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.

Franchising Regulations in Macau, SAR (II)

III. Mandatory Pre-sale Disclosure

Pre-sale disclosure by a franchisor to prospective franchisees is mandatory. As is the norm in many franchise regulations in the world, a franchisor must deliver a written disclosure document detailing the franchised business in accordance with Article 680 of the MCC. A franchisor, however, must note that the MCC does not stipulate a bright-line rule on how many days the disclosure must predate the execution of a franchise contract. The code only requires “adequate advance” disclosure. In comparison with a bright-line 30-day rule in China’s franchise regulation, the flexibility inherent in this rule could potentially cause trouble for a franchisor because a franchisee could always allege that disclosure was not adequately advance. Therefore, a franchisor should keep detailed records of the date when initial negotiations for a franchise, the date of delivery of disclosure, and of course the date of contract. In fact, for those franchisors used to the old FTC Rule (with a tricky trigger disclosure requirement), this MCC requirement should not be difficult to keep up with.

Information disclosure under Macau’s franchise regulation, to a certain extent, resembles that of the disclosure requirements under the Chinese franchise Disclosure Guidelines. The MCC does not prescribe a rigid format for disclosure, such as the Uniform Franchise Offering Circular ("UFOC") in the United States new FTC Rule; rather, it only stipulates a few categories of information to be provided in a truthful manner to prospective franchisees. Here they are:

a) the identification of the franchiser;
b) the franchiser's annual accounts of the last two accounting periods;
c) any judicial proceedings in which the franchiser, the holders of trademarks, patents and other industrial or intellectual property rights related to the franchise are or have been involved, as well as their sub-franchisers, which may directly or indirectly come to affect or render impossible the functioning of the franchise;
d) a detailed description of the franchise;
e) the profile of the ideal franchisee regarding previous experience, level of education and other characteristics that compulsorily or preferably he must have;
f) the necessity and extent of the franchisee's personal and direct participation in the exercise of the franchise;
g) the specifications as to the estimated sum of the initial investment needed for acquisition, installation and entry into functioning of the franchise;
h) the value of the periodic payments and other amounts to be paid by the franchisee to the franchiser or to third parties indicated by him, specifying the respective bases of calculation and what these remunerate, or the purpose for which they are destined;
i) the composition of the franchise network, lists of franchisees, sub-franchisees and sub-franchisers of the network, as well as of those who have left the network in the last 12 months;
j) the profitability of the franchisees' enterprises and the incidence of bankruptcies;
l) the professional experience gained, his know-how and entrepreneurial methods;
m) any services that the franchiser obliges himself to render to the franchisee for the duration of the contract.

See Article 680 (1).

In addition, a franchisor should also provide a sample contract (including relevant addendum) to a prospective franchisee in connection with the disclosure document. A failure to disclose information required in this article constitutes breach by the franchisor of the commercial code, which entitles a franchisee to annulment of the franchise contract. See Article 680 (3).

Relatively speaking, information disclosure as required in Article 680 is by no means expansive in comparison with disclosure in the United States and China. (A detailed comparison is beyond the scope of this post.)

--to be continued...

Licensing Your Trademark in China: One More Thing to Remember

I am on a “trademark” crusade, so I want to beat this dead horse of a topic again.

If you have not registered your trademark in China (the Chinese translation of your mark, including Chinese characters, pinyin, any proprietary pictures, graphics, etc.), you should not even consider signing any licensing agreement at all. Many China bloggers have repeatedly discussed this topic, and I loathe restating the obvious.

Assuming you have done your homework and registered your trademark with the Chinese Trademark Office (“CTMO”), you still have one more regulatory hoop to jump through—submit your licensing agreement to the CTMO and local Industry and Commerce Administration agencies. (Trademark Law of China Article 43)

Please add the above to your due diligence checklist. The failure to notify the CTMO will result in serious consequences. First, you will be subject to administrative penalty for failure to do so. Second, failure to notify the CTMO will unnecessarily make your attempt to enforce the license agreement more difficult. If you did not even follow the Chinese law while doing business there, invoking the protection of the Chinese law will of course make your life a little more complicated. Third, your trademark is likely the most valuable asset, and not doing what is necessary to protect it is just simply not good business practice.

Further assuming that you have done all of the above, your next job is to vigilantly watch the quality of products or services provided under the trademark license. A failure to monitor the quality of products or services under your trademark also bears consequences. Poor quality of products or services under your trademark might cause your licensing to be considered as naked licensing, which could theoretically strip you of your rights in the trademark. In addition, poor quality associated with your trademark might also subject you to administrative monetary penalties. (See Id.)

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.

Official Translation of the New Chinese Franchise Law

The official translation of what is generally known in the West as the Registration Guidelines came out recently on the Ministry of Commerce website. It can be accessed here.

Freedom of Contract in China: Not So Fast Yet (III)

To continue my musing on the topic of governmental, executive intrusion to the freedom of contract in China, I intend to discuss the origin of such power to regulate contract formation, and to shed a little on how the power has been exercised in some locales in China.

Legislative Designation of Executive Power to Regulate Contracts

Article 127 of the Contract Law of the P. R. China designates contract enforcement authorities to departments of the Industry and Commerce Administration and other relevant administrative agencies. However, such authority and power is restricted to “monitoring and handling illegal acts that harm the State or public interests through the conclusion of a contract, in accordance with the relevant laws and regulations.” See 16 Minn. J. Int’l L. 115, 142.


工商行政管理部门和其他有关行政主管部门在各自的职权范围内，依照法律、行政法规的规定，对利用合同危害国家利益、社会公共利益的违法行为，负责监督处理；构成犯罪的，依法追究刑事责任。

In other words, these administrative institutions and agencies are granted a restrictive authority to monitor and handle illegal activities associated with contracts. By inference, they do not have the power to invalidate either contracts or contract clauses unless a crime or illegal acts are involved which injure the State or public interests.

The Exercise of Executive Power in Regulating Contracts

In practice, however, local Industry and Commerce Administration departments enjoy greater power and authority than what is defined in Article 127 of the Contract Law. “Monitor” and “handle” were the two key words that define powers designated, but the power and authority exercised by the Beijing Municipal Department of Industry and Commerce, to my mind, far exceed powers granted by the Contract Law.

For instance, the Circular Regarding Intensifying the Supervision of Contract Terms and Provisions (“Beijing Order”) mandates the usage of form contracts drafted by Department of Industry and Commerce alone or along with other administrative agencies. Such form contracts cover a wide range of commercial agreements:
1. landlord-tenant contracts;
2. home renovation contracts;
3. utilities contracts;
4. business operations training contracts;
5. TV, communications services contracts;
6. Consumer loans, life and property insurance contracts;
7. Travel, transportation contracts;
8. Automobile purchase, lease, and repairs contracts;
9. franchise contracts;
10. Supermarkets transactions contracts.

