Prerequisite to Successful Franchising in China is strong IP !

Categories: Business In China | By John Tan

Clients often ask, why do they need to register their trademarks in the People’s Republic of China (Mainland China), and how can they use them in the business? Mainland China adopts the principle of First-To-File instead of the principle of First-To-Use. So, those who file the applications first, may be able to obtain the exclusive rights to their trademarks. However, it is franchising, especially in the field of food and beverage, retail, catering, education and training, beauty, healthcare, along with hospitality, that they can employ their expertise in. These are highly regarded as popular and profitable sectors to invest your money and know-how in.

Mainland China is one of the biggest and fastest growing franchise markets in the world, with more than 4,500 franchise systems as well as some 400,000 franchised outlets in over 70 industries. Franchising can be a quick and feasible option for clients to expand and develop their business in the market. Since the country is also highly populated and has a vast middle-income consumer-base, businesses achieve great success and are also making high profits.

Popular Franchise Models

KFC and McDonald’s are two famous franchisors we will never forget mentioning when we talk about franchising in Mainland China. They entered the market in the 1980s and 1990s, respectively, and entirely changed the scenario.

KFC began granting franchises in lower-tier cities in 1992 and now has around 6,000 outlets all over, which is twice as much as the number of McDonald’s outlets, who adopted franchising later in 2004. KFC and McDonald’s have both done an excellent job in franchising in Mainland China. It is only after they gained recognition that franchising came to be known as an official form of doing business in the Chinese market.

In fact, besides franchising, other business models such as foreign direct investment (FDI), exporting, global sourcing, and licensing also prevail as superior options. However, in my experience with the clients who we have assisted, I think franchising is a trendy business model because franchisors can leverage the local knowledge as well as the resources of the right franchisees, and thus occupy the markets very quickly. Also, companies having a high value proposition in the local market along with the ability to effectively adapt to China’s peculiarities may, however, find a promising as well as a profitable niche to operate in.

Definition

The definition of a franchise in Mainland China is similar to those in other countries, so it is commonly recognized all over the world. However, according to the Commercial Franchise Administration Regulations adopted by the authorities of MOFCOM (Ministry of Commerce) in 2007, commercial franchising refers to business operations by which an enterprise (franchisor) that owns certain registered trademarks, corporate logos, patents, know-how or proprietary technology, or any other business resources, such as copyrights to artistic works (franchise resources) authorizes or licenses other corporates (franchisees) to use the said franchise resources by a contract (franchise contract). The franchisees undertake business activities following a uniform business model as stipulated by the contract and pay franchising fees to the franchisors.

Regulations by MOFCOM

As a matter of fact, MOFCOM just sets some preconditions (as follows) that apply to both foreign as well as domestic franchisors who plan to establish a franchise in the country:

1). A franchisor, who engages in a franchise, shall possess a mature business model and the ability to provide the franchisees with long-term guidance, technical support, business training, as well as other necessary services.

2). A franchisor, who engages in a franchise, shall have at least two direct sales stores and shall have undertaken the business for more than one year. This is also called 2+1 requirements. Meanwhile, for a foreign franchisor, it is not required that such direct sales stores are located in Mainland China – those established abroad may also qualify. However, the franchisor must provide proof of such direct sales stores with relevant documents, such as business registration certificates or certificates of incorporation of the direct sales stores. These documents shall be notarized in the country where the stores are operated along with being legalized by the Chinese Embassy or consulate to the country,and translated into Chinese.

In other words, the threshold for franchises in Mainland China is not extremely high. Thus, several international companies (including retailers and other brand owners) in the fields listed previously, adopt franchising and take it as an essential mode to expand and develop their business in Mainland China.

However, franchisors from the countries that adopt the principle of first-to-use for trademarks often forget to file and register their trademarks in Mainland China primarily. So, not all franchisors are doing well in the industry, and some of them are also facing troubles.

To conclude the definition mentioned above and preconditions laid for a franchise stipulated in the relevant regulations by MOFCOM, franchisors must clearly have a mature business model, business guidance, technical support, expertise, proprietary technology, training, as well as franchise resources. These actually provide franchisors with the fundamental guidelines so they can gauge their preparedness to do business in Mainland China.

