SHIAC INTERNATIONAL
CASE SERIES
Episode 3
Arbitrating Cross-Border
Commercial Franchise Disputes
01
In commercial franchise relationship, the franchisee's familiarity and understanding of the relevant field and those of the franchiser are largely unequal. Therefore, when entering into a franchise contract, the parties should make clear and explicit agreement on the contractual obligations. This episode of SHIAC International Case Series is going to introduce a recent case dealt by SHIAC which involves a cross-border franchise agreement, and discuss on the typical questions in this case.
02
Party A, a Chinese company, and Party B, an Samoan company, entered into the City Agency Authorization Covenant (referred to as “the Covenant”), in which Party B agreed to license Party A to use the trademark, system, technical information and know-how in a food brand owned by Party B. The term for the license last for three years. The license fees for the whole term were more than RMB 3,000,000 yuan. In return, Party B agreed to provide Party A with trademark license, educational training, equipment, tools, decoration, advertising, sales planning, supply of products and operation protocols, etc. After the Covenant was signed, Party A transferred the license fee to Party B accordingly.
However, in the application for arbitration to SHIAC, Party A alleged that Party B did not possess the qualification or condition for providing commercial franchise and had been using immature business model to illegally conduct commercial franchise. Party A also alleged that Party B had failed to fulfill its legal obligations and resulted in successive shup-down of individual shops owned by Party A, thus depriving Party A of the possibility to realize the contractual purpose. As such, Party A sought a declarative relief on the termination of the Covenant as well as the returning of the license fees, the compensation for the losses in decoration incurred by the Party A and the liquidated damages, etc.
In its defense, Party B alleged that the Covenant was concluded on a real and voluntary basis and had been actually performed by the parties. Thus, Party contended that Party A’s argument on being deprived of the possibility to realize the contractual purpose was groundless. Therefore, Party B requested the arbitral tribunal to reject all of the Party A’s claims.
03
Issue 1: If the franchiser fails to satisfy the requirements set forth in Article 7.2 of the Commercial Franchise Management Regulation, does such failure constitute the grounds for terminating the Covenant?
Party A argued that its right to terminate the Covenant was based on the fact that Party B lacked the qualifications for conducting commercial franchises in China, which violated the Commercial Franchise Management Regulation. Party B defended that it had opened several shops outside China, therefore it had reached the standard of “two shops, one year” set forth in Article 7.2 of the Commercial Franchise Management Regulation. Party B also contended that due to the governmental agency’s limitation of “two shops, one year” to those operating in China, it was unable to fulfill the record-filing requirement. Therefore, Party B argued that Party A’s claim to terminate the Covenant was groundless.
On issue 1, the arbitral tribunal analyzed that the requirements set forth in the Commercial Franchise Management Regulation were managerially mandatory in its scope of application, rather than regulating the issue of the validity of the contracts. Therefore, the question of whether or not Party B met the requirements did not have substantial impact on the validity of the Covenant, nor did it constitute a ground for terminating the Covenant. As such, the claim for declarative relief sought by Party A was groundless and should not be supported by the arbitral tribunal.
Issue 2: Is the closure of Party A’s shops resulted by Party B’s breach of Covenant?
Party A argued that during the performance of the Covenant, Party B had the following breaches: unjustifiable rejection of Party A's proposal on the choice of shop’s location; failure to provide training to Party A as agreed; failure to make advertisement or sale planning for Party A; failure to provide guidance on business norms or product manufacturing to Party A; failure to send the updated version of the product sheet in writing form, etc. The breach of the Covenant by Party B resulted in successive closure of the shops owned by Party A and deprived Party A of the possibility of realizing its contractual purpose.
On the other hand, Party B defended that it had fulfilled its obligations under the Covenant, including but not limited to guidance on store location and Party A’s business operation. Party B contended that the above support behaviors could prove it had performed the contractual obligations, thus Party B did not breach the Covenant.