These contracts, according to the Beijing Order, are under scrutiny. And the governmental scrutiny manifests in two ways. First, contracting parties are encouraged to adopt the form contracts already drafted and circulated for use. Second, parties engaged in the above-list commercial activities can expect to be targeted in inspection. Violations of local enforcement regulations can result in heavy penalties.

Conclusion

The People’s Congress through the Contract Law grants Industry and Commerce Administration and other agencies the power to monitor and handle illegal acts associated with contracts. In reality, however, the power has been expanded beyond its designated sphere of law enforcement. It morphed into the power to draft form contracts for use in a wide range of commercial transactions. Although the use of such draft contracts is not yet mandatory, it surely would not surprise a business person in China when they do some day.

Freedom of Contract in China: Not So Fast Yet (II)

In yesterday’s post, I examined local rules affecting the freedom of contract, especially the Beijing and Shanghai Orders that declare certain contractual terms and provisions per se illegal and void. The local municipal governments' power to interfere with parties’ contract in this fashion led me to conclude that the basic spirit of freedom of contract has been violated by the Orders. Today, I want to continue the discussion by observing the stipulations on the topic of contract validity in the Contract Law of the P. R. China. [note: my comments are largely based on the article written by Professor Steven Hsu published in the Minnesota Journal of International Law. See 16 Minn. J. Int’l L. 115]

Per Se Void Contracts

Contracts, pursuant to Chapter Three of the Contract Law of P. R. China, can be invalid and void in the following five circumstances:

1). Contract executed through fraud or under duress, thereby harming the interest of the State;

2). Contract between parties who have colluded in bad faith, thereby harming the interest of the State, the collective, or an innocent 3rd party;

3). The contracting parties have hidden an illegal purpose under the disguise of a legitimate contract;

4). The contract harms public interests; or

5). The contract violates a mandatory provision of laws or administrative regulations.

Per Se Void Contract Clauses/Terms

Individual contract clauses, likewise, can also be per se invalid if they violate public policy or interests. Even though the rest of the contract can remain enforceable, clauses that meet the following description are per se invalid according to Article 53 of the Contract Law of P. R. China:

1). Clauses that exclude a party’s liability for personal injury sustained by the other party; and

2). Clauses that exclude a party’s liability for damages sustained by the other party through the other party’s intentional misconduct or gross negligence.

Voidable Contracts

Some contract, in contract with per se invalid contract, may be invalidated or voided by the injured parties through either judicial action or arbitration. Void contracts are, pursuant to Article 54, the following type of contracts:

1). The ones that are entered into with material mistake;

2). The ones that are clearly unfair upon execution.

3). The ones entered into when one party was under duress or was defrauded by the other.

The aggrieved party may petition a people’s court to either reform or cancel the contract. Alternatively, the same party may pursue redress through arbitration. But, the petitioned court or tribunal cannot cancel the contract if the remedy sought is a reformation.

Who Has the Authority to Invalidate Contracts?

Obviously, tribunals and courts with proper jurisdiction have the authority to invalid contracts or contract clauses. But the sticky question is—What legal standard shall the adjudicating institution apply where the local statutes/regulations differ from those of the central government?

To be continued…

Freedom of Contract in China: Not So Fast Yet

Freedom of contract plays a crucial rule in most commercial activities, and the basic idea is that both parties get the benefit of their bargain in exchange for the imposed contractual duties. Simply put, you “pay” for what you bargained for in the contract. In order for this basic form of commercial tool to work effectively and efficiently, the parties to the contract must have the freedom to decide what is good and bad for itself, free of other interferences and influences.

However, things do not work 100% well in reality. In the United States, courts sometime step in to declare certain terms and provisions null and void because the enforcement of which violates equity, fairness, or public policy in general. A detailed discussion of this topic is beyond the scope of this post.

In the same vein, contracts can be under scrutiny in China, thus being subject to governmental, administrative interference under the umbrella of consumer rights protection.

For example, the City of Shanghai enacted a municipal statute on July 13, 2000. (ordinance)—Regulations on the Supervision of Contract Terms and Provisions. (上海市合同格式条款监督条例) Similarly in Beijing, the Municipal Administration of Industry and Commerce issued an administrative order, which was blessed by the city government. Titled Circular Regarding Intensifying the Supervision of Contract Terms and Provisions, the order resembles the Shanghai statute. (关于加强北京市合同监督管理若干意见的通知) Hereafter, I refer to the above-mentioned municipal rules as “orders.”

According to the Orders, the following terms and provisions are per se illegal:

A. Terms and provisions that shield the drafting party from the following liability:

1. Liability arising out of personal injury to consumers;
2. Liability arising out of damages to consumer’s property due to intentional tort or gross negligence;
3. Warranty liability provided to consumers along with sale of products or services;
4. Liability due to the drafting party’s breach of contract;
5. Other liabilities under the law due to the drafting party’s breach of contract

B. Terms and provisions that increase consumers’ liability:

1. Unreasonable amount of liquidated damages or contractual damages;
2. Responsibility of operational risks that rightfully belong to the drafting party;
3. Other terms or provisions that unlawfully increase consumers’ liability

C. Terms and provisions that extinguish the following consumers’ rights:

1. The right to lawfully amend or rescind the contract;
2. The right to demand liquidated damages or actual damages;
3. To exercise the right of contract interpretation;
4. The right to litigate in the event of a dispute.
5. Any other consumers’ rights guaranteed under the law.

As a consumer, I am not against the protection of consumer rights. But the pervasive hand-on, in-you-face type of governmental interference in the contractual process, in my humble opinion, is an affront to the basic idea of freedom of contract. Even if there are instances of fraud, unfair contractual practices, governmental interference, like the Orders, is arguably not the most efficient means of correction, and I’d argue that the market itself is in the long term, which includes the consumers at large in a burgeoning market economy.

As a lawyer friend always says:"A litigation lawyer would die for a good argument." However true that might be, the reality of doing deals in China, especially in two of China's largest and important cities Beijing & Shanghai, demands foreign and domestic companies alike to draft contracts carefully so as to avoid the contracts being deemed void.

Franchise in China (IV): Detailed Registration Procedures

Based on information provided by the Ministry of Commerce, a registering franchisor shall follow the following procedures sequentially to properly register.

Step 1
Obtain Username and Password to access the Ministry of Commerce official Website (获取登录号)

1. If franchising is to occur within the boundaries of provinces, autonomous regions, or municipalities, the franchisor or its agent may hand deliver relevant documents to appropriate registering agencies in the province, autonomous region or municipality to obtain username and password. Or, username and password may also be obtained if same documents are mailed to the appropriate registering agencies.

