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Draft: [ ] 29 June 2017
Overview on PRC Legal Framework for Agreements
on Distribution and Franchising

Legislation Regulating Distribution And Franchising Agreements
Generally, just like all other contracts, the distribution and franchising agreements are
regulated by the General Principles of Civil Law promulgated in 1986 and the
Contract Law of 1999, and in particular the Contract Law Chapter Nine Purchase
and Sales Contracts and Chapter Twenty-two Commission Contracts.
In particular, we should also consider the 1997 Administrative Measures on
Commercial Franchising and the 1998 Several Administrative Regulations on
Merchandise Agency and Logistics Industries, respectively regulating franchising and
commission agent in distribution.
Besides, distribution and franchising agreements are also subject to certain provisions
of Pricing Law, Product Quality Law, Anti Unfair Competition Law, Law on
Protection of the Rights and Interests of Consumers, etc.
A new law on franchising is currently being drafted. The law is expected to be issued
later this year or early next year.

Definition Given For Distributor And Franchisee
There is no statutory definition. Distributor is a dealer who handles in selling and
supplying goods chiefly to retailers or commercial users. Roughly there are two types
of distributor, i.e. commission agent and wholesaler. Franchisee is a person being
granted according to franchising agreement the right to use in its business activities
the trademark, trade name, products, know-how and business modes of the franchisor.

Formalities Which Influence The Validity Of The Agreements
Distributor/franchisee can be both a natural person and a legal person. Except for
general requirements for business ability and resources (funds, premise, personnel,
etc.) there is no specific certification/license requirement for distributors of most
commodities, however for some goods such as salt, tobacco, audio and video
products, cotton, rubber, petroleum, chemical fertilizer, medicine, etc. that are subject
to special regulations, distributor need to obtain administrative licenses.
Distribution agreements are not subject to any specific formalities, but franchising
agreements must be in writing. Neither distribution nor franchising agreements need
to be registered as such, but franchising agreements are subject to the
registration/approval procedures applicable to trademark and/or technology license
agreement, if the franchising agreement includes such provisions.
There is no explicit provision about whether the distribution/franchising agreement is
freely transferable. Pursuant to Contract Law, the obligor can assign its contractual
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obligations to a third party only upon consent of the obligee. The obligee may assign
its contractual rights to a third party by giving the obligor notification. Where
notification is not given, the assignment shall have no effect on the obligor. However
in the following situations the rights cannot be transfers: (1) the rights may not be
assigned due to the nature of the contract; (2) the parties have agreed that the rights
may not be assigned; or (3) laws stipulate that the rights may not be assigned.
As for consignment stock, the Contract Law provides that, in respect to purchase and
sales contract ownership of goods is transferred from the moment that the goods are
delivered, except that the parties may agree that if the purchaser does not perform
payment or other obligation the seller may retain ownership of the goods. But even if
the seller retains ownership of the goods, the risk of damage or loss of the goods shall
be borne by the purchaser after the delivery, except where laws provide otherwise or
the parties agree otherwise. As to commission agent, it is provided by law that the
commission agent shall take appropriate care of the goods in his possession and shall
be liable for damage or loss of the goods. If the delivered goods are defective or easy
to decompose or deteriorate, the commission agent shall report to the
manufacturer/supplier and may dispose the said goods with consent of the
manufacturer/supplier. If the commission agent is unable to contact the
manufacturer/supplier, he should dispose the said goods in a reasonable manner,
otherwise the commission agent shall compensate the manufacturer/supplier of his
loss.

Obligations Of The Distributor/Franchisee
Apart from what are stipulated in the agreement, the laws provide that a commission
agent shall assume the following obligations:
(1) The commission agent should bear the expenses in the course of trading, unless
the parties agree otherwise;
(2) The commission agent is directly responsible to the contract he enters into with
third party. Where the manufacturer/supplier sustain losses due to failure of the third
party to perform its obligations, the commission agent shall be liable to provide
compensation for the loss sustained, unless otherwise agreed between the commission
agent and the manufacturer/supplier;
(3) The commission agent cannot become shareholder with unlimited liability of the
competitors of the manufacturer/supplier and engage in business activities that are in
competition with the manufacturer/supplier;
(4) The commission agent should report to the manufacturer/supplier of the market
situation and other related information as agreed. If the commission agent sells goods
at a price lower than the price specified by the manufacturer/supplier, the consent of
the latter must be obtained; otherwise the commission agent shall compensate the
difference in the relevant prices;
(5) The commission agent must respect the obligation of confidentiality and payment.
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There is no explicit provision by law as for wholesalers obligations, except for
product liabilities pursuant to Product Liability Law. Distributors shall be responsible
for the repair, replacement or return of the product sold if there is any problem with
the product quality. Distributor is jointly liable with the manufacturer/supplier for
third party if a defect in a product cause physical injury or damage to such third party.
But the distributor is entitled to recover the compensations paid or expenses incurred
to repair, replace or return the defected product if the defect is due to the
manufacturer/supplier. However, the allocation of liability between the distributor and
the manufacturer/supplier may be stipulated otherwise in the agreement.
The franchisee is subject to the following obligations provided by law:
(1) To strictly conform to the standard stipulated in the franchising agreement in
carrying out its business activities;
(2) To timely pay the royalties and other fees for the franchise in accordance with the
agreement;
(3) To protect the reputation and unified image of the franchised chain system;
(4) To accept direction and supervision of the franchisor.

