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Franchises in China – What you need to know

Fabio Giacopello

16 October 2012

Welcome to the webinar

Philippe Healey

China IPR SME Helpdesk Project Manager

16 October 2012

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16 October 2012 4

The China IPR SME Helpdesk

@iprchina

Fan page: 'China IPR SME Helpdesk'

'China IPR'

The China IPR SME Helpdesk provides free, confidential, business-focused advice

relating to China IPR to European Small and Medium Enterprises (SMEs).

Helpdesk Enquiry Service – question@china-iprhelpdesk.eu

Training & Events

Materials

Online Services - www.china-iprhelpdesk.eu

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Today’s Speaker

• Fabio Giacopello

• Of HFG Law Firm & IP Agency

• e-mail: giacopello@hfgip.com

• Direct Dial: +86 21 5213 5500

Agenda

• Market overview:

• A few examples of franchising

• Legal Framework

• Definition / What is not Franchising

• Requirements for the Franchisor

• Registration Duty

• Franchising Contract

• Disclosure Duty

• Modification

• Franchisee’s Obligations

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• Case Study 1: KFC

• Case Study 2: Dragonfly

• Case Study 3: Starbucks

Market Overview

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China is now the largest

franchise market in the world in

terms of the total number of

franchised outlets.

2,600 brands with some

200,000 franchised retail stores

in over 80 sectors.

Significant growth of about 35%

- 40% annually in the last few

years

A few examples of franchising

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Legal Framework

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The Regulation on the Administration of Commercial Franchises

2007, updated in November 2011 (hereinafter “Regulation”)

Administrative Measures for archiving Commercial Franchises

(updated in 2011 and effective since February 1, 2012)

(hereinafter “Measures”), and Administrative measures for the

record filing of commercial franchises

Measures for the Administration of Information Disclosure of

Commercial Franchises (updated in 2012) (hereinafter

“Information Disclosure”) :

Definition

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The term “commercial franchise”

refers to such business

operations by which an

enterprise owning a registered

trademark, enterprise mark,

patent, know-how or any other

business resource (“franchiser”)

confers the said business

resource to any other

Article 3

business operator (“franchisee”) by means of contract, and the

franchisee undertakes business operations under the uniform

business model as stipulated by the contract, and pay franchising

fees to the franchiser.

Definition

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Franchising shall include the

following 4 requirements:

- business resources (trademark, trade name, patent, know-how)

- uniform business format

- contractual

- franchise fees

What is not franchising

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1. Directly Operated Stores

(WFOE).

The foreign owner of the business format invest

directly in China, start-up a company and retail by

itself, leasing the premise, training the staff and

ultimately selling goods or offering services.

2. Retail operations based on

distribution contracts, goods or

service supply contracts,

Trademark/ Patent/ Know-how

License.

IP & Franchising

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Business resources (trademark, trade name, patent, know-how)

Freedom to operate

Acquisition / Registration

Maintenance (renewal/monitoring/anti-counterfeiting)

Requirements for Franchisor

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A franchiser shall:

possess a mature business model and the ability to

provide long-term business guidance, technical support,

business training and other services to the franchisee;

have at least two direct sales stores and have

undertaken the business for more than a year;

conclude a franchise contract and report it to the

administrative department for archival filing (for the first

time).

be an enterprise (no other entity or individual allowed)

Registration Duty

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Franchisors must submit within 15 days from the first contract:

1. Information about the franchise system, business license location of stores in

China, marketing plan

2. Registration certificates for the trademarks, patents, and other business

operational resources

6. Documents proving two directly managed stores for more than one year

7. The first franchise agreement concluded in China and a sample franchise

agreement

9. Table of contents of the franchise operation manual (estimate of pages)

10. Where any prior approval is required, approval from the relevant authority.

"In case of any foreign-invested enterprises, "the Certificate of Approval on

Establishment of Foreign-Invested Enterprises must be submitted and the

approved business scope must include ‘engagement in franchise activities"

11. A letter of undertaking attesting that the franchisor has satisfied all legal

conditions

12. Other documents deemed necessary by the reviewing authority

Franchising contract

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A franchise contract includes:

(1) basic information of franchiser and franchisee;

(2) contents and term of the franchise;

(3) type, amount and payment method for fees;

(4) specific contents and methods for providing business guidance,

technical support, business training and other services;

(5) quality, standards and guarantee measures for products or services;

(6) sales promotion, advertising and publicity;

(7) the protection of rights of consumers and liability;

(8) alteration, rescission and termination of the contract;

(9) liabilities for breach of the contract;

(10) dispute resolution methods;

(11) others.

Franchising contract

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A franchise contract shall

- be in written form

- be unilaterally rescindable

within a certain term

- fix term not be less than three

years (not mandatory)

Disclosure Duty

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A franchiser shall establish and implement a perfect information disclosure system

and not hide any relevant information or provide false information

The franchisor will provide to the franchisee, at least 30 days before signing the

franchise contract, the draft of the written agreement, and the following

information:

• Basic information about the franchiser and the franchised operations

• Basic information about the trademark, patent, know-how, business model of the

franchiser

• Information about franchising fees

• Information about prices and requirements for providing products to the

franchisee

• Information (contents, methods, implementation plans) for providing business

guidance, technical support and business training, etc…

Disclosure Duty

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• Information on bankruptcy or application for bankruptcy by the franchisor or

franchisor’s affiliate within the last 2 years.

• Financial information, and the source of such information, on the actual amount

of investment, average gross sales, costs, gross and net profits for existing

franchisee(s) within the territory of China. (before the revision, the franchisor

could choose between disclosing the actual and estimated amount).

