Stricter law enforcement required for commercial franchise operations

On 6 February 2007, the State Council promulgated the Administration of Commercial Franchise Operations Regulations. On 6 April of the same year, the Ministry of Commerce promulgated the Disclosure of Information in Connection With Commercial Franchise Operations Administrative Measures and the Recordal of Commercial Franchises Administrative Measures.

In the blink of an eye, more than two and half years have passed since the promulgation and implementation of what are often referred to as the “one regulation and two measures”. Through an analysis of the statistical data set out below, we can conclude that the thorough implementation of the “one regulation and two measures” remains an arduous task which is yet to be completed.

Based on a preliminary analysis of the statistics in the Report on the Investigation into the Developmental Status of Franchises in China 2009-2010, published by the China Chain Store & Franchise Association, there were more than 4,000 franchise chains in mainland China at the end of 2009. This represented an increase of almost 15% as compared to 2008, with a total of more than 330,000 franchise stores and an average of 83 stores per franchise chain.

Franchise stores directly provide more than 6.5 million jobs. In terms of both the number of franchise enterprises and the number of people involved, these figures show that China’s franchise industry is in a stage of rapid growth.

But despite the growth, the website of the Ministry of Commerce shows that, as of April 2010, only 1,335 franchise enterprises had completed recordal procedures in accordance with the “one regulation and two measures”.

The top 10 provinces, autonomous regions and municipalities directly under the central government account for 87.3% of all franchise enterprises that have completed recordal procedures .

Clearly, both the total number and the percentage of compliant enterprises is not large. At present, the phenomenon of fraud by fake and substandard franchisers is extremely serious, and includes investment platform and franchise market fraudsters exposed in national and local media. Many have yet to be effectively sanctioned. These fraudsters remain active in the market and continue to advertise and publicize widely, even involving some star spokespersons. The franchise market remains in a state of disorderly growth under a veneer of large scale.

It would seem that better enforcement of the “one regulation and two measures” so as to regulate the industry and ensure its orderly development is to be desired.

Reasons and measures

Reasons why enforcement remains patchy include government failure to put enough resources behind the “one regulation and two measures”; failure to punish enterprises that have not carried out recordal procedures; and failure to punctually and effectively respond to exposés by the media.

There are also problems in the legislation itself. The “one regulation and two measures” contain special chapters or articles specifying things such as the legal liability to be borne in the event of failure to carry out recordal procedures, and the type of legal liability to be borne in the event of failure to disclose information. However, the only legal liability imposed is punishment by fine. The entities responsible for imposing such fines are the competent commerce authorities at the various levels.

However, provisions on the rights that a franchisee can assert – in particular, the compensatory remedies available to him in the event that the franchise enterprise violates regulations, harming his interests – are relatively weak.

Furthermore, under a franchise contract, the franchisee finds himself in a weak position, further robbing him of the courage and motivation to report or expose the franchise enterprise. Consequently, it is natural that in such a circumstance where “people do not report and officials do not pursue the matter”, violations of laws and regulations by franchise enterprises cannot be effectively curbed.

Based on the court precedents that we have reviewed, in a dispute between a franchise enterprise and a franchisee, the competent court will render its judgment only based on the relevant provisions of the PRC Contract Law. It will not check to see whether the franchiser has fully disclosed information or whether it has carried out recordal procedures in accordance with the law. Perhaps this phenomenon can be attributed to an insufficient understanding of the “one regulation and two measures” by franchisees. It would seem that the “one regulation and two measures” lack “bite” in practice.

Media power

How can implementation of the “one regulation and two measures” be ensured and improved? We suggest that franchisees use the power of the media and industry associations to publicize the law and make it more widely known.

The majority of franchisees in China are individual proprietorships and small enterprises. Their awareness of the law may not be very strong but their awareness of their interests is. If the protection of their interests and supervisory responsibilities can be combined, placing the business activities of franchise enterprises under supervision, it might be easier to push them towards compliance.

Harry He is a partner of AllBright Law Offices. His main practice areas are foreign direct investment, M&A and labour disputes.