News & Insights

Changes to Franchisor’s Disclosure Obligations and Franchisee’s Confidentiality Obligations

China effected major changes to its 1997 franchise administrative measures (trial) in 2005, defining more clearly the way foreign brands might operate franchise businesses in China. The 2005 administrative measures applied to commercial franchising in China, and were revised and replaced by the currently prevailing “Administrative Regulations on Commercial Franchise (商业特许经营管理条例)” (“Franchise Regulations“), effective 1 May 2007.

A foreign invested enterprise seeking to operate franchising as a franchisor in China must necessarily meet the pre-requisites spelt out under the Franchise Regulations, including possession of a required track record; a good reputation with no prior record of fraudulent franchising conduct; the right to grant to others the use of relevant trademarks, know-how, business system or other intellectual property; the capability to provide long-term operational guidance and training and a commitment to provide relevant goods and/or services.

Under the Franchise Regulations, the franchisor is also required to discharge certain registration and filing obligations with the Ministry of Commerce or its local bureau (“MOFCOM“), including:

  1. registration of the franchisor with MOFCOM within 15 days of signing its first franchising contract; and
  2. filing of an annual report with MOFCOM, before 31 March of each year, to update the number of franchising contracts entered into in the preceding year, among other things.

Additionally, the franchisor is required to disclose certain information to a prospective franchisee in writing at least 30 days prior to signing the franchising contract. Details of the information required to be disclosed were originally set forth in the “Administrative Measures on Disclosure of Commercial Franchising Information (商业特许经营信息披露管理办法)” of 1 May 2007 (“2007 Disclosure Measures“). The 2007 Disclosure Measures were amended and replaced by the new “Administrative Measures on Disclosure of Commercial Franchising Information (商业特许经营信息披露管理办法)” (“2012 Disclosure Measures“) with effect from 1 April 2012. Major changes and adjustments effected are as outlined below:

  1. The 2012 Disclosure Measures widened the scope of affiliated parties to include the franchisor’s individual shareholders. Thus, where this applies, it will be necessary to provide requisite information in relation to such individual shareholders as the franchisor’s affiliates, particularly as regards an individual shareholder who will be involved as the supplier or provider of relevant products, equipment, services, or business resources such as intellectual property or know-how, to the franchisee.
  2. The 2012 Disclosure Measures specifically exempt the franchisor from the disclosure obligation in case of a renewal of a franchising contract on the same terms and conditions.
  3. Disclosure of the franchisor’s bankruptcy status in the past 2 years, rather than 5 years.
  4. Disclosure of the litigation/arbitration history of the franchisor (or its affiliate, if applicable) is limited to franchise business related litigation/arbitration.
  5. Instead of providing the content or index page and applicable pages of the technical support document, information on the manner and plan by which to provide technical support is to be provided.
  6. Information on the methods and content of guidance or supervision to be provided by the franchisor will have to include specifics on the manner by which the plan shall be implemented, including site selection, store decoration and management, advertising and promotion, product configuration, etc.; franchisee’s obligations and liabilities; how to respond to customer complaints and allocation of liability, etc.
  7. Rather than disclosing information based on the appraisal or evaluation of the franchisees’ businesses, the franchisor is now required to disclose information on the status of operation of its existing franchisees, including the amount of actual investment, average sales volume, costs, gross profit, net profit etc., as well as the corresponding sources of information.
  8. The franchisor is required to provide information on the litigation/arbitration cases (whether material or not) arising from its franchising business in the past 5 years, including the cause of action, claim, jurisdiction and outcome in each case.
  9. The confidentiality obligations of the franchisees (including prospective franchisees) are expressly expanded to:
a.  prohibit a franchisee from disclosing or misusing the franchisor’s trade secrets which came to its knowledge in the process of concluding a franchising contract, regardless of whether the franchising contract was eventually concluded;
b.  provide for the franchisee’s confidentiality obligations to automatically survive the termination of the franchising contract; and
c. render the franchisee liable for losses suffered by the franchisor or other parties caused by the franchisee’s breach of its confidentiality obligations.

It seems clear that the amendments and adjustments made to the disclosure requirements are intended to facilitate the supervision and administration of commercial franchising by the relevant authorities, and enable them to regulate the franchising market in China. The interests of the franchise operators are being fairly protected at the same time, signifying the government’s effort in creating a more friendly environment to attract foreign investment in franchising in China.

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