2. If franchising is to occur beyond the boundaries of provinces, autonomous regions, or municipalities, the franchisor or its agent may hand deliver relevant documents to the Department of Commercial Reform and Development located in Dongcheng District, Dong An Meng Dajie to obtain username and password. Or, username and password can be obtained if same documents are mailed to the same office.

Step 2
Sign In at the following URL http://txjy.syggs.mofcom.gov.cn/ (登录系统)

Step 3
Change Password (修改密码)

The initial password assigned to all franchisor are the identical numbers of 000000, so the system will automatically prompt a user to change its password.

Step 4
Fill in the forms and upload documents required under the Registration Guidelines (填报备案资料)

Upon completing the above 4 steps, click on “申报备案” to submit the data and files entered and uploaded.

It is that simple!

Franchise in China--Opportunities & Challenges Come Along with the New Law (III)

More Interpretative Problems

A. Franchisor Disclosure Amendments

Disclosure Guidelines states:

Article Seven With respect to changes to information provided in the
registration, a franchisor shall petition the registering agency to amend such
changes within thirty days of such changes.

Obviously, the letter of the law requires "changes" to be amended, but the sticky issue here is what do "changes" encompass. All changes, material and immaterial? Or just material?

It puzzles that that the government would impose the heavy burden of amending just any changes on a franchisor, especially foreign franchisors who operates in many countries with a high frequency of immaterial changes to the franchise system. But I am not in the position to twist arms with the express provisions in the Chinese law. So I consulted with a Chinese franchise lawyer based in Mainland China. He noticed the ambiguity in the Registration Guidelines too, and he opines that the "changes" referred to in Article Seven of the Registration Guidelines only encompass immaterial changes. Since he is in the process of writing an article on the same topic, I will wait for him to disclose his reasoning behind the interpretation even though I agree with him.

B. "Where exactly do I register?"--Franchisor

Article Three Relevant departments, in charge of commercial regulations in the
Ministry of Commerce, Provinces, Autonomous Regions, and Municipalities, are the
proper registration agencies. If franchising operations are within Provinces,
Autonomous Regions, and Municipalities, shall register the franchise in the
departments in charge of commercial regulations; if franchising operations cross
boundaries of Provinces, Autonomous Regions, and Municipalities, the franchise
shall be registered in the relevant department of the Ministry of Commerce.

Franchising to occur within provinces (省），autonomous regions (自治區），municipalities (直轄市), a franchisor needs to register in government agencies in charge of regulating commerce, and the cities must be the ones what have administrative districts (設區市).

Franchising to occur beyond geographical boundaries of provinces (省），autonomous regions (自治區），municipalities (直轄市), a franchisor needs to register with the Ministry of Commerce.

This rule begs the question: "If a franchisor wants to franchise within its province and beyond, does it have to register with the local agencies and the Ministry of Commerce?" According to a Chinese franchise lawyer, the answer to this question is affirmative.

Franchise in China--Opportunities & Challenges Come Along with the New Law (II)

Franchisor Registration

A. Timing of Registration

According to Article Six of the Registration Guidelines, “a franchisor shall register the franchise with governing registration agency within fifteen (15) days of the date of the execution of the first franchise contract with a franchisee in China.” In the same vein as the analysis above, “days” refer to calendar days rather than business days. And those franchisors already in operations in China have till May 1, 2008 to register their franchises.

B. Required Documents for Registration

Before initiating the registration process, it is advisable for a franchisor to ascertain with which agency to register the franchise. China has a complex administrative structure in that it is divided into provinces, autonomous regions, and municipalities, which are under direct control of the central government. As stated in Article Three of the Registration Guidelines, franchising to take place within provinces, autonomous regions, or municipalities shall be registered in the highest administrative agencies in charge of commercial regulations; whereas franchising to occur beyond or across boundaries of provinces, autonomous regions, and municipalities shall be registered with the Ministry of Commerce of China. Deciding the right place to register a franchise is a crucial first step in the registration process.

After choosing the right place, the next thing a franchisor need to know, naturally, is what documents to prepare for registration. Article Five of the Registration Guidelines is devoted to specifying the requisite documents for registration with any registering agency. Article Five requires the following:

(1) Basic information about the franchise.

(2) Basic information about the geographical distribution of all the franchised units in China.

(3) A copy of the franchisor’s marketing plan.

(4) A copy of the franchisor’s corporate business license or other important documents evidencing eligibility.

(5) A copy of the registrations of the franchisor’s trademarks, patents or other business resources related to the franchising operations.

(6) Documents provided by a commercial regulatory department in a city with administrative districts, evidencing a franchisor’s compliance with Article 7 Section 2 of the Regulations; with respect to company-operated units located outside China, a franchisor shall provide documents evidencing same (including Chinese Translation), which shall be notarized and certified by a Chinese Consulate located in the administrative region as such company-operated units.

The above section does not apply to a franchisor in franchising operations before May 1, 2007, but such a franchisor shall provide a copy of the first franchise agreement executed by both the franchisor and a franchisee inside China.

(7) Sample Franchise Contract.

(8) Table of contents of the Franchise Operation Manual (Must include the page number of each chapter and the total number of pages. With respect to the Franchise Operation Manual accessible via franchise system intranet, provide the estimated pages after printing.).

(9) With respect to franchising of services or products subject to pre-approval pursuant to relevant laws and regulations, a franchisor must provide documents evidencing such approval by relevant government agency.

(10) Franchisor’s affidavit, signed and sealed by legal agent of such franchisor.

A foreign franchisor needs to pay special attention to (6) of Article Five. The Regulations regrettably kept the “two company-operated units for at least one year” requirement (“2 + 1 Requirement”). It is an eligibility requirement whereby only franchisors with two existing company-operated units in operations for over a year can franchise in China. As onerous as it might be, the Registration Guidelines clarified the uncertainty inherent in the Registrations as to whether a foreign franchisor can satisfy the “2 +1” requirement with units in operations in its home country. And the answer is affirmative.

Item (6) suggests that in order to satisfy the requirement, a franchisor, however, has to have the assertion that it has two company-operated units in operation for over a year notarized and certified by a local Chinese Consulate. The Registration Guidelines do not address how item (6) works if the two company-operated units are located in two geographical places far away from each other, for instance Seattle, Washington and Houston, Texas. Shall the two units be notarized and certified by just one consulate or two? To avoid the potential problem of non-compliance, the author suggests that they be certified by the consulate administratively responsible for the location where the unit is.

C. Method of Registration

For ease of management, registration of franchise has gone hi-tech in China. A franchisor can directly fill out items (1)—(3) on the Chinese version of the Ministry of Commerce website: http://txjy.syggs.mofcom.gov.cn/, the rest of the items can be submitted on the same site in PDF format. But in order to start the process, a franchisor has to create an account and password. The English version of the website does not yet have the registration management data base running yet as of May 16, 2007, but the laws have gone into effect for 16 days. Navigating the Ministry of Commerce website is not exactly a breeze even for the author whose native language is Mandarin Chinese. Therefore, a attempting to register in the Chinese government database could present considerable difficulties to a foreign franchisor who has limited knowledge of the Chinese language.

