Copyright c 2004 Washington College of Law American University American University International Law Review 2004 19 Am U Int l L Rev 949 LENGTH 19490 words NOTE AND COMMENT Franchising in China Legal Challenges When First Entering the Chinese Market NAME MICHELE LEE BIO J D Candidate 2005 American University Washington College of Law B A Political Science and Public Relations 2002 Syracuse University I would like to thank the ILR editors and staf for their hard work in preparing this for publication Sincere thanks to Professor Ruskola for clarifying Chinese Law and to Andrew Sherman for his help in explaining franchise law I am particularly grateful to Jacob Rolls Kevin Murphy and Justin Gdula for their help in writing and bluebooking A special thanks to my friends Arish Gajjar Emily Livingston Fiona McKenna Kristen Mcgeeney Melanie Nakagawa Eric Liang Amy Lubrano Christine Lin and Pooja Mehta who were all constant sources of encouragement whenever I lost sight of the end Most importantly thank you to my sister and parents who provided me with such a hao de kai shi through their love and support SUMMARY The complicated and often inconsistent legal bars that face franchisors in China have not distracted these international investors from the glowing dollar signs There is no Chinese word for franchise and for many years franchising as it exists in the United States did not exist in China Despite the prevalence of U S based businesses in China the basic franchising structure whereby franchise rights are directly granted from the franchisor to the franchisee has been rare One frequently cited reason for this difficulty is China s corruption culture Franchise investors must be fully aware of the legal risks under Chinese law and the legal structure when considering franchising in China With a well connected Chinese partner the foreign investor hoped to avoid navigating an undeveloped legal system and political channels Full ownership of the enterprise allows the franchise to shape and develop the trademark the advertising and the products associated with the mark While the Chinese laws and legal structure are only beginning to reflect the rule of law corporations that draft efective contractual agreements and vigilantly police intellectual property will establish a strong start in long term franchise development HIGHLIGHT Two men look out through the same bars One sees the mud and one the stars Frederick Langbridge n1 TEXT 951 INTRODUCTION The complicated and often inconsistent legal bars that face franchisors in China have not distracted these international investors from the glowing dollar signs n2 While there are only about 1 000 franchisees in China operating approximately 100 000 outlets they generate over eighty five billion dollars in annual sales n3 The China Chainstore and Franchise Association predicts that franchising will comprise over thirty percent of retail sales by 2010 n4 With China s population gaining in affluence and maintaining a stronger middle class base U S based franchises in China have found a receptive market n5 In the past few years the franchise business model has grown from non existent to an attractive business 952 option yet even with the recent growth in popularity of the franchise format the potential for future growth in China is tremendous n6 With U S brand recognition currently at its peak well established franchisors seeking a less saturated market than the United States will find promising opportunities in the Chinese market n7 While the potential profit margin is enough for anyone to go East in search of striking gold several problems bar the path to easy profits n8 China s accession into the World Trade Organization WTO has done much to alleviate fears of foreign enterprise investors with U S franchisors looking forward to greater market access through the relaxing of geographic restrictions national treatment for foreign invested enterprises FEI and stricter intellectual property regulations n9 Despite the promised improvements franchisors should be wary of the lax licensing 953 regulations vague laws and weak intellectual property protection that could undermine the very identity of a franchise n10 This comment traces the development of franchise law in China and evaluates whether the evolution of the laws afecting foreign franchises in this country efectively provides protection for franchisors n11 While there have been changes in both the rule of law and the laws themselves this comment argues that the development in the laws are still not sufficient to provide adequate protection for franchises n12 Because of this insufficient protection foreign franchisors should take the additional protection of maintaining as much control over a franchise system as possible in its business ownership intellectual property and contractual agreements n13 Part I examines the diferent franchise structures in China and provides an overview of current regulations afecting franchises n14 Part II analyzes gaps in legal protection created by vague and inconsistent laws a thin rule of law and limited resources for legal enforcement in the Chinese legal system n15 Part III provides recommendations for 954 how franchisors can avoid legal pitfalls and take the necessary steps to franchise successfully in China n16 I BACKGROUND Since the start of communism China has maintained its isolation and done little to interact with other countries n17 Partly as a result of this isolationist policy the country declined in prosperity as it relied on a strictly controlled market that hinged on unsuccessful and corrupt state owned enterprises SOEs n18 China s history includes many unsuccessful government attempts to independently modernize China s economy n19 Success in creating change arrived in 1978 when the Communist Party focused on economic development n20 Despite the government s focus on market development China has continued its commitment to political socialism n21 The unique 955 atmosphere of a market oriented government in a strictly controlled political environment has forced foreign businesses to carefully adjust their business models to fit China s political objectives and policies n22 A Franchising Defined The franchise structure originated in the United States n23 and has since spread throughout the world n24 A franchise exists when a franchisor grants to a franchisee the right to market goods and services following established marketing and distribution
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