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Most franchising-related disputes are disputes over franchise contracts. Among these, conflicts over the validity of franchise contracts are particularly complex. This article attempts to analyse this issue by considering an actual case that occurred in Shanghai.

The case

Anyone wishing to engage in franchising activities is required to satisfy certain conditions, have certain capabilities and perform certain obligations, including those of information disclosure and filing.

Article 7 of the Commercial Franchise Operations Administrative Regulations, issued by the State Council requires any potential franchisor to possess ¡°a mature business model and the capacity to provide its franchisees with such services as business guidance, technical support and business training on a continuing basis¡±. The same article specifies that a potential franchiser ¡°shall have at least two stores that it operates directly and that have been in business for more than one year.¡± Further, article 8 of the Regulations provides that ¡°a franchiser shall, within 15 days of the date of entering into its first franchise contract, file that contract with the competent commerce authority¡±.

In April 2008, the plaintiff, surnamed Chen, entered into a contract entitled a ¡°cooperation agreement¡± with the defendant, a company in Shanghai. In reality it was a franchising contract. In June the same year, the plaintiff terminated the lease, halted operations, and ascertained not only that the defendant did not satisfy the business conditions or have the capacity (two stores, one year) set forth in article 7 of the Regulations, but also that it had failed to carry out its information disclosure obligations or the filing procedures in accordance with article 8.

On this basis, the plaintiff alleged that the defendant was not qualified to be a party to a franchising agreement, and therefore the agreement executed by him and the defendant was invalid. Accordingly, he asked the court to declare the cooperation agreement to be invalid, order the defendant to reimburse his fitting-out costs and franchise fee, and compensate him for his economic losses.

The court rejected the plaintiff¡¯s claim, holding the cooperation agreement to be valid, on the grounds that the administrative regulations pertinent to the case were established principally for administrative purposes. If the franchising activities carried out by the defendant, as the franchiser, violated such regulations, it should bear the attendant administrative liability, but this should not affect the defendant¡¯s qualification to engage in franchising activities, or the validity of a franchising agreement (or, in this case, the ¡°cooperation agreement¡± executed by it.

Legal analysis

The determination of the validity of the cooperation agreement was one of the points in dispute in this case. We believe that the court¡¯s judgment was lawful and well-considered.

Many franchisees mistakenly believe that the violation by a franchiser of the ¡°two stores, one year¡±, filing and information disclosure requirements of the Regulations necessarily results in the voiding of the contract. However, claims made on this basis by franchisees are seldom upheld by the courts.

The regulations pertinent to franchising include, on the one hand, ministerial level rules and regulations such as the Commercial Franchising Administrative Measures and the Commercial Franchisers Administrative Measures and, on the other, such laws and administrative regulations as the PRC Contract Law and the Regulations. The court¡¯s decision turned on the question of what level and type of law or regulation to be declared void?

According to the relevant provisions of the PRC Contract Law and associated interpretations of the Supreme People¡¯s Court, only the violation of laws promulgated by the National People¡¯s Congress and its Standing Committee and the administrative regulations promulgated by the State Council can lead to the voiding of a contract.

The court pointed out that in this case, the relevant provisions of the Regulations in respect of matters such as the qualification of franchisers were formulated mainly for administrative purposes and no provision is made for voiding of a contract in the event of a violation thereof. Rather, they are regulations of an administrative nature, and only provide for administrative liability. Although the franchise activities conducted by the franchiser violated those regulations, what the franchiser is required to bear is the attendant administrative liability, and violation of the regulations has no substantive impact on the validity of the cooperation agreement executed by it.

Be that as it may, we need to note Article 10 of the Supreme People¡¯s Court Several Issues Concerning the PRC Contract Law Interpretations (1), which specifies that ¡°a People¡¯s Court shall not declare a contract invalid because a party exceeded its scope of business in concluding it, unless such party violated state regulations on business that is subject to restrictions, franchise business, or the provisions of laws or administrative regulations which prohibit such business.¡± So, for example, if a franchise contract executed by a franchisee with a foreign investment enterprise violates mandatory provisions of PRC laws or administrative regulations concerning access for foreign investment, such contract will be determined to be invalid.

Full investigation

In order to duly protect their own interests and avoid the occurrence of such disputes, potential franchisees should, before signing a franchise contract, fully investigate the qualifications to act as a party of the purported franchiser and its business situation. This should include seeking basic information on the franchiser from the administration for industry and commerce, trademark office, patent office and other such relevant authorities; doing an on-the-spot examination of the place of business of the franchiser; and visiting franchise stores, so that, in the event of a dispute, it can promptly avail itself of the pertinent remedies in accordance with relevant laws and regulations.

Harry He is a partner of AllBright Law Offices. His main practice areas are foreign direct investment, M&A and labour disputes