In the unfortunate event that a registering agency finds deficiency in registration documents, the franchisor may be required to submit additional supplemental materials seven days following the initial round of registration. And if the franchisor submits materials as requested by the agency, the agency, according to Article Ten of the Registration Guidelines, is required to register the franchise within ten days of the submission of additional materials. Given the time difference, vast geographical distance, and language barriers, it might in reality take longer than ten days if a problem occurs in the registration process unless the foreign franchisor has local counsel inside China.

D. Changes after Registration

A registered franchisor is also required to file changes and annual reports with the registering agency. Article Seven of the Registration Guidelines mandates that “with respect to changes to information provided in the registration, a franchisor shall petition the registering agency to amend such changes within thirty days of such changes.” (Emphasis added) “Changes” are not modified by any adjectives, therefore, it means any changes, material or immaterial. It seems, undoubtedly, very burdensome to amend any changes with the registering agency. However, the critical word “petition” might be the word that decreases the burden to amend. After changes occur in the franchise system, the franchisor should petition the agency to amend. It is up to the agency to either grant the petition or deny the petition to amend. Logically, if the petition is granted, then amendment becomes mandatory; if not, amendment would be unnecessary. Of course, absent a clear and transparent demonstration of the standards to be used by the agency in its evaluation of the petitions, the franchisors would not know what types of changes ought to be amended and what not to.

Franchisors’ annual report filing seems less problematic than amendments. The bright line rule requires an annual filing before March 31. Article Eight of the Registration Guidelines states that the annual filing report should include basic information regarding new, cancelled, renewed or amended franchise contracts in the past year. Even though the law does not require that amended contracts be offered to future prospective franchisees, the annual filings become public information listed in the Ministry of Commerce website, which is easily accessible for any interested prospective franchisees.

Franchise in China--Opportunities & Challenges Come Along with the New Law (I)

Franchisor Disclosures

A. Timing of Disclosure

Consistent with the Regulations, Article Four of the Disclosure Guidelines requires a franchisor deliver a written disclosure document to a prospective franchisee at least thirty days (30) before the execution of a franchise contract. In addition, the franchisor must also concurrently provide a copy of the franchisor’s sample contract. Nothing regarding first meeting, contemplated in the current U.S. FTC Franchise Rule, is mentioned in the Disclosure Guidelines. Rather, it is the number of days that is the focal point of the time of delivery. Further, Disclosure Guidelines do not mention whether the days are either calendar or business days, but the author believes it is probably safe to assume that the thirty days refer to business days, which is consistent with the new U.S. FTC rule (replacing the ten business days with fourteen days.). In Mandarin Chinese, calendar days and working days have clear distinctions. Calendar days are typically shortened as “days”, whereas working days cannot be shortened. The exact language used in the Disclosure Guidelines is “Days.”

B. Content of the Disclosure Document

Article Five of the Disclosure Guidelines lays out the basic format of the necessary components of a disclosure document. In terms of functionality, the Article Five requirements resemble the current FTC disclosure format. Note that China does not currently have an equivalent of the Uniform Franchise Offering Circular (“UFOC”) in the United States. The following is a summary of the twelve items required under Article Five:

1. Basic information about the franchisor and its franchising activities;
2. Basic information about the franchisor’s business operational resources;
3. Basic information about franchise fees and charges;
4. Information about the pricing, conditions of products, services, and equipments to be provided by the franchisor;
5. Information about continuous training to be provided by the franchisor;
6. Franchisor’s methods and content of guidance for and supervision of franchisee in its operations;
7. Information about the investment budget for a franchise outlet;
8. Information about franchisees inside Mainland China;
9. Abstracts of the franchisor’s audited financials of the most recent two years;
10. Information about major litigations and arbitrations involving the franchisor in its franchising activities;
11. Information about major violations of operations not in compliance with the law, and major criminal violations; and
12. Franchise contract.

C. Areas of Concern for Franchisors

One area of concern for an international franchisor stems from information disclosure about franchisees inside China. If a foreign franchisor already has outlets in China, the franchisor needs to state the number of current franchisees, their geographic distribution, authorized operational areas as well as whether such areas are protected by exclusivity. In addition, earnings claims are required under Section 8 of Article Five, which departs from the current FTC Rule on earnings claims. An interpretative problem arises if a foreign franchise does not have franchise outlets in China yet. Should the franchisor provide earnings claims based on data collected from operational outlets inside the franchisor’s home country? The author does not believe that such earnings claims would be acceptable in China for a number of reasons.

First, Section 8 of Article Five clearly states that article requires information about franchisees inside Mainland China. Obviously, franchisees outside China fall outside the purview of this section. Second, subsection 2 of Section 8 demonstrates a concern for geographical relevance of earnings claims based on data collected inside China since it requires the franchisor to state conspicuously that such claims may differ from actual operational results of other prospective franchisees. Inferentially, earnings claims based on data collected outside China create a greater market relevance issue for any prospective franchisees in China who seek to rely on any indications of profitability.

Another point of concern for franchisors is the ambiguous ban on making earnings claims in a franchisor’s advertisements. Article Six provides: “A franchisor shall not engage in fraudulent and misleading conduct in its marketing and advertising; a franchisor’s advertisement shall not contain propaganda for any individual franchisee’s operational earning results.” Its prohibition of advertisement featuring an individual franchisee’s earnings has sound reasoning because such an advertisement would mislead prospective franchisees where such advertised earnings do not have market relevance to prospective franchisees.

However, Article Six is silent with respect to advertisement using average earnings data. A strict reading of Article Six would lead a reasonable reader to conclude that earnings data based on average operational results of franchisees does not constitute “propaganda for any individual franchisee’s operational earning results” within the meaning of this Article. In contrast to ads based on a specific franchisee’s earning results, ads using average earning results of many franchisees, presumptively, do not have the same mal-effects. (The author doubts the logic of Article Six, but strict reading of a Chinese statute without legislative history does not allow other interpretations absent further administrative opinions on this topic.)

D. Protections for Franchisors

Any franchisor should rightfully have the reason to be concerned about confidentiality before making disclosures to prospective franchisees, especially in a foreign country. In a country like China, where protection of intellectual property is by no means adequate, a franchisor should, however, not retreat from a risk of exposure to IP violation by locals. In fact, a reassuring trend in China has been developing, which ought to dispel some of the fear about rampant IP theft in China. Fore example, Article Seven of the Disclosure Guideline emphatically states that a franchisor has the right to require a prospective franchisee to sign a confidentiality agreement prior to making any disclosures.

