within China;
  5. information about investment budget for a franchise location;
  6. abstracts of the franchisor's financial and accounting reports and audit reports for the last two years;
  7. details of any major litigation concerning franchisees in the past five years; and
  8. summary of key terms of the franchise agreement.13

While it is not mandatory to provide the disclosure document in Chinese, it is recommended to avoid an argument that the local franchisee could not understand the information provided. Franchisors must keep franchisees updated on any changes in the information provided.

Hotel management agreements

In China's hospitality industry, the business model of management contract dominates the high-end hotel market, especially for quasi-five-star and above hotels. Foreign management companies coupled with foreign management teams are the major business model, while domestic management companies are still facing challenges. Under the management contract business model, hotel owners generally provide land use rights (land use rights are capable of being sold, leased or assigned provided certain conditions are fulfilled, i.e. the land has been suitably developed pursuant to the land grant contract), buildings, furniture, facilities, equipment and various certificates for operation to the management company. The first hotel in China using a hotel management contract structure is the Jianguo Hotel, which opened in the early 1980s on Chang'an Street in Beijing. The management company is the Hong Kong based luxury hotel Peninsula Group formally known as 'The Hongkong and Shanghai Hotels, Ltd'.

Otherwise, the standards and practices for hotel management contracts are much in line with international standards because this model has been imported to the China hospitality market by international chain brands when they entered the market, looking for a suitable business model in this so far unknown market.

Employment law

As a labour-intensive industry, the hospitality industry is always populated by employees with various levels of professional skills, experiences and issues.

Unlike other industries, employees in the hospitality industry are required to work long and irregular hours. Most hotel staff work eight hour shifts, but many employees actually work up to 12 hours a day or overnight without proper overtime payments because hotels use a comprehensive or flexible working hours system that gives them greater flexibility and lower costs. Many front-line staff face challenges when clocking in overtime or extra shifts during holidays. Common cost management measures include the widespread use of student interns and agency workers, who are often paid less than the minimum wage and have no social insurance.

China's strict employee-friendly labour laws pose hurdles to such practices. Article 36 of the Labour Law provides that the state shall adopt a working hours system, where labourers work for no more than eight hours a day and no more than 44 hours a week on average. Article 38 of the Labour Law provides that the employing unit shall guarantee that its staff and workers have at least one day off in a week.

Lack of workplace protection is another significant issue in relation to employees' health and safety. Many hotels, whether budget hotels or luxury hotels, have minimum protection provided to their employees. Though many have a magnificent lobby and gorgeous dining rooms, the back of the house is oftentimes sub-standard. Employees must walk in narrow, dark, dirty and low-ceiling spaces with potential safety risks. It is not uncommon that employees who work in the kitchen get hurt by equipment, getting cut, burned or other common injuries due to the lack of or incorrect training or misleading instructions. Creating a safe and harmonious workplace environment is the duty and responsibility of the hotel as an employer.

Given the general market conditions in China's hospitality industry, many international hotel chains employ foreign employees in China, particularly at the managerial level or above. Therefore, expatriate recruiting and management is one of the key components of a successful HR strategy for China's hotels. Problems often arise out of or in connection with work permits or residence permit applications. Immigration policies are subject to constant changes and require regular monitoring to comply with these, particularly considering the regular enforcement campaigns against foreign nationals illegally staying or working in China. Most recently, China introduced a classification mechanism (classification into three different levels) according to the labour market's needs. Taxation of foreign nationals' income can be complex and rather different from other countries. This means that dedicated management capacity is required to understand and correctly apply these taxation rules. Examples include; tax breaks on worldwide income, tax exempted allowances and social insurance payment exemptions for expatriates from certain foreign countries.

As a result of the seasonal patterns the hospitality industry is exposed to, there is often a shortage of staff in frontline and low-end service positions. For numerous reasons, many hotels outsource certain routine work that is not customer facing, or does not require in-depth training of respective staff. China may pose issues to such practices because staff outsourcing is subject to specific labour dispatch regulations and labour dispatch licences to be held by the dispatching entity. These need to be carefully reviewed to ensure compliance with the law. In practice, there may be numerous situations that constitute 'de facto labour dispatch'.14 For example, where an employer uses workers under the name of 'hire of work', 'outsourcing', etc. To determine 'de facto labour dispatch', decisive factors are usually employment management, the main payer of labour remuneration, the settlement method of contract expenses, and the qualification or licence of labour dispatch.

