Hong Kong Franchise Royalties: Clarify Turnover, Minimum Fees and Audit Rights Before Signing

When comparing franchise brands in Hong Kong, many prospective operators focus on the initial franchise fee and overlook how ongoing royalties are calculated. What matters is not just the percentage, but which income is included, when payment obligations arise and whether the franchisor can demand additional payments to cover a shortfall. Getting the calculation rules set out clearly before signing is essential to comparing the long-term costs of different brands.

1. Understand the contractual and legal basis for royalties

Royalties are usually fees paid by a franchisee for the ongoing use of a brand and its operating system. The documents may also call them licence fees or ongoing franchise fees. The label does not determine the actual obligation: charges described as ‘management fees’, for example, may be turnover-based, fixed monthly amounts or subject to a minimum payment.

Hong Kong currently has no dedicated franchise legislation, nor any generally applicable statutory franchise disclosure regime, franchise registration requirement or mandatory franchising code. Do not assume that a franchisor must provide a disclosure document in a prescribed format listing every charge.

The parties’ rights and obligations depend primarily on the franchise agreement and general principles of contract law. The Misrepresentation Ordinance (Cap. 284) may also apply to false statements that induce a party to enter into the agreement. Whether rescission or damages are available depends on the specific facts and legal requirements. Nor should you assume that a commercial franchise transaction enjoys all the protections available in ordinary consumer transactions.

In practice, ask the franchisor for a complete fee schedule and worked examples, and incorporate the agreed calculation rules into a schedule to the contract. A recruitment brochure promising ‘low royalties’ is not enough to establish your payment obligations.

2. Define exactly which receipts count towards turnover

‘Turnover-based fees’ may sound straightforward, but there is still considerable scope for disagreement. Does the franchisor use the value of customer orders, the value of completed transactions or the amount the outlet ultimately receives? These are not necessarily the same.

Before signing, check each of the following:

• Discounts and vouchers: Is the calculation based on the amount before or after discounts? Are subsidies from the franchisor or platform included?
• Refunds and cancelled orders: Can these be deducted? If a refund falls in a later month, which accounting period is adjusted?
• Delivery platform orders: Is the calculation based on the price the customer pays for the goods, or the revenue remaining after platform commission?
• Stored-value balances and gift vouchers: Are these recognised when sold or when redeemed? How is the same purchase prevented from attracting royalties twice?
• Other receipts: Are service charges, delivery fees and amounts collected on behalf of third parties all included in turnover?

For example, a platform deducting its commission before transferring the balance to the outlet does not necessarily mean royalties are calculated on net receipts. If the contract uses sales before commission as its basis, you will bear both the platform commission and royalties calculated on that sales figure.

Ask the franchisor to demonstrate the calculation using a sample monthly statement that includes discounts, refunds and platform orders, so you can check every item yourself. If they cannot explain a particular item, resolve it before signing.

3. Budget for minimum fees and payment timing

Beyond the percentage rate, check whether there is a minimum monthly fee and whether you pay ‘the higher of the minimum fee and the percentage-based amount’ or the minimum fee ‘in addition to’ the percentage-based charge. These arrangements have different costs; the heading in a fee schedule alone will not tell you which applies.

Confirm whether the minimum charge applies per outlet, per territory or per franchise agreement, and whether it is apportioned for a partial month. If the outlet closes temporarily for repairs or another reason, establish whether minimum fees continue to accrue. Do not assume that having no revenue means there is nothing to pay.

Payment timing also affects cash-flow requirements. If a transaction counts towards royalties as soon as it is completed, but the platform settles the proceeds later, the franchisee may have to fund the payment in advance. The contract should clearly specify the accounting period, reporting deadline, payment due date and procedure for adjusting subsequent refunds or accounting errors.

When comparing brands, prepare separate fee calculations for conservative, typical and stronger sales scenarios. Show minimum charges, fixed fees and percentage-based fees separately. Do not assess affordability solely using the franchisor’s ideal sales projections.

4. Set limits on audit rights and agree correction procedures

It is common for franchisors to request sales reports or audit records to verify royalties. However, the information they may inspect, how discrepancies will be handled and who pays the audit costs should all be agreed before signing.

Ask for the contract to specify:

• The format of routine reports, the scope of information required and how long records must be retained;
• Reasonable notice periods for audits, how they will be conducted and limits on disruption to trading;
• Auditors’ confidentiality obligations and the permitted uses of the information;
• Procedures for reviewing under-reported sales, paying any shortfall and allocating costs;
• Deadlines for refunds or credits where an overpayment is identified.

Pay particular attention to whether the franchisor can estimate turnover and demand payment simply because a report is late. If the agreement contains such a clause, specify the basis for estimates, the adjustment procedure once the franchisee supplies actual figures and the route for raising a dispute. Do not allow a provisional estimate to become a final bill without review.

If an audit involves personal data that can identify customers, the Personal Data (Privacy) Ordinance (Cap. 486) must also be considered. Verifying total sales does not necessarily require a complete customer list. First establish whether aggregated or appropriately redacted information would suffice, rather than granting unrestricted access to all transaction records.

Practical takeaway: Before signing, obtain a worked royalty example that you can recalculate yourself. Have a solicitor review it alongside the turnover definition, minimum fees and audit correction procedures. Only when the basis of every charge is clear can you assess whether the franchise is affordable.