G2000 v. 2000: Do Fear the Domino Effect

In my previous post, I indicated that G2000 has a much bigger problem ahead. Here is why.

Only one issue might be on appeal at the Zhejiang Higher People’s Court --the 20 million Yuan in damages for Plaintiff. No matter how the Court decides, Defendant G2000 will desperately want another bite at the apple regarding the validity of Plaintiff’s “2000 ” mark, but that is just a fanciful wish. In Chinese trademark litigations, as well as other civil trials, parties only get one appeal, which already occurred at the Beijing Higher People’s Court. Second, Beijing 1st Intermediate People’s Court and the Beijing Higher People’s Court have the exclusive jurisdiction on administrative trademark cases, which renders Defendant’s fanciful wish even more distant from reality. In short, Plaintiff’s “2000 ” mark is valid for the goods/services registered for, and that is written in the stone as of now, unless Plaintiff somehow forfeits it at a later date. But that is not the concern here.

So, what do all these mean to G2000, the big Hong Kong fashion company, the successful and expanding international franchisor?

IT IS ALL BAD NEWS for a number of reasons!

First, obviously, G2000 will be ordered to cease the use of the “G2000” mark on its ties, socks, belts, and scarves. Well, relatively speaking, this is no big deal since what franchisees can do to G2000 is a tremendous headache. Since trademark, in most cases, is the core of a franchise system, uncertainty in the trademark casts a very long shadow on the franchise system itself. If the G2000 mark violates the rights of another with respect to the types of goods complained of, G2000’s franchise system suffers a major loss in its family of trademarks, and that translates into a major loss in revenues.

Second, Chinese franchisees can sue G2000 for violating the Chinese franchise regulations. Pursuant to the Regulations on the Administration of Commercial Franchise, a franchisor must disclose to prospective franchisees the status of its intellectual property, and its disclosures must be complete, accurate, and truthful. See Arts. 22-23. If in the unfortunate event that G2000 did not disclaim or disclose the status of its litigations on the “G2000” mark, it could find itself in a heap of trouble with the Chinese franchise regulators (AICs, and the Ministry of Commerce). The administrative penalties for violation of these Regulations can be substantial. See id., Art. 24-29. What is worse, franchisees could sue G2000 for breach of contract, fraud, and repudiation of the contract because of the failure to disclose. See id.

Third, as part of the domino effect (if number 2, above, occurs), G2000’s entire franchise system in China will be in jeopardy. It will have to deal with possible lawsuits from its some 436 franchisees. In addition, the named co-defendants won’t want to share the blame for the joint and several liability in the original law suit. Furthermore, G2000’s image, no matter how bright and attractive, will have been tarnished not only among its consumers, but more importantly among prospective franchisees. Growth and expansion in China through franchising, the fastest growing method of product distribution in China, will suffer at the minimum a slow down.

As one can see, one big mistake, especially in a company’s overall IP strategies in China, could have far-reaching impact on its bottom line. In this age of globalization and commercialization, intellectual property, trademark in this case, is of utter importance. Without a comprehensive, proactive, and sound IP strategy, franchisors march into China at their own peril.

American Passport & China Franchise Registration

What do getting an American passport and registering a franchise in China have to do with each other? Normally, I would say NOTHING unless you have to register your franchise personally in China (which by the way is totally unnecessary).

Now, I think one word accurately describes them both---hard.

If you are an American and you need a passport to travel this summer, my deepest sympathy goes to you for what will have to endure to acquire it. Images of people encircling a passport office in the summer heat makes me feel lucky about my passport experience in China seven years ago.

The Bush Administration initiated a new security rule requiring all U.S. citizens to show their I.D. and proof of U.S. citizenship at border crossing. (Read about it here.) This requirement threw Americans quiet a bit, and a large number of Americans began to apply for a passport at the beginning of 2007. Passport offices, faced with a sudden increase of applications, are not equipped with the necessary personnel and equipment to process the applications, thus generating a back log of applications. When travelers figured out that if they do not do something to speed up the application process, they would not be able to leave the country as planned. Hence, the long lines.

The root of the problem is governmental regulations without the requisite resources to carry them out.

