Tuesday, October 31, 2006

China’s Legal System Must Be Considered in Interpreting Franchise Law

This post was written by Peter Reap, editor of CCH Business Franchise Guide.

When translating and interpreting China’s laws and regulations applicable to franchising, the structure of China’s legal system must be kept in mind, Toronto franchise attorney Paul Jones writes in his recent article, China’s Franchise Laws: Cases and Commentaries. China has adopted a civil law model in which broad principles are set out in laws of general application and the decisions of courts do not have precedential value.

China’s general Contract Law, which became effective in 1999, and its Measures for the Regulation of Commercial Franchising (CCH Business Franchise Guide ¶7065), which became effective in 2005, both require pre-contractual disclosure. Examining third-party translations of both laws and providing his own translation of the disclosure obligations imposed by the Measures, Mr. Jones alerts franchisors that the list of disclosure obligations in the Measures is not intended to be exhaustive. In several places, the list requires the disclosure of what is best translated as “similar information.”

One of the first decisions by a Chinese court to review a franchisor’s failure to make disclosures required by the Measures is Haiyan v. Beijing Hansen Cosmetology Ltd. Co. (Beijing Chaoyang District People’s Court, 2005). The franchisee of a cosmetics shop business had paid a franchise fee of approximately $22,000 to a franchisor, but subsequently discovered that the franchisor’s trademark was not registered; that the franchisor’s brand was not, as had been represented, an international brand; and that there were undisclosed problems in product supply. The court noted that the Measures required written disclosure of basic information and found that the franchisor had intentionally violated its disclosure obligation.

In its analysis of the purpose of the Measures, the court determined that a violation of the disclosure obligation constituted fraud. Citing provisions of China’s Contract Law, the court declared the parties’ agreement to be lacking in fairness, rescinded the agreement, and ordered the return of the franchisee’s money.

Court decisions holding franchise agreements invalid due to the franchisor’s lack of necessary qualifications are currently more common than decisions ordering rescission for a failure to disclose, Mr. Jones observes. Article 7 of the Measures sets out the qualifications required for a franchisor to operate in China. While foreign commentators have focused on the barrier to entry posed by the requirement of having operated two locations in China for at least one year, Chinese commentators have focused on whether the foreign franchisor is duly organized under China’s laws and regulations to offer franchises, the author concludes.

The full text of the article, China’s Franchise Laws: Cases and Commentaries, appears at CCH Business Franchise Guide ¶7068.

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