How Businesses in China Can Set Up a Franchise Transfer Approval Process Before Franchising

Established businesses preparing to build a franchise network often focus on recruiting their first franchisees, overlooking what happens if a franchisee later wants to sell their outlet. If the outgoing franchisee accepts payment before asking head office to approve the new operator, all three parties may find themselves in a difficult position. Before launching a franchise network, businesses should create a dedicated process covering transfer applications, assessment, contract signing and the handover of operating authority.

1. Distinguish between outlet assets and franchise rights

Article 18 of China’s Regulations on the Administration of Commercial Franchising provides that a franchisee must not transfer franchise rights to another party without the franchisor’s consent. Buying an outlet’s equipment, stock or fit-out therefore does not automatically entitle the buyer to use the brand or operate as a franchisee.

The contract should distinguish between three situations: a sale of assets such as equipment only; a new legal entity taking over the franchised business; and a change in shareholders or ultimate control while the franchisee company remains the same. The third situation should not automatically be treated as a transfer of franchise rights. Depending on the operational risks, head office can include separate contractual notification and review requirements for material changes of control.

Guidance for franchisees should make clear that the asset transaction is the responsibility of the buyer and seller. Head office approves brand authorisation and the franchise relationship; its approval does not replace landlord consent, the necessary licensing procedures or checks on outstanding debts.

2. Turn approval criteria into a verifiable checklist

A transfer clause should do more than state that “head office consent is required”. It should also specify the application documents, the department responsible, how to submit missing information, indicative processing times and the procedure for written responses. The following are recommended management arrangements, not a standard approval procedure prescribed by the Regulations.

The application checklist should cover at least:

• Transaction structure: The assets to be transferred, how contractual obligations will be taken over, the planned handover date and whether the operating entity or control will change.
• Incoming franchisee’s capability: Legal status and eligibility, funding arrangements, the person who will actually manage the business and plans to complete any necessary training.
• Current state of the outlet: Outstanding fees, stock, equipment, staffing arrangements, unfulfilled customer orders and other unresolved matters.
• Business continuity: Whether the lease can continue or be transferred, whether relevant licences need to be obtained afresh and who will operate the outlet during the handover period.

Head office should assess applications against predetermined criteria and retain records supporting its decisions. Where an application cannot be approved, it should identify the specific omissions or risks. Sales staff should not make verbal promises that “payment guarantees approval of the transfer”. Any training, assessment or similar fees should be explained in advance, including the services covered, who pays and the payment conditions. Opaque charges should not be added at the last minute.

3. Settle the contractual approach before completing the transaction

Article 11 of the Regulations requires franchise agreements to be made in writing and to address key matters including amendment, rescission and termination. Whether a transfer should involve taking over the existing agreement or ending the original franchise relationship and signing a new agreement with the incoming franchisee should be reviewed by legal advisers in light of the particular transaction. A simple “outlet transfer consent letter” is not enough.

If head office enters into a new franchise agreement with the incoming franchisee, it must comply with Article 21: the prescribed information and a copy of the contract must be provided in writing at least 30 days before the agreement is signed. The fact that the incoming franchisee has visited the outlet or knows the brand does not justify skipping the statutory disclosure process.

Nor should the new agreement’s term simply mirror the time remaining under the original contract. Article 13 provides that the franchise term must be at least three years unless the franchisee agrees otherwise. If a shorter term is proposed, this should be clearly explained and the relevant consent obtained.

It is advisable to make head office’s written consent, the contractual documents taking effect and the necessary operating conditions being met prerequisites for completion. The approval document should identify the outlet and incoming entity, state the conditions attached to approval and explain what happens if those conditions are not met.

4. Use a completion checklist to confirm authority and responsibilities

Approval of a transfer does not mean that the handover is complete. Head office should coordinate with both parties to agree the actual changeover date and check brand authorisation, ordering accounts, access permissions for outlet systems, training records and operational contacts. Existing accounts should not simply be passed to the new operator. Access permissions should be reassigned to the appropriate users, with the necessary records retained.

Written documents should also separately allocate responsibility for fees payable to head office, after-sales matters and unfinished business before and after completion. An agreement between buyer and seller about who will pay a debt does not, by itself, mean that the creditor has agreed to release the original debtor. Matters affecting third parties, such as customers, employees and landlords, must be dealt with separately in accordance with the law.

After completion, arrange a specific follow-up check to confirm that the actual operating entity matches the approval documents, that the incoming franchisee has completed the agreed preparations and that the outgoing franchisee no longer controls the accounts. Any discrepancies should be remedied under the contract, rather than overlooked on the assumption that the transaction is finished.

Practical takeaway: Before signing the first franchise agreements, prepare a transfer application form, an approval checklist and a completion confirmation form. Keeping a clear distinction between “being able to buy the outlet” and “being authorised to take over the franchise” will help reduce disputes over responsibility within the franchise network.