On issue 2, the arbitral tribunal concluded that although the Covenant provided for educational training, equipment, tools, decoration, advertisement, business planning, supply of products, payments and business protocols, etc., these agreements lacked the necessary details to be executed. The Covenant also did not provide for product quality standards or measures for assurance. Likewise, the Covenant did agree on product promotion and advertising, but there is no specific content or delivery method. Besides, on the one hand, the arbitral tribunal found that Party A failed to provide sufficient evidences to show that Party B had breached the Covenant or to show the causality between the alleged breach of the Covenant and the closure of shops. On the other hand, Party B did have provided some evidences and shown that it had performed its contractual obligations. Nevertheless, based on the submitted evidences, the arbitral tribunal was unable to quantify Party B’s breach. In the end, the arbitral tribunal rejected the claims of Party A.
04
Combined with the analysis of the focus of the case dispute, the arbitral tribunal affirmed that the Covenant expired , so it did not support Party A’s request to terminate the Covenant and compensate for the loss of the closure of its shops. For Party A’s request to return the license fees, after considering the fact that Party B was in lack of qualification under the Commercial Franchise Management Regulation, etc., the arbitral tribunal decided that Party B should return a portion of the license fees paid by Party A at its discretion.
05
This case is a typical foreign-related franchise dispute. The arbitral tribunal used Chinese law in the hearing since the parties had stipulated in the Covenant that Chinese law applied, and it also applied or made reference to the following legal provisions:
Article 7 of “Administration of Commercial Franchise Procedures” reads:“…Franchiser engaged in franchising activities should have at least 2 directly operated stores, and the operation time is more than 1 year.” Article 8 reads: “The franchiser shall, within 15 days from the date of the first conclusion of the franchise contract, file a record with the competent commercial department in accordance with the provisions of these Regulations. ...”
Article 7 of “Guiding Opinions of the Beijing Superior Court on Several Issues Concerning the Application of Law in the Trial of Commercial Franchise Contract Disputes” reads:“The franchiser shall, within 15 days from the date of the first signing of the franchise contract, file a record with the competent commercial department according to law. If the franchiser fails to file with the competent commercial department in time, the validity of the franchise contract is generally not affected.” Article 19 also reads:“If the franchise contract is not established, not effective, invalid, rescinded, or revoked due to the reasons of the franchiser, or the performance of the franchise is terminated due to the reasons of the franchisee, then the franchisee requests the return of the license fee already paid, the amount, proportion, or method of return shall be reasonably determined by taking into account the conclusion and performance of the contract, the actual term of operation, the degree of fault of both parties, and other factors.”
In accordance with the above provisions，the arbitral tribunal found that Party B did not formally comply with the requirements set forth in the Commercial Franchise Management Regulations, but it objectively did have registered trademarks, corporate logos, patents and other business resources. And Party A also set up two franchised stores by using the above resources. Combined with the fact that the performance of the Covenant was terminated in advance, the arbitral tribunal found that the violation of the requirements set forth in the Commercial Franchise Management Regulations did not constitute a reason for Party A to terminate the Covenant. On the premise that Party A’s request for rescission of the Covenant was not supported, the arbitral tribunal also made an award on the amount of license fees that Company B should return based on the actual time of brand authorization in the case.
It can be seen from this case that, unless the provisions of laws and administrative regulations are mandatory in nature, they do not necessarily affect the validity of the contract or the realization of the contractual purpose of the parties, nor does the violation of those provisions constitute a legal cause for the disputing party to terminate the contract. In addition, in the determination of the appropriateness of the contractual performance, when the contract does not make clear and quantifiable obligations to be performed by the franchiser, the arbitral tribunal would be in a difficult position to determine whether the franchiser's behavior violates the contract or not, and would eventually make a conclusion unfavorable to the franchisee. The risk deserves the attention of the parties in similar contracts.
Franchise contract disputes are more professional and complex than other types of contract disputes. Usually, the franchisee's familiarity and understanding of the relevant field and those of the franchiser are largely unequal. In this case, the franchisee's claim was partially not supported due to the lack of clarity in the Covenant. Therefore, when entering into the relevant franchise contracts, the parties should a make clear and explicit agreement on the contractual obligations that the franchiser should perform, instead of just using vague wording, and should cooperate to quantify the franchised resources and services that the franchiser agrees to provide. Otherwise, the franchisee may find itself in a disadvantageous position when the dispute arises.
