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Amid intensifying competition and the rapid growth of e-commerce, retail brands are pursuing swift market expansion primarily through franchising and distribution models. However, these two models differ fundamentally in their legal nature and risk allocation, and their interchangeable use may give rise to contractual disputes or legal risks.

Brand owners must carefully assess their business needs and, from a compliance and long-term risk prevention perspective, select the appropriate commercial model while optimising contractual provisions.

Legal nature

In industry practice, the co-operation agreement between a brand owner and its partner may be titled as a ¡°franchise agreement¡±, ¡°brand licensing agreement¡±, ¡°chain operation agreement¡±, ¡°special distributor agreement¡± or ¡°distribution agreement¡±, among other names.

In judicial practice, however, distinguishing a commercial franchising contract from a distribution contract is not based on the contract title but rather on the following aspects concerning their legal nature.

Profit channels and contract subject matter. Under a commercial franchising contract, the franchisee earns revenue by using the franchisor¡¯s operating resources, including but not limited to core brand, know-how and trademarks, which constitute intangible assets. The subject matter of the contract is the operating resources provided by the franchisor.

In contrast, under a distribution contract, the agent earns profit by either purchasing specific products bearing the brand¡¯s trademark or logo for resale at a margin, or by receiving a commission based on sales volume. In this case, the subject matter of the contract is the specified products.

Contract consideration. Under a commercial franchising contract, the franchisee pays a fee to the franchisor for the continuous use of the franchisor¡¯s operating resources, which include intangible assets such as trademarks, trade names, patents, proprietary technology and trade secrets.

In practice, franchisors often collect this fee under various designations, including training fee, brand usage fee, membership fee or sales commission, rather than directly as a ¡°franchise fee¡±. Under a distribution contract, the consideration paid by the agent to the brand owner is generally the purchase price of the specific products.

Applicable law. Commercial franchising contracts are primarily regulated by the Regulation on the Administration of Commercial Franchises, whereas distribution contracts, not being a named contract under the Civil Code, are governed by the general contract rules set out in the contract chapter of the Civil Code.

Management intensity. Under the commercial franchising model, the franchisor requires the franchisee to conduct business activities in a fixed and uniform manner. In practice, there is a strong emphasis on the consistency of both the operational system, store decor, service standards and product pricing.

It is important to note that a standardised ¡°appearance¡± is not the sole criterion for determining whether the business model is uniform. Industry-specific factors and the level of control over upstream and downstream parties must also be considered.

Under the distribution model, the brand owner generally imposes requirements only regarding the distribution territory, the type of authorisation (for example, exclusive or non-exclusive), the range of products and the retail price.

Contracting party qualifications. Under a commercial franchising contract, the franchisor must have ownership of or the right to dispose of the licensed operating resources. Should the franchisor¡¯s rights to the operating resources be revoked or declared invalid during the term of the contract, the franchisee may request termination.

If the franchisor does not operate at least two directly managed stores that have been in business for more than one year, they may be subject to penalties from the relevant authorities. By contrast, under a distribution contract, it is not necessarily required that the brand owner holds the ownership or exclusive rights to the brand. The party may instead be a distributor authorised for a regional distribution and permitted to distribute the products.

Choice of business model

The franchise model enables the franchisor to transfer market operating costs and risks to the franchisee. The uniform business model established between the franchisor and the franchisee enhances brand recognition and influence among target consumers. By sharing operating resources, both parties can achieve co-ordinated growth.

Retail brand owners opting for the franchise model are required to strictly comply with statutory business registration and disclosure obligations and to retain relevant evidence of disclosure.

Franchise agreements must clearly define the scope of the licensed operating resources (including, but not limited to, trademark registration numbers, proprietary technical information and versions of the store operations manual) to prevent disputes arising from ambiguous licensing terms.

In promotional materials, content must be truthful and lawful. Investment returns should not be exaggerated to avoid being deemed ¡°false advertising¡± that could mislead franchisees.

In contrast, the distribution model enables distributors to swiftly bring products to market and expand market reach. For brand owners, management costs are relatively low, with minimal involvement in day-to-day operations and reduced training expenditure.

However, distributor loyalty and commitment to a single brand may be limited, potentially hindering the deepening of brand influence. Retail brand owners who opt for the distribution model should clearly define the rights and obligations regarding designated sales territories, product range, return and exchange policies, commission or rebate policies and inventory repurchase arrangements.

When establishing price control provisions, it is essential to ensure compliance with the relevant provisions of the Anti-Monopoly Law. Liability clauses should also focus on preventing issues such as unauthorised sales among distributors and overdue payments.

Zhou Le is a partner and Tian Yu is an associate at Blossom & Credit Law Firm