Many businesses, small or large, in the hospitality industry do not have a clear set of employment related policies and procedures (i.e., employee handbook or code of conduct). In some cases, employee handbooks have been issued but did not go through the required formal process. In other cases, the code of conduct is formed, but fails on reasonableness requirements. Therefore, every hotel should have a set of well-crafted written standard policies and procedures, so that employees know what is expected of them. If an accident happens or a legal action is brought against the hotel, the hotel may use the set of policies and procedures as part of a defence in a court of law or an arbitration tribunal.

Dispute resolution and management

China does not have a long history of formal western-style dispute resolution practices. The hospitality industry was one of the earliest industries that opened up to foreign investment, and have, therefore, been on the forefront of forming practices and usage for international businesses operating in China bridging the – sometimes perceived – gap between international ways of doing business and local behaviour, some of them grey area or simply illegal in nature. This has subsequently caused legal disputes.

In China, the predominant dispute resolution methods are:

  1. settlement by negotiation;
  2. litigation;
  3. arbitration; and
  4. court or arbitrator-administered mediation.

If parties to a hotel management agreement or other commercial agreements cannot resolve the disputes between them through amicable negotiation and reach a settlement agreement, the other two basic options, namely litigation and arbitration, are the alternative and basic methods of resolving the dispute.

For litigation, a general procedure for a civil claim in the first instance shall be concluded within six months of the commencement of the proceedings15 (the period for trial of foreign-related civil cases by courts shall not be subject to the six-month time limitation and restriction).16 A first instance proceeding includes a couple of steps from the registration of the complaint by the claimant and filing by the court, notification of the defendant and submission of defence, related evidence and counterclaims (if any), and finally the hearing to issue the judgment. In general, Chinese courts follow two instances of trial. Normally, the first instance judgment or ruling is not final. The second instance judgment or ruling becomes legally effective immediately and then is final.

Court practices can vary significantly across China, though the quality of Chinese court litigations is improving. Overall, arbitration remains a better option for dispute resolution in China, unless the parties can settle the case through negotiation. In principle, arbitration proceedings are confidential and not open to the public.17 Arbitration provides for a final and binding arbitral award that makes it comparably faster than litigation. Also, decisions are made by specialised neutral arbitrators selected by the parties,18 independent of any intervention by administrative organs, social organisations or individuals.19 For requesting interim relief (for example, to preserve evidence or assets) or enforcing an arbitral award in China, you still need to engage PRC courts.

Foreign court judgments are rarely recognised and enforced in China. However, China is a party to the New York Convention for the Recognition and Enforcement of International Arbitral Awards. Chinese courts readily recognise foreign arbitral awards from other member countries of the New York Convention,20 subject to certain exceptions such as order public that may serve as a ground for refusal.21 The non-enforcement of foreign arbitral awards and the setting aside or non-enforcement of domestic arbitral awards with foreign-related elements are both subject to a reporting mechanism established by the Supreme People's Court (SPC) in 1995.22

For court or arbitrator administered mediation, judges or arbitrators often suggest mediation during the proceedings (often with the same judge or arbitrator as the mediator), which is otherwise quite unusual.

Under PRC law, parties to a civil commercial contract are free to choose laws governing their commercial contract if the contract is 'foreign-related'.23 Foreign-related contracts are defined as contracts containing any of the following characteristics: (1) either party or both parties are foreign citizens, foreign legal persons or other organisations or stateless persons; (2) the habitual residence of either party or both parties locate outside the territory of the PRC; and (3) the subject matter is outside the territory of the PRC; (4) the legal fact that leads to establishment, change or termination of the civil relation happens outside the territory of the PRC; or (5) other circumstances that may be determined as a foreign-related civil relation.24

However, even if a commercial contract is deemed 'foreign-related', Chinese law must apply in some instances (e.g., for Sino-foreign equity or cooperative joint venture contracts).25 In addition, foreign law cannot govern a contract where mandatory laws, regulations or prohibitions on foreign related civil relations apply,26 or if its application will damage the social and public interest of the PRC.27

For example, a foreign-related contract for the management of a Chinese hotel may be governed by Hong Kong law, but the terms in relation to the protection of the hotel's employees' rights and interests or the terms concerning food or public health security would be governed by Chinese law based on Article 10 of the Interpretation of the Supreme People's Court on Several Issues Concerning the Application of the Law of the PRC on Foreign-Related Civil Relations (I).

Therefore, non-Chinese parties shall adopt the following approach: (1) consider whether Chinese law is legally required; (2) if Chinese law is not legally required, to select a law that is familiar to the party; (3) if Chinese law is the governing law, to engage a qualified lawyer to review the contract.

