CHINA Trends and Developments Contributed by: Qiang Ma and Yan Feng Liu, Jingtian & Gongcheng
chisee the right to terminate the agreement. The court distinguished this from situations where a trade mark is merely one of several operating resources, giving dispositive weight to the specific contractual promise of exclusivity that could not be legally fulfilled. Franchisee’s unauthorised operations A significant risk for franchisors is the potential for a franchisee to leverage the brand’s reputation to engage in business activities that are outside the scope of the franchise agreement (ultra vires), there - by causing harm to consumers. While the franchisor is often insulated from direct legal liability for such unauthorised actions, the commercial and reputa - tional risks can be substantial. Franchise agreements typically define the franchisee as an independent legal entity, responsible for its own operations and liabilities, and strictly delineate the scope of authorised business activities. Conse - quently, when a franchisee offers unauthorised prod - ucts or services, their actions are legally considered independent business conduct. In a prominent case involving a major national gold retailer, consumers incurred significant losses from a “gold custody” service offered by a franchisee. This service was not authorised by the franchisor and was expressly pro - hibited by the franchise agreement. The court ulti - mately determined that the custody service was an independent act of the franchisee, falling outside the scope of the franchise agreement. Accordingly, it held that the franchisor was not legally liable for the con - sumers’ losses. However, a favourable legal judgment does not elimi - nate what might be a significant commercial fallout. Consumers are often drawn to a franchisee by the power and reputation of the franchisor’s brand, and they may not distinguish between authorised and unauthorised services. When a franchisee’s unauthor - ised actions lead to widespread consumer losses, the resulting public outcry and negative media attention directly tarnish the franchisor’s brand image. As seen in similar high-profile incidents, the franchisor, despite being legally shielded, may be compelled by market pressure and the need to protect its reputation to advance payments to compensate affected consum - ers. This creates a significant contingent liability and
business risk, where the franchisor may find it com - mercially necessary to cover losses for which it bears
no legal responsibility. Practical Implications Cooling-off period
The franchisee’s right to terminate is functional, not chronological. It is extinguished by the substantial uti - lisation of the franchisor’s resources, which is typically marked by the commencement of business opera - tions. Oral agreements An oral franchise agreement can be validated by per - formance. The primary risk shifts from contractual invalidity to the evidentiary burden of proving the oral terms, and such informality often signals deeper, sub - stantive compliance failures. The “2+1” rule Non-compliance with the “two stores, one year” requirement does not void a contract but serves as strong evidence of the franchisor’s lack of a mature system, substantially aiding a franchisee’s claim of fundamental breach when linked to an operational failure. Archival filing The filing requirement is an administrative duty. A failure to file invites regulatory penalties but is not, in itself, sufficient grounds to terminate a franchise agreement. Information disclosure fraud A franchisee seeking to rescind a contract based on non-disclosure must demonstrate that the franchisor’s misrepresentations were material and induced the agreement, rising to the level of fraud rather than mere commercial puffery. Unregistered trade marks Licensing an unregistered trade mark can be deemed as a defect in operation resources. However, a fran - chisee who continues to operate the business after discovering the issue may be deemed to have waived their right to terminate the contract on this basis.
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