In my experience and opinion, one of the essential guidelines is that franchisors must be legally entitled to the franchise resources, namely, intellectual properties (IP), such as trademarks, patents, copyrights, domain names, and so on. IP plays a vital role in franchising as franchisors can actually own them, or may also have the right to franchise some IP owned by other parties to franchisees. For example, they may have the right to authorize and franchise the trademarks from their parent companies. However, in reality, some franchisors ignore it entirely or just do not place much attention to it.

Case Study

In 2015, one of our clients decided to start a franchise business in Mainland China. They wanted to get a firm grip on the field of education and training in science and engineering, particularly for kids. They did not register their trademark in advance and legally own it before their business schedule. But, they began negotiating with the franchisee and then authorized a lawyer to file applications for their trademarks in March 2015. Expectedly, things did not go the right way and as smoothly as they would have. China Trademark Office rejected their applications because some other party filed for their trademarks around one year before them, and the trademarks were registered by the other party, which we can call squatting.

This client, then, came to us for a solution, and we studied the details of both cases. We suggested the client file a request to invalidate the prior registered trademarks grabbed by the squatter and submit their applications again at the same time.

During the process of invalidating the prior registered marks, we argued that the squatter infringed the copyright of the artistic works (logo in this case) completed by the client long ago in 2008 and put to use since 2009. We collected all the evidence to support the requests of invalidation. We also argued that the squatter tried to make a profit from the reputation of our client by grabbing their trademarks, breaching the principle of good faith, disturbing the market order, as well as breaking fair competition in the market.

In the end, we won the invalidation to the prior registrations in early 2017, and the previous registrations were cancelled. Examiners adopted our arguments that the squatter infringed the client’s copyright of their artistic works and the squatter (by the name, it may be a competitor in the same industry as the client) was trying to leverage the copyright of the client and conducted an unfair competition for illegal profit.

After the obstacles of the prior registrations got removed, the client’s trademarks were registered in April 2018. Of course, this was a lucky client, and not every client has this kind of opportunity. In the end, even we succeeded in the case with our experience and expertise, but it was not an easy battle. The client had wasted a lot of time, efforts and money on this fight against the squatter. What got worse was the plan for the franchise that was delayed by almost three years as they were not prepared in intellectual properties, which constituted an essential part of franchise resources. What a loss in business! What a pity!

Final Note

In our experience, intellectual properties, such as trademarks, patents, copyrights, know-how, and the likes are the most crucial franchise resources, and they interlink with each other. There are different systems for managing intellectual properties under various jurisdictions, and according to various laws and regulations. So, it is imperative to make sure that a franchisor is legally entitled to such intellectual properties or own such intellectual properties in the jurisdictions they are franchising.

For intellectual properties (except copyright) registered in jurisdictions other than Mainland China, literary works, as well as artistic works, are automatically protected in member countries according to the Berne Convention for the Protection of Literary and Artistic Works. But, the registration of other intellectual property rights such as trademarks or patents in other jurisdictions, does not automatically provide clients with any protection in Mainland China. So, without the registration of intellectual properties according to the related laws and regulations in Mainland China, there is little we can do to protect the clients in this jurisdiction.

As a must-take step, we must make sure that the franchisor legally owns all these intellectual properties in Mainland China, or have the right to use these intellectual properties. This will assure that you are ready to enter the Chinese business environment. IPs must also conform to the relevant laws that govern intellectual property rights in Mainland China, such as the Trademark Law, the Patent Law, the Copyright Law, the Anti-Unfair Competition Law, along with other applicable procedures. Or else, you may face a lot of difficulties with regards to business development in Mainland China as the above-stated examples.

John Tan, is one of our attorneys with 15 years of experience in his areas. He focuses his practice on general corporate governance, commercial law, intellectual property law, employment law, and litigations in his areas. His clients majorly include entrepreneurs, Fortune 100 companies and SMEs, and span the globe to include clients from the US, Canada, UK, Germany, France, Austria, Italy, Japan, Singapore, Australia, Spain, Portugal, Brazil, Mexico, Russia, and many others. You may write to [email protected] for more support from him.  
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