Like most countries, China also has laws in force to prohibit anticompetitive behaviour, which can often be a source for disputes with authorities and competitors alike. Breaching these laws is a criminal offence and may result in significant fines, the closure of businesses and jail terms for management as well as the offender. In serious cases, regulatory authorities may commence investigations and raid the offices of a company to collect evidence. If the company does not accept a decision made by the SAMR, for instance, it may apply for administrative review or file an administrative lawsuit.

The key legislation is the Anti-Monopoly Law (AML), which came into effect on 1 August 2008. Meanwhile, China has a separate Price Law and Anti-Unfair Competition Law (amended in November 2017 to remove some provisions that overlapped with the AML) that collectively provide the regulatory framework to safeguard genuine competition among businesses, driving efficiency and economic growth. Anticompetitive behaviour is illegal. The AML is applicable to monopolistic practices that include:

  1. the conclusion of monopoly agreements between operators, unless the operators can demonstrate that the monopoly agreements they entered into are for the purpose of improving technology or research and development, enhancing product quality, reducing costs, improving product efficiency or unifying product specifications or standards, enhancing overall competitiveness of small and medium-sized enterprises and those that are aimed at protecting public interest, such as environmental protection or energy conservation;28
  2. the abuse of a dominant market position by operators; and
  3. mergers that may have the effect of eliminating or restricting competition.29

This law is also applicable to monopolistic practices outside China that have an effect of eliminating or restricting market competition in China.

If a hotel has a dominant market position, the following conduct by a hotel will be considered abusive and hence prohibited: pricing below cost, refusing to trade without justified reasons and requiring exclusivity, implementing tie-in sales such as hotel packages that restrict choice or imposing other discriminatory or unreasonable trading terms without justified reasons.30 Furthermore, a hotel with a dominant market position abuses its position by selling products or services at unfairly high prices to its customers or buying at unfairly low prices from its suppliers.

Outlook

There are no updates at this time.

Footnotes

1 Sven-Michael Werner is a partner and Grace Zhao is an associate at Bird & Bird..

2 Part I Article 1 of the Standardization of Access to and Administration of Foreign Investment in the Real Estate Market (Jian Zhu Fang [2006] No.171).

3 Part II Article 7 of the Standardization of Access to and Administration of Foreign Investment in the Real Estate Market (Jian Zhu Fang [2006] No.171).

4 Part 2 of the Circular of the Ministry of Housing and Urban-rural Development and Other Authorities on Adjusting Policies on the Market Access and Administration of Foreign Investment in the Real Estate Market (Jian Fang [2015] No. 122).

5 Article 2 of the Interim Measures for the Recordation Administration of the Formation and Modification of Foreign-Funded Enterprises (Order No. 6 [2018] of the Ministry of Commerce of the People's Republic of China).

6 Article 18 of Anti-Unfair Competition Law.

7 Article 4 of Trademark Law of the People's Republic of China.

8 Article 6 of Anti-Unfair Competition Law.

9 Article 38 of the Personal Information Protection Law of the People's Republic of China.

10 Article 11 of the Administrative Regulations on Commercial Franchising.

11 Article 12 of the Administrative Regulations on Commercial Franchising.

12 Article 8 of the Administrative Regulations on Commercial Franchising.

13 Article 5 of the Measures for the Administration of Information Disclosure of Commercial Franchises (Order of the Ministry of Commerce [2012] No. 2).

14 Article 27 of Interim Provisions on Labour Dispatch.

15 Article 149 of PRC Civil Procedure Law.

16 Article 270 of PRC Civil Procedure Law.

17 Article 40 of PRC Arbitration Law.

18 Article 6 of PRC Arbitration Law.

19 Article 8 of PRC Arbitration Law.

20 China acceded to the New York Convention on 22 January 1987, which became effective on 22 April 1987. When acceding to the Convention, China agreed only to recognise and enforce awards (1) made in the territory of another contracting state; and (2) concerning differences arising out of legal relationships, whether contractual or not, that are considered commercial under national law.

21 Article 282 of PRC Civil Procedure Law.

23 Article 3 of Law of the PRC on Application of Law in Foreign-related Civil Relations.

24 Article 1 of Interpretation of the Supreme People's Court on Several Issues Concerning the Application of the Law of the PRC on Foreign-Related Civil Relations (I).

25 Article 126 of PRC Contract Law.

26 Article 4 of Law of the PRC on Application of Law in Foreign-related Civil Relations.

27 Article 5 of Law of the PRC on Application of Law in Foreign-related Civil Relations.

28 Article 15 of the Anti-Monopoly Law.

29 Article 3 of the Anti-Monopoly Law.

30 Article 17 of the Anti-Monopoly Law.

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