Chinese franchise regulators have created just the same problem. Three pieces of franchise regulations went into effect on May 1, 2007:

Regulations for the Administration of Commercial Franchising Operations
Commercial Franchise Registration Management Measures
Commercial Franchise Information Disclosure Management Measures

These new regulations did away with pre-approval in order to franchise in most industries in China. However, they impose mandatory registration and disclosure duties on franchisors. For American franchisors, registration and disclosure are nothing new because disclosure is required under the FTC Franchise Rule, and 15 states require registration as well. Registration of franchises, however, is new to both Chinese franchisors and regulators in that it has not been done before, and administrative glitches abound, to say the least.

Both local and central governments are not adequately equipped and prepared to implement the registration rules. Registration of a franchise in China involves a large quantity of paper work to be reviewed by regulators, and documents filed by franchisors are to be archived by the government. In addition, franchisors are required to amend material changes and file annual reports with the regulators. These mandates inevitably necessitate personnel, equipment, office space, and other resources.
A lack of planning and preparation is not the end of the story. At the end of 2006, China has about 26,000 franchise systems in place according to an industry report. Mandatory registration requirement means all of the 26,000 plus franchise systems must be registered before May 2008 to avoid administrative penalties. Imagine the amount of documents, the volume of phone calls, and number of inquiries that the regulators would have to keep up with. I am not even counting all of those foreign franchisors impatiently waiting to cash in before the 2008 Olympic gold rush.

The Chinese franchise regulators are not prepared, if not overwhelmed, to carry out rules made by the government.

With due respect to regulators in China and the U.S or elsewhere, regulating personal or commercial activities ain’t as simple as passing a law (sorry to state the obvious). Before making people do or not do something, it benefits all if the government would do a little bit more planning.

Please!

Chinese Franchise Regulation: What Next?

With the promulgation of three pieces of key legislation, the Regulations, the Disclosure Management Measures (“Disclosure Guidelines”), and the Registration Management Measures (“Registration Guidelines”), the Chinese government has made significant strides in creating a systematic, efficient, and predictable franchise regulation regime. Undoubtedly, a well-established regulatory system in a dynamitic and relatively new product/service distribution model—franchise will theoretically lead to greater success for franchisors and franchisees alike.

The recent published 2007 China Franchise Industry Report [Chinese only] provides detailed statistics on the tremendous growth of franchising in China. To illustrate, China boasts of franchise systems in excess of 2,600, and franchised units exceeded 200,000 by the end of 2006. All that growth happened in a matter of nine years, starting in 1997 with the enactment of an interim franchise adminitration regulation.

China currently has already two great things going for exponential growth of the franchise scene: a fairly well-established regulatory regime coupled with a market ripe for affordable, proven business investment opportunities.

So, what is left in the regulatory puzzle?

In comparison with the U.S. franchise regulations, China has not compiled a Uniform Franchise Circular Offering (“UFOC”), which is the standard information disclosure document for franchisors. The FTC has officially adopted the UFOC format with some changes in 2007, and franchisors to franchise in the U.S. will have to comply with the mandatory disclosure requirements by 2008. Will China institute a standard, uniform disclosure document similar in nature to the UFOC? Or will it elect to just let the Disclosure Guidelines and the Regulations serve as the regulatory blueprint for franchisor disclosure? The Chinese Ministry of Commerce issued some opinions during a press conference on June 15, 2007 relative to the implementation of the Disclosure Guidelines and Registration Guidelines.

In the conference, the speaker stated that: “the Ministry of Commerce will continue to improve regulations on disclosure and registration systems…” This is not a definitive answer as to whether a UFOC like document will be instituted in the future.

In addition, the speaker also indicated that on the agenda of the Ministry of Commerce with respect to franchising regulation are the following:

1. to continue research into franchise contract regulation so as to effectively avoid contract fraud;

2. to continue to look for solution to balance the rights and interests of both franchisors and franchisees; and

3. to ensure and guide the healthy development of the franchise industry in China.

While the Ministry of Commerce work on its "to improve-and-renew-agenda", the current regulatory regime should be sufficient to protect the interests of franchisors and franchisees.