Improved balance between franchisors and franchisees

As of 1 April 2012, the Measures for Administration on Information Disclosure of Commercial Franchise (“Measures”) took effect. The Measures were issued by the Ministry of Commerce of the People’s Republic of China on 23 February 2012 and replace the current version, which had been in effect since 1 May 2007.

A draft of the Measures was published for comment on 28 April 2011. Compared to the above draft, several items in the final Measures have been further revised. Same as in the past, the franchisor must disclose certain information to the franchisee at least 30 days before concluding the franchising contract. In the new Measures, the intention of the government to specify the franchisor’s disclosure obligations towards the franchisee is clearly apparent. However, the Measures also impose a number of stricter requirements on the franchisee..

Compared to the previous regulations, the most important innovations in the Measures are as follows:

1. Widened scope of the term “affiliated parties”
   
   A franchisor must disclose to the franchisee all of its affiliated parties that became insolvent or applied for insolvency in the last two years. The Measures have widened the definition of affiliated parties to include the franchisor’s individual shareholders. Formerly, affiliated parties were only the parent company of the franchisor and the parent company’s or the franchisor’s majority-owned subsidiaries. Additionally, if the affiliated party provides the franchisee with goods and services, the affiliated party itself rather than the franchisor must now disclose its information to the franchisee.
   
   
2. More detailed specification of the information to be disclosed
   
   The Measures specify the information which the franchisor must disclose to the franchisee in greater detail. Formerly, it was required to disclose, inter alia, the franchising system’s detailed content and the manner of provision of operational guidance. Now the Measures elaborate on the above content by requiring the franchisor to provide specific details such as site selection, store decoration and management, advertising and promotion and product configuration.
   
   Furthermore, the Measures expressly require disclosure of information on all litigation and arbitration proceedings concerning franchises of the franchisor in the last five years, including the cause of action, litigation and arbitration claims, jurisdiction and results. Under the previous regulations, only information on major litigation and arbitration proceedings was required.
   
   
3. Stricter confidentiality obligations on the franchisee
   
   The Measures not only impose stricter obligations on the franchisor, but also on the franchisee, for example pre- and post-contractual confidentiality obligations. According to Article 7 of the Measures, the franchisor has the right to require the franchisee to sign a non-disclosure agreement prior to disclosing information to the franchisee. The franchisee will be held responsible for any breach of such a non-disclosure agreement after termination of the franchise contract, even in cases where no separate confidentiality agreement was concluded after termination of the franchise contract. If the franchisee discloses or makes improper use of confidential information in breach of the above provisions, thereby causing loss to the franchisor or third parties, the franchisee is liable for damages.
   
   
4. More restrictive termination rights
   
   The Measures impose stricter requirements for termination of the franchise contract by the franchisee. The previous regulations stipulated that “if the franchisor hides the information that shall be disclosed, the franchisee may terminate the franchise contract”. Now, pursuant to the Measures the franchisee may terminate the franchise contract only if the franchisor fails to disclose information that affects fulfilment of the franchising contract and this renders the objective of the contract unachievable. Compared to the previous regulations, the condition for termination in the Measures is more reasonable, specific and practicable. It is also better suited to preventing misuse by the franchisee.

The Measures impose stricter and more specific obligations on the franchisor, in particular concerning information disclosure. Foreign and foreign-investor franchisors will need to adjust their business practices to reflect the new Measures when entering into franchising activities in the PRC. In return, the Measures impose stricter confidentiality obligations and requirements for termination on the franchisee. The Measures therefore provide greater clarity and ensure a balance between both parties’ rights.