Furthermore, Starbucks' victory speaks for itself with respect to IP protection in China. Additionally, reports of widespread IP violations without redress in China typically occur in the sectors of commerce, where the government does not have an effective enforcement framework. However, in commercial sectors, such as franchising, both the courts and the administrative agencies have demonstrated the willingness and will to enforce IP laws rigorously to create a friendly investment environment for foreign capital.

Franchise in China--Opportunities & Challenges Come Along with the New Law

With the recent promulgation of the Commercial Franchise Information Disclosure Management Measures (“Disclosure Guidelines”) and Commercial Franchise Registration Management Measures (“Registration Guidelines”), the Chinese franchise regulatory framework is basically complete. The two Guidelines were drafted and promulgated in accordance with the Regulations of the Commercial Franchise Operations (“Regulations”), and they supplement the Regulations with specific details on its enforcement. Even though the two Guidelines have eliminated a lot of uncertainty in the Regulations, they still have potential pitfalls for foreign franchisors in their compliance measures. The next two blogs aim to to expose the areas where dangers lurk in a franchisor’s attempt to comply with the Guidelines.

Commercial Franchise Information Disclosure Management Measures --Chinese Franchise Regulation

商业特许经营信息披露管理办法

As discussed below, this law came out on the same date as the "Registration Measures", and it similarly contains a few areas of ambiguities, which I am in the process of writing.

MINISTRY OF COMMERCE
OF
THE PEOPLE’S RUBLIC OF CHINA
16TH ORDER 2007

Commercial Franchise Information Disclosure Management Measures has been promulgated during the 6th meeting of the Ministry of Commerce. It shall go into effect on May 1, 2007.

Minister of Commerce

Bo Xi Lai
April 30, 2007

Commercial Franchise Information Disclosure Management Measures

Article One To protect the bilateral rights of franchisors and franchisees, the Disclosure Measures have been promulgated pursuant to the Regulations of Commercial Franchising Operations (“Regulations”).

Article Two The Disclosure Measures apply to all commercial franchising operations inside the People’s Republic of China.

Article Three The affiliated companies in the Disclosure Measures refer to franchisor’s parent company, subsidiaries controlled directly or indirectly by the franchisor who owns either all the stocks or the majority of stocks, or companies controlled directly or indirectly by the franchisor who owns either all the stocks or the majority of stocks.

Article Four Pursuant to the Regulations, a franchisor shall provide written disclosure of information in accordance with Article Five of the Disclosure Measures thirty days before the execution of a franchise contract with a franchisee, and shall provide a prospective franchisee a copy of the franchise contract.

Article Five A franchisor shall disclose the following information:

1. Information regarding the franchisor and the franchise.

(1) The name, mailing address, contact information, registered agent, president, registered capital, operational scope of the franchisor; and information about company directly-operated units, including the total number of units, addresses, and telephone numbers.

(2) A brief introduction of the franchisor’s experience in franchising.

(3) The franchisor’s registration status.

(4) If the affiliated companies provide products and services to franchisees, basic information of such affiliated companies shall be disclosed.

(5) Information about the franchisor’s or affiliated companies’ bankruptcy or applications for bankruptcy.

2. Basic information about the franchisor’s operational resources.

(1) In written form, provide a prospective franchisee with information that can show the franchisor’s corporate name and business resources related to franchising operations, such as registered trademarks, corporate logo and symbols, patents, proprietary technologies, and operational model.

(2) If the above-mentioned operational resources belong to the franchisor’s affiliated company, basic information about the affiliated company shall be disclosed. Meanwhile, the franchisor shall disclose and explain how the franchise system will be dealt with if the contract, between the franchisor and the affiliated company granting the franchisor such operational resources, terminates.

(3) Information about the litigation or arbitration involving the franchisor’s (of its affiliated company) operational resources, such as registered trademarks, corporate logo and symbols, patents, and proprietary technologies.

3. Basic information about franchise fees

(1) The types, amount, standard, method of payment of fees charged by the franchisor and third parties. If such information cannot be disclosed, the franchisor shall state the reasons thereof. If the standards for fees are not uniform, the franchisor shall disclose the highest and lowest fees, and state the reasons thereof regarding such discrepancy.

(2) The conditions for collecting and returning security deposit; time and method of return of such security deposit.

(3) If a fee is required of a prospective franchisee prior to the execution of the franchise agreement, the franchisor shall state in writing the purpose, condition of return, and method of return of such a fee.

4. Conditions and prices of products, services, and equipments provided to a franchisee.

(1) Whether a franchisee must purchase products, services, and equipments from the franchisor or its affiliated company; the price, conditions thereof for such purchase.

(2) Whether a franchisee must purchase products, services, and equipments from suppliers designated (or approved) by the franchisor.

(3) Whether the franchisee may choose other suppliers, and conditions for such other suppliers.

5. Information about providing continuous services to franchisees.

(1) The specific content and method of providing professional training as well as the specific plans of execution of such training. In addition, also provide information about the location, method, and length of such training.

(2) Specific content of technical support; information referencing the table of contents as well as the relevant page numbers of the franchise operations manual.

6. Information about the methods and content of a franchisor’s guidance for and supervision on a franchisee.


[to obtain the full text of my translation, please e-mail me or leave a comment with a request for same.]

The full text of the law in Chinese can be accessed here.

Commercial Franchise Registration Management Measures--Chinese Franchise Regulation

商业特许经营备案管理办法

This new law, yet another importance piece of regulation in the Chinese franchise realm, came into effect on May 1,2007. It was signed into law on April 30, 2007, just one day before the effective date of the Regulations of Commercial Franchising Operations of the People's Republic of China. There seems to have quite a few areas of ambiguity, as does the Commercial Franchise Disclosure Management Measures, which I will post next.

MINISTRY OF COMMERCE
PEOPLE’S REPUBLIC OF CHINA
15TH ORDER 2007

Commercial Franchise Registration Management Measures has been promulgated during the 6th meeting of the Ministry of Commerce. It shall go into effect on May 1, 2007.

Minister of Commerce
Bo Xi Lai
April 30, 2007

Commercial Franchise Regisitration Management Measures

Article One To strength the regulatory management of commercial franchising, and to maintain orders in the franchising market, the Measures have been promulgated pursuant to the Regulations of Commercial Franchising Operations (“Regulations”).

Article Two The Measures apply to all commercial franchising operations inside the People’s Republic of China.

Article Three Relevant departments, in charge of commercial regulations in the Ministry of Commerce, Provinces, Autonomous Regions, and Municipalities, are the proper registration agencies. If franchising operations are within Provinces, Autonomous Regions, and Municipalities, shall register the franchise in the departments in charge of commercial regulations; if franchising operations cross boundaries of Provinces, Autonomous Regions, and Municipalities, the franchise shall be registered in the relevant department of the Ministry of Commerce.

