Legal remedies for termination of franchise agreements

By Wang Jihong and Gao Lichun, Zhong Lun Law Firm

In a dispute over a TOT (teams of tomorrow) franchise agreement, where a foreign-funded enterprise, which set up a project company and a specific operating entity (collectively called the investor) invested in a domestic sewage-treatment plant, the local government defaulted in the payment of sewage-treatment fees and refused to allow the facility to be shut down for maintenance, causing the plant and equipment to go into a long-term overloaded operation. In the matter, the government’s competent authority for environmental administration issued the administrative penalty decision, the decision on the order to correct illegal acts, and the decision on consecutive daily penalties, totalling RMB32 million (US$4.6 million), for excessive water pollutants, excessive air pollutants and other circumstances. Thereafter, the government notified the investor to end the franchise agreement and regain control of the sewage-treatment plant. As a result, the investor forcibly took over the plant before handing it over to other enterprises to operate.

 王霁虹 WANG JIHONG 中伦律师事务所合伙人 Partner Zhong Lun Law Firm
Zhong Lun Law Firm

Strong practical significance of subdivision and selection of dispute resolution methods. Article 12 of the Administrative Procedure Law of China (2017 revision) provides that the said law shall apply and the administrative counterparty may initiate an administrative procedure when an administrative agency fails to perform according to the law or as agreed upon, or illegally modifies or rescinds, a government franchise agreement. There is no express provision in law or judicial interpretation on whether the parties involved may initiate a commercial arbitration or civil procedure for any breaching liabilities, damages, determination of project price or other dispute having no direct relation to government administrative approval, administrative licensing and administrative functions under a franchise agreement, as civil legal relations.

The opinions in certain decisions of the Supreme People’s Court in relevant cases and the opinions of the high people’s courts of certain provinces and municipalities are inclined to believe that “the disputes involving administrative planning, licensing, penalty, management and supervision, and other administrative functions are administrative legal relations; the disputes where contracts represent specifically the rights, obligations and breaching liabilities between the parties are civil legal relations”. As such, in a case where the government terminates a franchise agreement, remedy for the investor may be achieved through administrative law or civil law generally based on the claims of the investor. In certain cases, the selection of proper legal remedies can help an investor recover huge property losses.

高丽春 GAO LICHUN 中伦律师事务所合伙人 Partner Zhong Lun Law Firm
Zhong Lun Law Firm

Legal remedies for protection of investor’s interest. Generally, there are factual and legal bases for the decisions of the competent authority for environmental administration on administrative penalty, orders to correct illegal acts, and consecutive daily penalties if the sewage-treatment plant is guilty of environmental violations. When only dealing with environmental administrative legal liabilities, it is difficult for the sewage-treatment plant to request that the administrative review agency or the court revoke the decision on the administrative penalty. As an environmental infrastructure, the sewage-treatment plant involves public interest and cannot be shut down. It is more difficult to return it to the investor’s control and operation when the government and other operating enterprises actually take over and implement security. In such a case, if the investor is dissatisfied with the administration, supervision and government’s recovery of the franchise right, it should resolve such an issue through an administrative review and procedure.

However, if the investor believes the government must bear the civil legal liability for compensation or indemnification for its breach of contract (default in payment of sewage-treatment fees, refusing to close for maintenance, resulting in losses of long-term overload operation of facilities and equipment), he/she may seek commercial arbitration from the arbitration institution, based on the arbitration clause or agreement stipulated in the franchise deal. If there is no such arbitration clause or agreement in the franchise deal, the investor may file a civil lawsuit with the people’s court for legal remedy.

Potential dispute over TOT franchise deal of sewage-treatment plant. The sewage-treatment plant is responsible for intercepting purifying upstream sewage. The effect of its operation is to control environmental pollution and directly not to generate, discharge or add pollution. This means the plant is a pollution-control enterprise rather than a sewage-discharge enterprise. The effluent water the plant produces through purification of the sewage depends on three main factors, i.e., degree of pollution of the upstream water, the matching of the influent water volume and the designed sewage-treatment capacity, as well as the repair and maintenance levels of the facilities and equipment.

The investor’s interest will be severely damaged in any of the following circumstances: (1) Assuming the plant’s daily treatment capacity is 100,000 tons and the actual volume reaches as high as 150,000 tons, resulting in long-term overloaded operation of the facilities and equipment; (2) the government has forcibly requested that the effluent water quality be raised from the secondary standard to the primary one; (3) the government’s long-term arrears of sewage-treatment fees leads to the enterprise’s lack of funds to update facilities and equipment; (4) COD, SS, TN, TP, PH, toxic and hazardous substances and other indicators of affluent water quality continue to deteriorate and exceed initial expectations; (5) the government does not approve the request of the franchisee to shut down operations for repairs and maintenance, in accordance with the maintenance plan; or (6) the local competent authority for environmental administration imposes administrative penalties on the plant, based on the upper limits of the Water Pollution Prevention Law (Article 83), the Environmental Protection Law (Article 59), the Regulations on Urban Drainage and Sewage Treatment, the Measures for the Implementation by Competent Environmental Protection Departments of Consecutive Daily Penalties and other laws and regulations. In view of the said potential risks and actual unfavourable factors, we suggest investors create, collect, fix and prepare in advance all evidence in terms of contract negotiation, conclusion and performance and for the operation of the sewage-treatment plant, data storage and key data retention.

Wang Jihong and Gao Lichun are partners at Zhong Lun Law Firm

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