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CHINA: Recent Appeal Decision regarding the definition of a franchise and the right of unilateral termination in franchise agreements.

A very common feature of domestic PRC franchise cases is that the alleged franchisor disputes that its agreement is a franchise agreement.

Paul JONES - 16.11.20
Country expert

Sometimes they appear to be generally unaware of the Franchise Regulations. And sometimes this is the way the alleged franchisor can avoid the extra obligations of a franchise system, such as in this case where the prospective franchisee sought to exercise the right to unilaterally terminate the franchise agreement, even though the franchise agreement is silent on this point. Even though China is not a case law country, decisions issued from higher courts still have referential value. A recent appeal decision on Beijing Thomas Education Consulting Co., Ltd. vs Yang Xiaoqin (in Chinese, 北京托马斯教育咨询有限公司 诉 杨晓琴) from the Beijing Intellectual Property Court[1] strengthened the major opinions of Chinese courts on those two issues.

In the case here, the Appellant, Beijing Thomas Education Consulting Co., Ltd. (hereinafter as “Thomas Education”), and the Respondent, Ms. Xiaoqin Yang (hereinafter “Ms. Yang”), entered in to an agreement (hereinafter as “Agreement”) on August 14, 2018, which authorized Ms. Yang to establish and operate English training institute by using Thomas Education’s English and STEAM courses. Importantly for Ms. Yang, the Agreement allows Ms. Yang to use Thomas Education’s brand “Thomas English School” and to purchase training materials from Thomas Education. In order to prove that assistance in operations and trainings has been provided, Thomas Education proffered the court email exchanges with Ms. Yang indicating that STEAM teaching plan, materials and course schedule had been delivered to Ms. Yang. Ms. Yang also sought advice from Thomas Education about the layout, decoration and tuition fees for the school. On November 12, 2018, Ms. Yang sent an email to Thomas Education to terminate the Agreement because she was not able to obtain the local license for operating an educational institute and claimed a refund of the consulting fee, training materials fee and a deposit previously paid by Ms. Yang. Thomas Education claimed that the Agreement is purely a contract for providing consulting services to Ms. Yang and does not constitute a franchise agreement. Therefore, Ms. Yang is not entitled to terminate the Agreement unilaterally.

The first important issue that needs to be addressed is whether the agreement between Thomas Education and Ms. Yang is a franchise agreement (特许经营合同) or a consulting contact (咨询合同) as Thomas Education claimed. Article 3 of the Regulation on the Administration of Commercial Franchises (hereinafter as “Regulation”) (in Chinese 《商业特许经营管理条例》) provides the definition of franchise business[2]. The Appellate Court here illustrated this definition and emphasized that a franchise business must feature three fundamental elements: (1) having specific business resources, including registered trademark, trade name, patent etc.; (2) having standardized operation model, including management, marketing, quality control, store design and decoration, and the franchisee must operate the business within the frame defined by the franchisor; (3) franchisees pay a franchising fee to franchisors for using the business resources provided by the franchisor. The Court also reaffirmed that to determine whether an agreement constitutes a franchise agreement, judges shall focus on those three elements listed above (the essence of the agreements) rather than the name of the agreement. This position is consistent with previous judicial decisions related to the nature of franchise agreements. Based on the evidence, and in particular the right granted to use the trademark, the court upheld the first trial court’s decision that the agreement involved in this case is a franchise agreement in nature.

The court further addressed the issue whether Ms. Yang has a right of unilateral termination. Article 12 of the Regulation prescribes that the franchisee has the right to terminate the agreement unilaterally within a certain period of time after the agreement is executed (the “cooling-off period”). But the Regulation does not provide for the length of the cooling-off period. In the case here, the agreement between Thomas Education and Ms. Yang did not include a cooling-off clause. The court considered that the purpose of Article 12 is to balance the interests of franchisors and franchisees, and protect the franchisees who are normally in a disadvantageous position. Therefore, even though the franchise agreement does not contain a cooling-off clause, the franchisee can still claim a unilateral termination within a reasonable period of time pursuant to Article 12, provided that the franchisee has not started to operate the franchise. Given the fact that Ms. Yang did not obtain and use Thomas Education’s business resources, the court upheld Ms. Yang’s right to terminate the agreement within 90 days after the execution of the agreement and the court concluded that the agreement was legally terminated.

In practice, it is not uncommon that franchisors often ignore Article 12 of the Regulation. We have seen several cases where franchisors did not include a cooling-off clause in their franchise agreements, and some other cases in which the franchise agreements contained such a clause but did not provide a fixed period of time for revocation. Since the purpose of Article 12 is to protect franchisees’ interests, if a franchise agreement does not have a cooling-off clause with a fixed period of time, the court will assess this issue by taking into account of a variety of factors, the most important of which is, whether a franchisor’s business resources have been provided to and used by the franchisee. But if a franchise agreement contains a fixed-term cooling-off period, the courts tend to honor it. In light of such circumstances, our suggestion for most franchisors is that in order to avoid any uncertainty and risks arising from Article 12, it is highly recommended that the franchise agreement should contain a cooling-off clause with a fixed term.

 

[1] Decided May 27, 2020. Available in Chinese at: http://wenshu.court.gov.cn/website/wenshu/181107ANFZ0BXSK4/index.html?docId=efa8cb7f21bc499b807dabd0000d6fb9

[2] Article 3 The term “commercial franchise” (hereinafter referred to as “franchise”) as mentioned in this Regulation refers to such business operations by which an enterprise owning a registered trademark, enterprise mark, patent, know-how or any other business resource (hereinafter referred to as “franchiser”) confers the said business resource to any other business operator (hereinafter referred to as “franchisee”) by means of contract, and the franchisee undertakes business operations under the uniform business model as stipulated by the contract, and pay franchising fees to the franchiser.

 

Paul Jones, IDI Country Expert for franchising in China

Zoe Huang (黄子峨)

Leo Xu (徐鑫)

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