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CASE SERIES
Episode 3
Arbitrating Cross-Border
Commercial Franchise Disputes
01
Case Synopsis
In commercial franchise relationship, the franchisee's familiarity and understanding of the relevant field and those of the franchiser are largely unequal. Therefore, when entering into a franchise contract, the parties should make clear and explicit agreement on the contractual obligations. This episode of SHIAC International Case Series is going to introduce a recent case dealt by SHIAC which involves a cross-border franchise agreement, and discuss on the typical questions in this case.
02
Basic Facts
Party A, a Chinese company, and Party B, an Samoan company, entered into the City Agency Authorization Covenant (referred to as “the Covenant”), in which Party B agreed to license Party A to use the trademark, system, technical information and know-how in a food brand owned by Party B. The term for the license last for three years. The license fees for the whole term were more than RMB 3,000,000 yuan. In return, Party B agreed to provide Party A with trademark license, educational training, equipment, tools, decoration, advertising, sales planning, supply of products and operation protocols, etc. After the Covenant was signed, Party A transferred the license fee to Party B accordingly.
However, in the application for arbitration to SHIAC, Party A alleged that Party B did not possess the qualification or condition for providing commercial franchise and had been using immature business model to illegally conduct commercial franchise. Party A also alleged that Party B had failed to fulfill its legal obligations and resulted in successive shup-down of individual shops owned by Party A, thus depriving Party A of the possibility to realize the contractual purpose. As such, Party A sought a declarative relief on the termination of the Covenant as well as the returning of the license fees, the compensation for the losses in decoration incurred by the Party A and the liquidated damages, etc.
In its defense, Party B alleged that the Covenant was concluded on a real and voluntary basis and had been actually performed by the parties. Thus, Party contended that Party A’s argument on being deprived of the possibility to realize the contractual purpose was groundless. Therefore, Party B requested the arbitral tribunal to reject all of the Party A’s claims.
03
Issues and Opinions
Issue 1: If the franchiser fails to satisfy the requirements set forth in Article 7.2 of the Commercial Franchise Management Regulation, does such failure constitute the grounds for terminating the Covenant?
Party A argued that its right to terminate the Covenant was based on the fact that Party B lacked the qualifications for conducting commercial franchises in China, which violated the Commercial Franchise Management Regulation. Party B defended that it had opened several shops outside China, therefore it had reached the standard of “two shops, one year” set forth in Article 7.2 of the Commercial Franchise Management Regulation. Party B also contended that due to the governmental agency’s limitation of “two shops, one year” to those operating in China, it was unable to fulfill the record-filing requirement. Therefore, Party B argued that Party A’s claim to terminate the Covenant was groundless.
On issue 1, the arbitral tribunal analyzed that the requirements set forth in the Commercial Franchise Management Regulation were managerially mandatory in its scope of application, rather than regulating the issue of the validity of the contracts. Therefore, the question of whether or not Party B met the requirements did not have substantial impact on the validity of the Covenant, nor did it constitute a ground for terminating the Covenant. As such, the claim for declarative relief sought by Party A was groundless and should not be supported by the arbitral tribunal.
Issue 2: Is the closure of Party A’s shops resulted by Party B’s breach of Covenant?
Party A argued that during the performance of the Covenant, Party B had the following breaches: unjustifiable rejection of Party A's proposal on the choice of shop’s location; failure to provide training to Party A as agreed; failure to make advertisement or sale planning for Party A; failure to provide guidance on business norms or product manufacturing to Party A; failure to send the updated version of the product sheet in writing form, etc. The breach of the Covenant by Party B resulted in successive closure of the shops owned by Party A and deprived Party A of the possibility of realizing its contractual purpose.
On the other hand, Party B defended that it had fulfilled its obligations under the Covenant, including but not limited to guidance on store location and Party A’s business operation. Party B contended that the above support behaviors could prove it had performed the contractual obligations, thus Party B did not breach the Covenant.
On issue 2, the arbitral tribunal concluded that although the Covenant provided for educational training, equipment, tools, decoration, advertisement, business planning, supply of products, payments and business protocols, etc., these agreements lacked the necessary details to be executed. The Covenant also did not provide for product quality standards or measures for assurance. Likewise, the Covenant did agree on product promotion and advertising, but there is no specific content or delivery method. Besides, on the one hand, the arbitral tribunal found that Party A failed to provide sufficient evidences to show that Party B had breached the Covenant or to show the causality between the alleged breach of the Covenant and the closure of shops. On the other hand, Party B did have provided some evidences and shown that it had performed its contractual obligations. Nevertheless, based on the submitted evidences, the arbitral tribunal was unable to quantify Party B’s breach. In the end, the arbitral tribunal rejected the claims of Party A.
