How Can a Foreign Investor Operate a Commercial Franchise in Mainland China

The Ministry of Commerce of China recently promulgated the Regulations on the Management of Commercial Franchises which are new measures to replace the original regulations. In the face of rising popularity of franchising in China, the Chinese government envisages that there is a need to: (1) regulate commercial franchises; (2) protect the legal rights of the parties; and (3) promote the healthy growth of franchising. 

The new regulations apply to both domestic and foreign investment enterprises (including wholly-owned foreign enterprises and Sino-foreign joint venture). To become a franchisor in China, a company has to meet the following conditions: 

1. It must be a business entity established in accordance with the laws.
   
   

2. It has the right to permit another party to use the relevant trademark, trade name and mode of operations.
   
   

3. It has the capability to provide long-term operation guidance and training service to the franchisee.
   
   

4. It has at least 2 self-operated shops in China; or its holding company/subsidiary has at least 2 self-operated shops in China, each having 1 year's trading record.
   
   

5. For a franchisor which is also a supplier of goods, it has a system that can ensure stable supply and quality of the goods and the supporting services.
   
   

6. It has a sound reputation, with no previous record of involvement in fraudulent activities by way of franchising.

The new regulations stipulate that the term of a franchise should not be shorter than three years. The new regulations provide a list of sample provisions which are normally adopted in a franchise agreement and can be a very useful reference when negotiating the terms of a franchise. It should be noted that the new regulations impose rather onerous obligations on the franchisor to make disclosure. 

Moreover, according to the Foreign Investment Scope of Business Administration Measures promulgated on 1 June 2004, a foreign company cannot act as a franchisor. A foreign company must set up a FIE - either a wholly foreign owned enterprise or a Sino-foreign joint venture to act as a franchisor. In other words, a foreign company established outside China cannot grant franchise to a franchisee in China directly. 

FIEs must take heed of the Foreign Investment Industrial Guidance Catalogue which prohibit FIEs to conduct certain prohibited activities in the form of franchising. FIEs should apply to add "conduct business activities in the form of franchising" into their business scope from the original approval authority and register the change. 

FIEs which have already been engaged in business operations in the form of franchising can continue to conduct business as before, but have to report their business operations information to the original approval authority in compliance with the provisions of the new regulations. 

The new measures certainly will result in tighter control on how FIEs can engage in franchising activities and offer better protection to franchisees which are very often small enterprises. While these measures may prove to be necessary now in China where franchising is still a fresh experience to many domestic enterprises, new development in this area of law is expected when the franchising mode of business becomes one of the norms in the future.

Prepared in August 2005.