Obligations Of The Manufacturer/Franchisor
Unless explicitly stipulated in the agreement, the manufacturer/franchisor is not
bound to exclusivity obligation.
The manufacturer/supplier should bear the costs of necessary training and technical
support to distributor, as well as the expenses to carry out large sales promotion
activity and for related advertisement if the manufacturer/supplier instruct the
distributor to do so.
It is the manufacturer/suppliers obligation to deliver the goods in compliance with
agreed quality requirements and to guarantee that no third party can claim any interest
in the goods against the purchaser.
Likewise, the manufacturer/supplier is subject to the same payment and
confidentiality obligations as well as product liabilities toward third parties as those
assumed by the distributor.
There is no compulsory obligation for the manufacturer/supplier to repurchase the
goods in stock of the distributor after the expiry of the agreement.
Particularly, in the commission agency, the manufacturer/supplier is responsible for
supplying goods in a timely and balanced way, and the total amount of supplied goods
shall not be less than the minimum sales targets as set in the agreement. The
manufacturer/supplier shall also provide to the commission agent with technical or
service support as well as other related materials as agreed. If the
manufacturer/supplier decides to lower the price due to reasons like market
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competition, he should compensate the commission agent for the unsold goods based
on the percentage of lowered price.
The statutory obligations of franchisor are as follows:
(1) To provide to the franchisee with the symbol representing the franchised chain
system and the manual for use or business guide;
(2) To provide to the franchisee with pre-training and education;
(3) To direct the franchisee in preparation for starting the business;
(4) To provide to the franchisee with long-term business guidance, training and
supply of agreed materials.

Compliance With Anti-Trust Provisions
In China at present there does not exist any anti-trust legislation.

Duration Of The Distribution/Franchising Relationship
It is stated in the regulations that the parties should stipulate duration in the
commission agency agreement as well as in the franchising agreement. However the
laws do not provide any duration should the parties have not set one in their
agreement. Usually in such case the agreement may be deemed to be under unlimited
duration.
The Contract Law only provides that the party seeking dissolution of the contract
must notify the counterparty, but there is no compulsory requirement for minimum
advance notice. It is completely at the parties’ discretion to determine the
circumstances under which the agreement can be terminated and the procedures to be
followed in case of termination. It is free and possible to terminate the agreement
without advance notice as long as it is so stipulated in the agreement.

Consequences Of Termination
It is completely at the parties’ discretion to envisage clauses regarding indemnity in
agreement. The only case explicitly provided by law where such agreed indemnity
shall not be applicable is force majeure.
Again, it is the freedom of parties to agree on indemnifications.
The right to indemnification can be waived, but if the party who waives its right is
obligor to a third party and his waiver consequently cause his obligee sustain losses,
the obligee may petition the court to nullify the obligor’s waiver. The right to
indemnification can also be transferred and there is no specific form or competence
restrictions to such transaction except for notification to the obligor.
The parties may stipulate a penalty for breach of a specified amount; however, if the
agreed penalty for breach is less than the actual losses, a party may request the court
or arbitration panel to increase the said amount, or, when the penalty is excessively
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high comparing with the actual losses, a party may request the court or arbitration
panel to decrease the said amount in an appropriate way. The parties may also agree
on a method of calculating the total amount of indemnity. If no calculating method
agreed, the indemnity shall be equivalent to the total losses sustained by the observant
party including benefits that the observant party would have been able to obtain upon
the agreement being performed, but this amount shall not exceed the total losses that
the breaching party foresaw or should have foreseen at the time of concluding the
agreement.
No explicit discipline regulating the goods still in stock upon termination of the
agreement, except that the Contract Law provides that after a contract has been
dissolved, the performance of any obligations which have not been performed shall be
terminated; where obligations have already been or partly been performed, depending
on the nature of the performance, a party may demand a return to the original state of
affairs.

Applicable Law
Parties to a distribution/franchising agreement with foreign element(s) may freely
choose the law in force of any country as the applicable law. PRC law shall be applied
should the agreement is a purely domestic one.
However the mandatory rules of PRC are still applicable anyway.
If no applicable law is chose, the law of the country with the closest connection to the
agreement shall be applied.

Competent Court
Controversies regarding a purely domestic agreement shall be subject to Chinese
court. Parties to an agreement with foreign element(s) may freely choose the
competent forum.
The parties to either domestic or foreign-related agreements can freely choose
arbitration in China or abroad. But arbitration ad hoc is not applicable yet in China.
The parties must indicate expressly the arbitration organisation in agreement.
If the parties make no choice on the forum, generally the court in the defendant’s
domicile or location shall hear the case. Alternatively, the court in the place where the
agreement is being implemented also has jurisdiction over the case in relation to an
agreement. Tortious action can be heard by the court in the place where the tort was
committed.
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