The management of franchise registration shall be implemented in a national network. Franchisors in compliance with the Regulations shall register their franchise through the governmental website: www.mofcom.gov.cn

Article Four Any person or entity has the right to report activities in violation of the Measures to agencies in charge of franchise registration.

Article Five A franchisor petitioning for registration shall provide the following documentation to the registering agency:

(1) A brief introduction of the franchise.

(2) A brief introduction of the distribution of all the franchised units in China.

(3) A copy of the franchisor’s marketing plan.

(4) A copy of the franchisor’s corporate business license or other important documents evidencing eligibility.

(5) A copy of the registrations of the franchisor’s trademarks, patents or other business resources related to the franchising operations.

(6) Documents provided by a commercial regulatory department in a city with administrative districts, evidencing a franchisor’s compliance with Article 7 Section 2 of the Regulations; with respect to company-operated units located outside China, a franchisor shall provide documents evidencing same (including Chinese Translation), which shall be notarized and certified by a Chinese Consulate located in the administrative region as such company-operated units.

The above section does not apply to a franchisor in franchising operations before May 1, 2007, but such a franchisor shall provide a copy of the first franchise agreement executed by both the franchisor and a franchisee inside China.

(7) Sample Franchise Contract.

(8) Table of contents of the Franchise Operation Manual (Must include the page number of each chapter and the total number of pages. With respect to Franchise Operation Manual accessible via franchise system intranet, provide the estimated pages after printing.).

(9) With respect to franchising of services or products subject to pre-approval pursuant to relevant laws and regulations, franchisor must provide documents evidencing such approval by relevant government agency.

(10) Franchisor’s affidavit, signed and sealed by legal agent of such franchisor.

The above-listed items (1) through (3) shall be filled out directly on the website; items (4) through (10) shall be submitted electronically via the website in PDF format.

To get the complete translation, please e-mail me or leave a comment with your address. My e-mail address is：bluo@vernongoodrich.com

To access the complete texts of the law in Chinese, go here.

STARBUCKS v. SHANGHAI COPYCAT

The latest news report out of China marks a sweet victory for STARBUCKS in its legal battle with a Shanghai Coffee house--Shanghai Starbuck Coffee Ltd.

After the Shanghai 2nd Intermiediate Court's affirming its own decision to hold Shanghai Starbuck Coffee liable for trademark infringement and unfair competition on January 4,2007, Shanghai Starbuck hesitated to change its business name as ordered. The court followed through on its order and forced it to change its corporate name. After almost four months of game play, Shanghai Starbuck finally did change its name to "Shanghai Fang Yun Coffee Ltd." (上海芳韵咖啡馆有限公司）

This is yet another unprecedented step in Chinese court's progress in enforcing IP rights in China. The court not only handed down a victory to STARBUCKS but also saw through the actual enforcement of its own orders.

To help readers understand the history of the entire case, the following is my brief of this fascinating IP case in China.


In re STARBUCKS

Parties:
Plaintiffs / Appellees: Starbucks Co. and Shanghai Unified Coffee, Ltd.

Defendants/ Appellants: Shanghai Xing Bake Coffee, Ltd. and Shanghai Xing Bake Coffee, Ltd. Nanjing Road Branch.

Facts:

A. Plaintiffs:
Starbucks Co. registered the name and pictures associated with its trademark “STARBUCKS” in 1996 in P.R. China; it then registered 30 types of products associated with “STARBUCKS” in 1997; and it registered more services and products associated with the trademark “STARBUCKS” in China.

On February 1, 1999, Starbucks Co. first registered the Chinese version of Starbucks—“Xing Bake” [星巴克] in Taiwan, however it did not begin the registration of “Xing Bake” in China until 1998. While waiting for an approval for the registration of “Xing Bake”, Starbucks began its massive advertising with the trademark “STARBUCKS” and “Xing Bake”. In addition, the first Starbucks chain store began operation in Beijing in January 1999.

Starbucks Co. registered the “Xing Bake” [星巴克] trademark on December 28, 1999.

On March 23, 2000, Starbucks entered into a contract with co-plaintiff Shanghai Unified Coffee, allowing it the legal right to use the trademarks “STARBUCKS”, “Xing Bake” [星巴克], and other unregistered trademark.


B. Defendants:
While Starbucks Co.’s application for the trademark “Xing Bake” [星巴克] was pending, the defendants pre-registered the corporate name “Xing Bake” [星巴克] and gained approval. On March 9, 2000, Shanghai Xing Bake Coffee, Ltd. was incorporated, whose principal business is the sale of beverages, western style meals, and retail alcoholic drinks. And it formed its branch office, the co-defendant, on July 1, 2003.

They printed “Starbuck Coffee” on its price list, and they used characters “Xing Bake Coffee” in their store front and advertising billboards.

C. Lawsuit:
The plaintiffs sued the defendants for trademark infringement and unfair competition in the trial court, Shanghai Intermediary Court.

D. Procedural History:
The trial court held that the defendants violated the plaintiffs’ trademark rights and engaged in unfair competition.

On appeal, the Supreme Court of Shanghai affirmed and required the appellants to issue a public apology, pay damages and attorneys fees to the appellees.

On motion to reconsider by the appellants, the Supreme Court again affirmed.

Issues:
1. Whether the appellant’s successful pre-registration of the corporate name “Xing Bake” defeats the appellees’ claim of trademark infringement?

[Holding: No.]

2. Whether the appellant’s usage of the corporate name “Xing Bake” and “Starbuck Coffee” constitute unfair competition?

[Holding: Yes.]

Analysis:

1. Pre-registration of the corporate name “Xing Bake” [星巴克]
a. This pre-registration of corporate name constitutes subjective bad faith because the president of the future company Shanghai Xing Bake Coffee, Ltd. acknowledged to a major Chinese newspaper in 2003 that the trademark and name “Xing Bake” [星巴克] is very famous and the Starbucks Co. has been very successful. So he decided to race the Starbucks Co. to the corporation name registration office.

b. The trademarks “STARBUCKS” and “Xing Bake” [星巴克] have been widely known in China prior to the appellants’ corporate name registration.

c. Starbucks Co.’s usage of and attainment of relevant rights to “Xing Bake” [星巴克] are earlier than Shanghai Xing Bake Coffee, Ltd. Further, the appellant’s registration of the corporate name “Xing Bake” [星巴克] with the express knowledge that such registration was inconsistent with rights of others violated Trademark Law of China. And the appellant’s behavior violated the basic commercial ethics—equality, honesty and good faith.

2. Unfair Competition
a. The appellants’ use of “ Starbuck”, although different from the appellees’ trademark “STARBUCKS” constituted a confusion considering prominence and reputation of the appellees’ trademark. In addition, “Starbuck” is the key element of the appelees’ trademark.

b. The appellants’ pictorial emblems—one small circle inside a bigger one, green background color, and two stars embedded inside the overlapped area of the two circles generated confusion with the appellees’ trademark “STARBUCKS” and other registered trademarks.


