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Franchising in China: An Excellent Business Opportunity

McDonald's, KFC, Burger King, and Papa John's have already set up shop in China.Franchisors are moving into China for obvious reasons: 1.3 billion people, 230 million middle class consumers (as of 2005), the world's highest economic growth rate in the last 20 years, WTO membership, and more favorable franchise and contract laws make it a place for brands to grow rapidly.

As the Chinese economy continues to expand at over 6% per year, PRC citizens are seeing their incomes rise rapidly。  As a result, many of them are anxious to enjoy the trappings of life in Western countries, including foreign cars, stores and even fast food。  As has been demonstrated by the success of this model in the PRC for McDonalds, Kentucky Fried Chicken and other companies, there is a very bright future for franchising foreign brands within the PRC。   There is therefore a very bright future in franchising in the PRC, but potential franchisors need to ensure they adhere to the letter of the law in offering franchising operations to Chinese companies。

As China has developed over the past three decades, many foreign (particularly American) companies have become wildly popular。  This is particularly true of American fast food restaurants like Kentucky Fried Chicken or McDonalds。  However, it also includes retail establishments, fashion labels and a whole host of other industries。 Foreign brands are increasingly popular and will only continue to become more so as Chinese consumers enjoy the fruits of their country’s breakneck economic growth in their paychecks。  This makes franchising foreign businesses in China a particularly lucrative business opportunity, but an opportunity that needs to be approached with caution by foreign companies, who must tread carefully to ensure they comply fully with China’s complicated legal framework relating to offer franchises。  They also need to ensure they have appropriately registered all applicable trademarks and put serious efforts into training employees, finding local partners to work with in each Chinese market they enter, and ensure uniformity across all franchises throughout China。   In addition, franchising in China can offer some unique challenges that many would be franchisors need to understand clearly before entering the Chinese market by offering franchise opportunities in the PRC。

Legal Requirements to Franchise under PRC Law

There are several sets of regulations and promulgations that set forth the law and regulation controlling franchising in the PRC。  Currently, the key regulations on franchising in China are the Regulation on the Administration of Commercial Franchises, the Administrative Measures for the Registration of Commercial Franchises, and the Administrative Measures for Information Disclosure of Commercial Franchises。 The first was promulgated by the PRC State Council, while both the second and third regulatory schemes were issued by the Chinese Ministry of Commerce (MOFCOM)。

Before this legal regime was put into place by the State Council and the MOFCOM, franchisors were not permitted to franchise directly from another country into China.  Instead, foreigners either had to establish entities in China which would carry out the franchising or form joint ventures with Chinese partners who had foreign trading rights. Then, through a series of independent contracts, these entities would be awarded a license to use the franchisor’s trademarks and technology and obtain supplies and other items necessary to carry on business in the country as a franchisee of the foreign business.

With the enactment of this legal regime, foreign franchisors are now permitted to directly franchise from abroad into the PRC.  Nevertheless, there are several stringent requirements for potential franchisors looking to offer franchising opportunities within the country must comply with.  First, only business entities can offer franchising opportunities.  Secondly, the franchisor must have a registered trademark or patent.  Finally, and perhaps most importantly, PRC law specify that the franchisor must own at least two franchises itself in the PRC and must have operated those two franchises for at least a year.  (Some attorneys and businesspersons in the PRC call this the 2+1 rule). Therefore, in the McDonald’s example, the group that bought the rights to offer franchises in China is legally required to own at least two restaurants within the country in order to comply with PRC law and those restaurants must have been open at least a year before the consortium can offer a franchising opportunity to a Chinese business, for example.  Nevertheless, this should not be an issue, as McDonald’s will have a stake in the consortium.