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China: The new frontier

China is one of the largest franchise markets in the world. Increasingly, franchise systems of all sizes are looking toward China as a possible avenue for expansion. Franchising is a method of distribution – one possible avenue to provide products and services to consumers. Whether you are an established franchise system or you have a new product or service that you are attempting to market, now is the time to start thinking about China, if for no other reason than to protect your trademarks and service marks.

Before engaging in franchise operations, a franchisor is required to register the trademark licensing agreement in accordance with the Trademark Law of the People’s Republic of China and its implementing rules. China, like many foreign countries, is a “first to file” country. Thus, if you do not take steps to protect (i.e., register) your marks in China today, there is a risk that when you are ready to enter China, your name may no longer be available without resorting to unpalatable options such as purchasing your marks from a prior trademark registrant or engaging in difficult legal proceedings.

Businesses are increasingly using the franchise business model to expand into China. As a condition to its accession into the World Trade Organization, China made a commitment to lift restrictions on foreign investment in franchising. As a result, the Ministry of Commerce of the People’s Republic of China promulgated the Measures for the Regulation of Commercial Franchise (Measures), which became effective February 1, 2005. Prior to their promulgation, franchising in China was fraught with uncertainties. The intent of the Measures is to promote “healthy and orderly development of commercial franchising” in China, and although certain provisions of the Measures remain open to interpretation, the general consensus is that they will have a positive impact on franchising in China.

As is the case in the U.S., the Measures require a franchisor to make numerous pre-sale disclosures. A franchisor is required to provide a prospective franchisee with a written disclosure document and a copy of the franchise agreement at least 20 days before signing the agreement. The franchisor’s obligations include disclosure of, among other things, financial information, estimated initial investment, source of product and supplies, and information on existing and terminated franchisees.

In general, these are the types of disclosures that are provided in the U.S. and elsewhere.

However, the Measures add a somewhat unusual disclosure obligation – that the franchisor make all disclosures “requested by a franchisee.” This provision could, in effect, expand the disclosure obligations to an unlimited number of items. Furthermore, this provision could arguably apply to existing franchisees in addition to prospects – imposing onerous disclosure obligations on the franchisor. This is especially important because the Measures impose liability on the franchisor for “economic losses” caused by “inadequate disclosures or misrepresentations.”

In addition to the disclosure requirements, the Measures contain a number of substantive provisions that significantly impact the franchisor-franchisee relationship. For example, the Measures require that the term of a franchise agreement generally cannot be less than three years. Similarly, there is a unique provision that imposes liability on the franchisor for certain products and services provided by its designated third-party suppliers.

Moreover, the Measures require a franchisor to operate in accordance with the principles of fair dealing, honesty and trustworthiness – terms that are open to interpretation.

One of the most important and controversial provisions of the Measures requires a franchisor to operate two “company-owned” units in China for more than one year prior to offering franchises for sale. This requirement, in effect, requires a franchisor to establish a local presence in China through a foreign-invested enterprise (FIE). All FIEs must register with and receive approval from the applicable governmental agencies, in accordance with the procedures established in the Measures, prior to offering franchises. Greenebaum has assisted a number of clients in establishing FIEs, and has considerable experience in this area.

The Measures are still relatively new, and it is likely that they will continue to evolve over time. While the Measures were issued at the ministry level (more akin to a regulation issued by a governmental agency), it is anticipated that the Measures will ultimately be replaced in the future by formal legislation, tentatively titled the Commercial Franchise Regulation. This regulation has been pending before the State Council of the People’s Republic of China for some time.

However, the extent to which this Regulation will amend or change the Measures is yet to be seen. Thus, it remains important for businesses to continue to monitor the changing franchise landscape in China.

Any decision to expand into China should be considered in light of a business’ overall global expansion strategy. China is just one of a number of countries that have implemented pre-sale disclosure requirements.

A business looking to conduct international franchising should consider whether it wants to use a single “international” disclosure document, a traditional uniform franchise offering circular with a country-specific “wrap,” a country-specific disclosure document or a geographic or language-specific disclosure document. Such a decision will depend largely on the nature of the franchise system and scope of international expansion. Thus, all businesses, whether an established franchise system or new and expanding business, should consider their long-term expansion strategies into China and elsewhere as early as possible.

  • Patrick J. Welsh
    Senior Partner

    Pat is a member of the Business Services Department. He is involved in the day to day activities of the Firm's clients, and advises them with respect to acquisitions, contractual issues, real estate and other business related topics ...



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