Brad Luo’s Comments:

1. Why didn’t Starbucks Co. register the Chinese version of “STARBUCKS”-- “Xing Bake” [星巴克] at the same time it did in Taiwan? Why didn’t it register as soon as such a trade name became known in Chinese? It could have avoided all these litigation had it done so.

Coupled with Pfizer’s recent loss in a Chinese court for failing to be the first one to register the Chinese version of “Viagra”—“Weige” [伟哥] (meaning “Great Man”), the Chinese courts are speaking clearly and loudly—REGISTER YOUR TRADEMARKS EARLY, BOTH IN ENGLISH AND CHINESE. Also, it is important to know that the trademark registration regimes in mainland China, Taiwan, Hong Kong and Macau are independent of each other, and that a trademark owner needs to register the mark throughout the Greater China area.

2. It is settled law that China is a “first register first served” jurisdiction with respect to trademarks. However, the Supreme Court of Shanghai mentioned in dicta that Starbucks Co. did use the Chinese version “Xing Bake” [星巴克] first. Does this mean that courts in China will start looking into who first used a trademark or trade name? It is too early to tell. But the safest thing is to REGISTER FIRST!

Heavier Penalties for Violations of the New Chinese Franchise Law

Under the new Chinese Franchise regulation, here are the requirements and penalties for breach thereof:

Article 7---2 Units in Operation for 1 Year

A franchisor shall have at least two directly-operated units under operation for more than one year.

Penalties for Breach of Article 7

Article 24 A franchisor, who is unqualified under Section 2 of Article 7, yet conducts franchising operations, shall be subject to an ordered correction from commerce regulatory authorities, confiscation of profits, a monetary fine between 100,000 and 500,000 yuan, and a public reprimand.

Entities or individuals other than registered enterprises, who conducts franchising operations, shall be subject to an order from regulatory authority to cease illegal operations, confiscation of profits, and a monetary fine between 100,000 and 500,000 yuan.

Article 8---Registration

Article 8 The franchisor shall register a franchising operation with commerce regulatory bodies pursuant to the Regulation within 15 days of its first franchise contract.

Penalties for Breaching Article 8

Article 25 A franchisor, failing to register with appropriate commerce regulatory authorities pursuant to Article 8, shall be subject to an order from such regulatory authorities to register the franchise within a specified time and a monetary fine between 10,000 and 50,000 yuan; if the franchisor fails to register within the specified time, it shall be subject to a monetary fine between 50,000 and 100,000 yuan and a public reprimand.

No doubt that the increase in the amount of penalties is intended to discourage violations of the rules as specified in the new law. However, from the view point of a United States consumer (franchisee), the administrative penalties do not seem too high. Yet at the same, the franchisee is entitled to traditional contract damages if a breach occurred.

If a reader knows whether Chinese contract law allows exemplary damages for a breach of contract in connection with a tort like fraud, please let me know. In the mean time, I will do some research on this topic after my final exams in early May, 2007.

New Chinese Franchise Law Effective Now

As of May 1, 2007, the new Regulations of Commercial Franchise Operations of China is effective.

Coupled with the rush of investments before the 2008 Olympics games in Beijing, this new law is expected to generate a lot franchising activities in China. Read this article in Dallas Business Journal.

Here is a list of the new laws that went into effect on May 1, 2007. (In Chinese only)

Regulations for the Administration of Commercial Franchising Operations

Order of the State Council of the People’s Republic of China-1
The 485th Order

The Regulations for the Administration of Commercial Franchising Operations, which was adopted at the 167th executive meeting of the State Council on January 31, 2007, are hereby promulgated and shall come into force as of May 1, 2007.

Premier Wen Jiabao

Chapter 1 General Provisions

Article 1 The Regulations are promulgated to standardize commercial franchising operations, enhance the healthy, orderly development of commercial franchising, and maintain orders in the market.

Article 2 All commercial franchise operations shall conform to the Regulations.

Article 3 Commercial franchise herein (franchise hereafter) refers to a contractual relationship whereby an enterprise (franchisor hereafter) with registered trademark, trade name, patent and other business resources grants a franchisee the right to use its business resources, and the franchisee operates under a uniform operational model and pays a franchise fee to the franchisor in accordance with terms of the contract.

Individuals and entities, which are not registered enterprises, shall not engage in franchising operation as franchisors.

Article 4 All franchise operations shall be conducted in accordance with the principles of free will, good faith and fair dealing.

Article 5 The Ministry of Commerce shall be responsible for the administration of franchise operations on a national scale pursuant to the Regulations. Commerce regulatory authorities of provinces, autonomous regions, municipalities and districts shall be responsible for the administration of franchise operations therein.

Article 6 Any entity or individual has the right to report activities in violation of the Regulations to commerce regulatory authorities. Such authorities receiving reports shall respond in a timely manner in accordance with the law.

Chapter 2 Franchise Operations

Article 7 The franchisor shall have a mature business model, and the capacity to provide a franchisee with operational guidance, technical support and training services.

A franchisor shall have at least two directly-operated units under operation for more than one year.

Article 8 The franchisor shall register a franchising operation with commerce regulatory bodies pursuant to the Regulation within 15 days of its first franchise contract. Franchise operations within provinces, autonomous regions and municipalities shall register with commerce regulatory authorities therein; franchise operations across provinces, autonomous regions and municipalities shall register with the Ministry of Commerce.

For registration, the franchisor shall provide the following documentations:
(1) A copy of business license or certification of business registration;
(2) A copy the standard franchise contract;
(3) Franchise operation manual;
(4) Marketing plan;
(5) Written affidavit of compliance with Article 7 and supporting documents;
(6) Other files and documents mandated by the Ministry of Commerce.

A franchisor, whose franchises either products or services, shall also provide documents evidencing lawful approval of such franchise operations.

Article 9 Commerce regulatory authorities shall register a franchise operation within 10 days upon receipt of a franchisor’s documents pursuant to Article 8, and notify the franchisor. Said regulatory authorities may request from a franchisor additional supplemental file and documents within seven days if a franchisor’s files and documents are not complete.

Article 10 Commerce regulatory authorities shall publish the name of registered franchisors on government websites and update such websites in a timely manner.

Article 11 To engage in franchise operations, the franchisor and franchisee shall execute a written franchise contract.

A franchise contract shall include the following:

(1) Basic information of the franchisor and franchisee;

(2) Content and the term limit of the contract;

(3) Type, amount and method of payment of franchise fee;

(4) Specific content and the method of providing operational guidance, technical support and training services;

(5) Requirements on the quality and standard of products or services and quality control procedures;
(6) Marketing or advertising of products or services;

(7) Consumer rights protection and responsibilities for remedial damages in franchise operations;

(8) Revision, cancellation and termination of the franchise contract;

(9) Responsibilities for breach of contract;

(10) Methods of dispute resolution;

(11) Other contractual provisions agreed to by the franchisor and franchisee.

