In a case decided August 25th but released only in October, the Beijing No. Intermediate People’s Court held that where a franchisor is not in compliance with the requirement to have operated two locations for at least one year (Article 7(2) of the Franchise Regulations) the franchise agreement is still valid and there is not a remedy of rescission for the franchisee. Instead the franchisor is subject only to administrative penalties. This is an appeal of the decision of the Beijing Haidian District Court decision of April 16, 2010.
Zhang Linxia entered into a contract called a ‘Cooler than Mice Clothing Sales Contract (Regional Exclusive Distribution)’ with the Franchisor on July 26, 2008 for the sale of children’s clothing. Zhang was unhappy with the quality of the product that was provided and sought to terminate the contract and recover her expenses. Firstly she had to show that this was in fact a ‘franchise agreement.’ Secondly she sought to rely on the fact that at the time she signed the contract the franchisor did not have the required two outlets that it had operated for one year.
Firstly the court found that despite the name of the contract, it was a franchise agreement because the Franchisor provided continuing supervision and inspection, and provided a business model rather than a simple sales contract.
(‘In summary, although it Is not called such, the contract signed by both parties is a franchise agreement, as the terms and other characteristics are consistent with a franchise agreement, and therefore it should be recognized as a franchise agreement.’)
Secondly the Beijing No. 1 Intermediate People’s Court said that the 2+1 Rule relates only to the relationship between the franchisor and the franchisee and is not related to the general public interest. Therefore the 2+1 Rule is not a mandatory requirement for a franchisor. The current judicial practice is that a franchisor who violates the 2+1 Rule is subject to administrative penalties. Thus the franchise agreement was held to be valid. The concept of a ‘mandatory requirement’ is a civil law concept used to determine which aspects of the law cannot be contracted out of.
The decision of the Beijing No. 1 Intermediate People’s Court regarding the 2+1 Rule is quite significant. Although China has a civil law system where courts are not bound by previous decisions or precedents, cases are still used in court for their persuasive value and judges search internet databases for cases such as these when working on their own decisions.
Further the Intellectual Property Bench (where franchise cases are now decided) of the Beijing No. 1 Intermediate People’s Court is very highly regarded for the quality of its decisions.
This decision should ease the concerns of some about franchising in China. But the 2+1 Rule is very much alive with regard to the required registration as a franchisor.
Citation: Zhang Linxia v. Beijing Jiuling Chang Sheng Investment Advisory Co., Ltd., Beijing No.1 Intermediate People’s Court, 2010 10112?.
Paul Jones, IDI franchising country expert for China.