04
Arbitral Award
Combined with the analysis of the focus of the case dispute, the arbitral tribunal affirmed that the Covenant expired , so it did not support Party A’s request to terminate the Covenant and compensate for the loss of the closure of its shops. For Party A’s request to return the license fees, after considering the fact that Party B was in lack of qualification under the Commercial Franchise Management Regulation, etc., the arbitral tribunal decided that Party B should return a portion of the license fees paid by Party A at its discretion.
05
Brief Comments
This case is a typical foreign-related franchise dispute. The arbitral tribunal used Chinese law in the hearing since the parties had stipulated in the Covenant that Chinese law applied, and it also applied or made reference to the following legal provisions:
Article 7 of “Administration of Commercial Franchise Procedures” reads:“…Franchiser engaged in franchising activities should have at least 2 directly operated stores, and the operation time is more than 1 year.” Article 8 reads: “The franchiser shall, within 15 days from the date of the first conclusion of the franchise contract, file a record with the competent commercial department in accordance with the provisions of these Regulations. ...”
Article 7 of “Guiding Opinions of the Beijing Superior Court on Several Issues Concerning the Application of Law in the Trial of Commercial Franchise Contract Disputes” reads:“The franchiser shall, within 15 days from the date of the first signing of the franchise contract, file a record with the competent commercial department according to law. If the franchiser fails to file with the competent commercial department in time, the validity of the franchise contract is generally not affected.” Article 19 also reads:“If the franchise contract is not established, not effective, invalid, rescinded, or revoked due to the reasons of the franchiser, or the performance of the franchise is terminated due to the reasons of the franchisee, then the franchisee requests the return of the license fee already paid, the amount, proportion, or method of return shall be reasonably determined by taking into account the conclusion and performance of the contract, the actual term of operation, the degree of fault of both parties, and other factors.”
In accordance with the above provisions，the arbitral tribunal found that Party B did not formally comply with the requirements set forth in the Commercial Franchise Management Regulations, but it objectively did have registered trademarks, corporate logos, patents and other business resources. And Party A also set up two franchised stores by using the above resources. Combined with the fact that the performance of the Covenant was terminated in advance, the arbitral tribunal found that the violation of the requirements set forth in the Commercial Franchise Management Regulations did not constitute a reason for Party A to terminate the Covenant. On the premise that Party A’s request for rescission of the Covenant was not supported, the arbitral tribunal also made an award on the amount of license fees that Company B should return based on the actual time of brand authorization in the case.
It can be seen from this case that, unless the provisions of laws and administrative regulations are mandatory in nature, they do not necessarily affect the validity of the contract or the realization of the contractual purpose of the parties, nor does the violation of those provisions constitute a legal cause for the disputing party to terminate the contract. In addition, in the determination of the appropriateness of the contractual performance, when the contract does not make clear and quantifiable obligations to be performed by the franchiser, the arbitral tribunal would be in a difficult position to determine whether the franchiser's behavior violates the contract or not, and would eventually make a conclusion unfavorable to the franchisee. The risk deserves the attention of the parties in similar contracts.
Franchise contract disputes are more professional and complex than other types of contract disputes. Usually, the franchisee's familiarity and understanding of the relevant field and those of the franchiser are largely unequal. In this case, the franchisee's claim was partially not supported due to the lack of clarity in the Covenant. Therefore, when entering into the relevant franchise contracts, the parties should a make clear and explicit agreement on the contractual obligations that the franchiser should perform, instead of just using vague wording, and should cooperate to quantify the franchised resources and services that the franchiser agrees to provide. Otherwise, the franchisee may find itself in a disadvantageous position when the dispute arises.
（Editor: Research Department of SHIAC）
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示范仲裁条款
Model Arbitration Clause
凡因本合同引起的或与本合同有关的任何争议，均应提交上海国际经济贸易仲裁委员会/上海国际仲裁中心进行仲裁。
Any dispute arising from or in connection with this Contract shall be submitted to Shanghai International Economic and Trade Arbitration Commission / Shanghai International Arbitration Center for arbitration.