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CHINA:Franchisor’s Liability for Failure to Disclose in the People’s Republic of China (the “PRC”).

In this appellate court decision regarding a franchise agreement dispute, the Shanghai IP Court dismissed the Franchisee’s claim for the termination of the Franchise Agreement due to the Franchisor’s failure to make disclosures. In deciding this case, the court mainly relied on the lack of substantial negative impact caused by the Franchisor’s failure to disclose.

Paul JONES - 15.04.19
Country expert

In 2017, the Franchisor and the Franchisee signed a Franchise Agreement granting the Franchisee an exclusive right to operate and sub-franchise a Russian ice cream brand “KOROVKA” (格林诺夫) in Lianyungang City, Jiangsu Province, China (“Territory”). The Franchise Agreement outlined detailed provisions regarding the benefits provided to the Franchisee for a share of the franchise fees for each sub-franchises developed in the Territory. The Franchise Agreement also outlined various rebate provisions for ice cream ingredients and advertisements. The Franchise Agreement allowed the Franchisee to develop sub-franchises by itself or with the assistance of the Franchisor.

In 2018, the Franchisee sued the Franchisor for the termination of the Franchise Agreement based on, inter alia, the Franchisor’s failure to disclose relevant information. The Franchisee claimed that the Franchisor should have disclosed a competing franchise developed by the Franchisor with a third party in the Territory, the Franchisor’s trademark not being registered at the time of disclosure and the Franchisor’s failure to complete the franchise registration with the Ministry of Commerce of the PRC, etc. This case was initially heard by Shanghai Minhang District People’s Court where the court dismissed the Franchisee’s claims. The Franchisee appealed to the Shanghai IP court where the court upheld the trial court decision.

In its decision, the Shanghai IP court first recognized that pursuant to the provisions in the Franchise Agreement, the Franchisee’s rights and interests as an exclusive master franchisee mainly stem from the development of sub-franchises. Second, pursuant to the Franchise Agreement, the Franchisor is permitted to assist the Franchisee to develop sub-franchises in the Territory and the Franchisee is entitled to receive various benefits and rebates for the sub-franchises developed in this manner. Last and most significantly, the Shanghai IP court recognized that there was no evidence to prove that the franchise rights and interests conferred under the single-unit franchise agreement signed between the Franchisor and the third party are equivalent to the rights and interests conferred under the Franchise Agreement at hand.

The Shanghai IP court was not persuaded that the existence of the single-unit franchise developed by the Franchisor can substantially undermine the potential business interests of the Franchisee, resulting in the Franchisee’s inability to realize the purpose of the Franchise Agreement. Along the same line of reasoning, the court dismissed the Franchisee’s claim to terminate the Franchise Agreement for the Franchisor’s failure to disclose that its trademark was not registered at the time of disclosure. The court further held that there is no legal basis that supports the termination of the Franchise Agreement due to the Franchisor’s failure to complete the franchise registration. In conclusion, the Shanghai IP court dismissed all claims made by the Franchisee.

Interestingly, in this case, the trial court held in general terms that provisions regarding franchisors’ disclosure obligations under the Commercial Franchise Administration Regulation of the PRC (商业特许经营管理条例) are “administrative provisions” and that they do not affect the parties contractual obligations. Though the Shanghai IP court concurred with the trial court’s decision, it did not comment on the trial court’s reasoning on the nature of franchisor’s disclosure obligations. It is still to be seen how future cases in China will address the inconsistent views regarding the nature of franchisor’s disclosure obligations under the Commercial Franchise Administration Regulation.

Although not mentioned this decision, we want to remind the readers of this article that regulations in the PRC, including Commercial Franchise Administration Regulation, must be interpreted in accordance with the relevant laws that state the general principles for all contracts and obligations. In this regard Article 42 of the PRC Contract Law (合同法)should always be kept in mind when drafting and interpreting franchise agreements. Article 42 reads as follows:

“In the making of a contract, the party that falls under any of the following circumstances, causing thus loss to the other party, shall hold the liability for the loss.

(1) engaging in consultation with malicious intention in name of making a contract;

(2) concealing intentionally key facts related to the making of a contract;

(3) taking any other act contrary to the principle of good faith.”

 

Paul Jones, IDI Country Expert for franchising in China

Yixian Chen

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