• Information on all major litigation and arbitration concerning their franchises in

the latest 5 years.

• Information about illegal operation involving the franchisor or its legal

representative if the fine exceeds 300,000 RMB, and if the franchisor or its

representatives have been investigated for any illegal operation.

Modification

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A franchiser shall communicate

to franchisee and authorities any

major change in any of the

information subject to disclosure

duty or archival duty

Franchisee’s obligations

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The franchisee has to respect the confidentiality

obligations, during the execution of the franchise

contract and after its termination:

He may not disclose or improperly use trade secrets in the course of executing

the franchise contract, no matter whether the contract is executed or not. Upon

the termination of the franchise contract, he must assume the confidentiality

obligation even if he has not executed a confidentiality agreement after the

termination of the contract. On the contrary, he shall be liable for the

corresponding damages and compensation.

Pay franchising fee and other obligation stipulated in

the contract

Case Study 1

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From 20 outlets in the year 2000 to 3200

outlets today in over 650 cities in China in

2012. KFC has proved to be a franchising

inspiration with its finger-lickin’ success

story.

Before the real success story began, KFC

started two different enterprises and one

joint venture with state owned

KFC entered China in 1987, a time when the word “franchise” wasn’t even

directly translatable into Chinese. The KFC menu in China does not only

contain the America-inspired Zinger burger but also congee - a rice

porridge that can feature pork, pickles, mushrooms and preserved egg.

KFC China serves you soup with every meal and even steamed rice or

noodles with vegetables on the side.

companies like Beijing Corp. of Animal Protection, Processing, Industry

& Commerce and Beijing Travel and Tourism

Case Study 2

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Dragonfly is a spa brand established in Shanghai,

China in 2003. As of January 2012 the brand has

19 locations in mainland China and Hong Kong. A

typical retreat is now 250-350 square metres.

Dragonfly has combined company owned

operations with franchised operations for its shops

in China.

Dragonfly's franchise model requires an initial

franchise fee along with a design fee.

Ongoing costs to franchisees include a monthly royalty fee, monthly

advertising minimum spend and training for new hires. [9] Franchisees

may negotiate for a territory with an additional territory development

fee. Franchisees pay a 6% royalty fee.

Case Study 3

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“About 14 years ago, I met an entrepreneur who wanted to open up coffee

shops around China. I never thought the coffee business would work there.

The Chinese would not easily give up their tea-drinking culture for a bitter,

overpriced drink, I told him. Starbucks has proven me wrong. Howard

Schultz, the CEO of Starbucks (SBUX), announced that China will soon

become its largest market outside the United States. It has opened over 500

outlets in the country, which are more profitable per outlet than in the U.S.

even though sales per outlet lags its U.S. counterparts considerably,

according to the chain's chief financial officer, Troy Alstead.”

By Shaun Rein, CNBC.com

Starbucks developed flavors, such as green tea-flavored coffee drinks,

that appeal to local tastes.

Rather than pushing take-out orders, Starbucks become a de facto

meeting place for executives as well as for the gathering of friends

The average coffee sold in China is far more expensive than in the

U.S. Carrying a Starbucks cup is seen as a status symbol

Poll 1

Can a company without operations in China be a franchisor?

A. Yes, if it has at least two directly operated shops abroad for at least one year

B. No

C. Yes, but as a joint-venture with a local partner

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Poll 2

Can the franchisee disclose the information obtained during the franchising relationship?

A. Yes

B. No

C. Yes, but only after the contract is terminated

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Poll 3

Is it possible to have a franchising relationship without royalty ?

A. No

B. Yes, if there is uniform business format

C. Yes, if there is trade mark/patent license

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Key Messages for SMEs

• It might be difficult to determine if the business relationship is franchising or other distribution contract: it is safe to approach authority for consultation.

• To start a franchising network in China you need to have mature business (2 shops + 1 year rule) and be able to provide continuous guidance to franchisee.

• It is important to disclose all the useful and mandatory information to the franchisees in advance.

• Written contract + termination right for fee

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Q&A

• Fabio Giacopello

• Of HFG Law Firm & IP Agency

• e-mail: giacopello@hfgip.com

• Direct Line: +86 21 5213 5500

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here

Upcoming Helpdesk Events

Save the dates of our upcoming events: Upcoming Training Events in China: 25 October, Beijing: SME Conference 2012: Practical Solutions to Help You Think Big 6 November, Beijing: Briefing to 'Made for China' Trade Mission 13 November, Shanghai: Protecting Your Company's Intellectual Property in China 14 November, Shanghai: Partnering for Success: Finding and Working with Chinese Business Partners 21 November, Beijing: Partnering for Success: Finding and Working with Chinese Business Partners

Upcoming Training Events in Europe: 17 October, Berlin: Schutz Geistigen Eigentums in China 18 October, Milan: 18 October, Milan: China in Transition and in Practice 22-23 October, Paphos, Cyprus: Annual Enterprise Europe Network Conference 14 November, London: IPR Protection for Making and Selling Fashion in China

Upcoming Webinars: 29 October: Successful Technology Transfers to China

FOR MORE INFORMATION ON THESE EVENTS

CLICK HERE

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Thank you

The China IPR SME Helpdesk provides free, confidential, business-focused advice

relating to China IPR to European Small and Medium Enterprises (SMEs).

Helpdesk Enquiry Service – question@china-iprhelpdesk.eu

Training & Events

Materials

Online Services - www.china-iprhelpdesk.eu

For more information please contact the Helpdesk:

Room 900, Beijing Sunflower Tower

No. 37 Maizidian Street

Chaoyang District

Beijing 100125, P.R. China

Hotline number: +86 (10) 6462 0892

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