CHINA: Comments on recent Appeal Decision regarding burden of proof on calculation of franchise royalties.

Paul JONES | CHINA | 2020-07-15


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In a recent decision on Dalian Hongcheng Catering Management Co., Ltd. vs Li Cheng (Franchisee) (in Chinese, 大连弘程餐饮管理有限公司 诉 李成)[1], the intermediate court of Dalian city upheld the franchisor’s claim on the amount of royalties that were payable by the franchisee based on the reason that the franchisee failed to provide its monthly gross revenue by which the royalties could be calculated. And therefore, the amount claimed by the franchisor shall be upheld.

The franchise agreement between the franchisor and the franchisee in this case stipulates that the franchisee shall pay royalties to the franchisor on a monthly basis. For the first year, the royalties shall be calculated as 5% of the franchisee’s then-current monthly gross revenue; and starting from the second year, it will be increased to 6%.

The franchisor alleged that the franchisee owed royalties in the amount of RMB20,000. At the first instance, the trial court did not support such claim because the franchisor did not provide sufficient evidence to prove the franchisee’s failure to pay the royalties as well as the amount owed. The franchisor appealed to the intermediate court.

The intermediate court found that the trial court erred in the issue of the burden of proof regarding the payment of royalties and the amount owed. The intermediate court mainly relied on Article 5 and Article 75 of the Some Provisions of the Supreme People’s Court on Evidence in Civil Procedures (最高人民法院关于民事诉讼证据的若干规, the “Provisions”). Article 5 prescribes that in a dispute over whether a contract is performed, the party under the obligation of performing the contract shall be responsible for producing the evidence. In this case, regarding the issue of payment of royalties specifically, the franchisee was obligated to pay the royalties as agreed in the franchise agreement. And the franchisee had the burden to prove that the royalties had been paid. However, the franchisee could only prove the fact that it had made several payments to the franchisor in the first season of 2018, but failed to provide evidence to prove the details and the nature of those payments. The court did not support the presumption that those payments made by the franchisee included the payment of royalties.

As for the issue of determining the amount of royalties owed to the franchisor, the intermediate court cited Article 75 of the Provisions, which prescribes that when there is evidence showing that where one party possesses evidence but refuses to provide such evidence without good reasons, and if the other party claims that such evidence is unfavorable to the possessor of the evidence, such claim will be presumed to be established. In the case here, the franchisee’s monthly gross revenue is key to the calculation of the royalties owed. However, the franchisee did not provide the figures of its monthly gross revenue and did not explain why it refused to produce the evidence. The court thereby assumed that the franchisor’s claim was factual and supported the amount claimed by the franchisor.

We do not know the exact reason why the franchisee refused to provide its monthly gross revenue to rebut the number of the royalties owed claimed by the franchisor. Maybe the number claimed by the franchisor is lower than the actual number calculated based on franchisee’s monthly gross revenue. Maybe there are some tax reasons. But if the number claimed by the franchisor is far higher than the actual amount owed by the franchisee to the franchisor, the franchisee may be more inclined to disclose the actual numbers. Therefore, if the franchise agreement does not grant the franchisor access to franchisee’s sales numbers, and the royalties are calculated as a percentage of franchisee’s revenues, for a dispute similar to this case, the franchisor may consider claiming a higher number within a reasonable scope, which will force the franchisee to rebut such a number by producing its actual sales if the number claimed by the franchisor is higher than the amount the franchisee actually owes.




Paul Jones, IDI Country Expert for franchising in China

Zoe Huang (黄子峨)

Leo Xu (徐鑫)

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