Article 12 The franchisor and franchisee shall provide in the franchise contract that the franchisee can unilaterally cancel the contract within an agreed period of time.

Article 13 The term limit for a franchise contract shall be no less than three years, except for express agreement by the franchisee.

The above section does not apply to the renewal of a franchise contract between a franchisor and franchisee.

Article 14 A franchisor shall provide a franchisee a franchise operation manual, and provide a franchisee with franchise operations guidance, technical support and training services in the method agreed to in the contract.

Article 15 The standard and quality of franchise products or services shall conform to relevant laws, administrative regulations and other governmental regulatory measures.

Article 16 If a franchisor requires a fee from a franchisee prior to the execution of a franchise contract, the franchisor shall explain to the franchisee in written format the purpose, condition and method of return of such fee.

Article 17 A franchisor shall utilize the advertising fee collected from a franchisee for purposes agreed to in the franchise contract. A franchisor shall disclose to a franchisee the status of usage of the advertising fee in a timely manner.

A franchisor shall not engage in fraudulent and misleading activities in the course of advertising and publicizing a franchise. In its advertising, the franchisor shall not include content concerning a franchisee’s earnings results in the franchise operation.

Article 18 Without a franchisor’s permission, a franchisee shall not transfer the right to a franchise unit to others.

The franchisee shall not disclose or allow others to use a franchise’s trade secrets gathered in the course of operations.

Article 19 A franchisor shall provide yearly reports to commerce regulatory authorities regarding the franchise contracting status within the first season of each year.

Chapter 3 Information Disclosure

Article 20 A franchisor shall establish and implement a complete disclosure system in compliance with the regulations of the Ministry of Commerce.

Article 21 A franchisor shall provide franchisee written disclosures of information as required in Article 22 at least 20 days prior to the execution of a franchise contract, and the franchisor shall provide a franchisee a copy of the franchise contract.

Article 22 A franchisor shall provide the following information to a franchisee:

(1) the franchisor’s name, address, legal representative, registered capital, scope of business and basic information in franchising activities;

(2) the basic information about the franchisor’s registered trademark, trade dress, patent, patented techniques and operational model;

(3) the type, amount and method of payment of franchise fee (including whether a security deposit is required and the condition and method of return of any deposit.)

(4) the price of and condition therefor the provision of products, services, and equipments to the franchisee;

(5) the specific contents, method and implementation plans of continuous operational guidance, technical support, and operational training to the franchisee;

(6) the specific method of guidance and supervision with respect to the franchisee’s operational activities;

(7) the estimated initial investment for a franchise unit;

(8) the number, location, and operational assessment of all the franchisees inside China;

(9) the abstracts of audited accounting and audit statements of the past two years

(10) any litigation or arbitration involving the franchise operations in the past five years;

(11) the information on whether the franchisor and its legal representative engaged in major illegal operations

(12) any other information mandated by regulatory authorities within the Ministry of Commerce.

Article 23 The franchisor shall provide truthful, accurate, complete information to the franchisee. The franchisor shall not withhold relevant information or provide false information.

If material changes occur to information previously provided by the franchisor, the franchisor shall notify the franchisee of such material changes in a timely manner.

The franchisee may terminate the franchise contract if the franchisor withholds relevant information or provides false information.

Chapter 4 Legal Penalties

Article 24 A franchisor, who is unqualified under Section 2 of Article 7, yet conducts franchising operations, shall be subject to an ordered correction from commerce regulatory authorities, confiscation of profits, a monetary fine between 100,000 and 500,000 yuan, and a public reprimand.

Entities or individuals other than registered enterprises, who conducts franchising operations, shall be subject to an order from regulatory authority to cease illegal operations, confiscation of profits, and a monetary fine between 100,000 and 500,000 yuan.

Article 25 A franchisor, failing to register with appropriate commerce regulatory authorities pursuant to Article 8, shall be subject to an order from such regulatory authorities to register the franchise within a specified time and a monetary fine between 10,000 and 50,000 yuan; if the franchisor fails to register within the specified time, it shall be subject to a monetary fine between 50,000 and 100,000 yuan and a public reprimand.

Article 26 A franchisor in violation of Article 16 and Article 19 shall be subject to an ordered correction from commerce regulatory authorities, and may be issued a monetary fine less than 10,000 yuan; in case of a serious and egregious violation, the franchisor shall be subject to a monetary fine between 10,000 and 50,000 yuan and a public reprimand.

Article 27 A franchisor in violation of Section 2 of Article 17 shall be subject to an ordered correction from Administration of Industry and Commerce, a monetary fine between 30,000 and 100,000 yuan; in case of a serious and egregious violation, the franchisor shall be subject to a monetary fine between 100,000 and 300,000 yuan and a public reprimand; if a violation constitutes a crime, the franchisor shall be subject to criminal liability.

A franchisor engaging in misleading and fraudulent advertising shall be subject to penalties in accordance with the Advertising Law of China.

Article 28 A franchisor in violation of Article 21 and Article 22, reported by a franchisee and confirmed by commerce regulatory authorities, shall be subject to an ordered correction and a monetary fine between 10,000 and 50,000 yuan; in case of a serious and egregious violation, the franchisor shall be subject to a monetary fine of 50,000 and 100,000 yuan and a public reprimand.

Article 29 Criminal activities defrauding others’ money or property under the disguise of franchising shall subject the perpetrator to criminal liability; activities, not constituting a crime, shall subject an actor to penalties in accordance with the Law of Public Security and Punishment of China.

Those conducting pyramid sales under the disguise of franchising shall be subject to penalties in accordance with the Regulations Prohibiting Pyramid Schemes.

Article 30 Employees of commerce regulatory authorities engaging in abuse of authority, professional negligence and self-dealing shall be subject to criminal liability if such activities constitute a crime; if not a crime, such employees shall be subject to punishment in accordance with the law.

Chapter 5 Addendum

Article 31 Laws governing trademark and patent as well as administrative regulations shall apply to issues arising out of franchise operations concerning trademark licensing, patent licensing.

Article 32 Franchising organizations and associations are to, under the guidance of regulatory authorities within the Ministry of Commerce, formulate standards for franchising operations, strengthen professional self governance, and provide services to parties engaging in franchise operations.

Article 33 A franchisor conducting franchising operations before the Regulations goes into effect shall register the franchising with commerce regulatory authorities in accordance with the provisions herein within one year the from the date when this Regulations goes into effect; the franchisor failing to register within said exemption period shall be subject to penalties provided in Article 25.

The franchisor under the above section is exempt from Section 2 of Article 7.

Article 34 The Regulations shall go into effect on May 1, 2007.