Franchising a Hong Kong Business: Choosing the Franchisor Entity and Allocating Responsibilities

A stable existing outlet does not necessarily mean that its current operating entity is the right choice for launching a franchise network. Who collects franchise fees, who promises training and who can provide ongoing support will all affect how contractual obligations are met and claims pursued. Before building a franchise network, a business should identify the entity that will take on the franchisor’s responsibilities, rather than simply putting a company name on the first page of the agreement.

1. Compare legal liability, not just set-up costs

Common business structures in Hong Kong include sole traders, partnerships and limited companies. All can conduct business, but they allocate liability differently. Ease of opening a bank account or low administrative costs should not be the sole basis for the decision.

A sole trader business has no legal personality separate from its owner. The owner is liable for the business’s debts and contractual obligations. Once the franchisor collects fees from multiple franchisees and promises long-term support, the risks extend beyond those of a single company-operated outlet. Trading under a different name does not separate personal liability from business liability.

An ordinary partnership should not be treated as a way to ring-fence liability either. Hong Kong’s Partnership Ordinance governs partnership relationships. A partner’s actions in the ordinary course of business may bind the partnership and the other partners. Even if the partners agree that one person will be responsible for franchising, this does not automatically make that person solely liable to third parties.

A limited company has a separate legal personality. Shareholders’ liability is generally limited to their capital commitments, but the company itself must still fulfil the franchise agreement. Incorporation does not remove liability arising from personal guarantees, a director’s own unlawful acts or other personal obligations. The choice should take account of risk, governance, accounting and ongoing compliance costs.

2. Decide whether the existing company or a new company should act as franchisor

Using the existing company has the advantage that staff, systems, cash and operational experience are usually already held within one entity. The drawback is that liabilities from company-operated outlets and the franchise business may remain within the same company. If the directly operated business incurs substantial liabilities, the franchisor’s ability to deliver its promised support may also suffer.

Setting up a separate franchise company can create a clear division of accounts and functions. However, a new company does not automatically acquire the existing business’s assets, contracts or rights to use the brand. Nor should it be presented as a fully resourced franchisor if it actually lacks staff, funding or enforceable support arrangements.

Before deciding, set out four things:

• The existing business’s debts, leases and outstanding contractual obligations;
• The staff, systems, equipment and funding the franchisor will need;
• Which entity owns those resources and how the franchisor will gain access to them;
• Who will provide working capital and the resources needed to meet contractual obligations if franchise income falls short.

The key question is not which structure looks more substantial, but which entity genuinely has the capacity to meet its obligations throughout the relationship.

3. Map out responsibility for the brand, fees and services

If the founder owns the brand, the company operating the existing outlets provides training and another company collects franchise fees, the relationships between them must be clearly explained. Companies within the same group are not the same legal entity, even if they share a brand.

Start by drawing up a “franchisor responsibility matrix”. For each commitment, identify the entity accountable to franchisees, the party that will carry out the work and any internal agreements required. For example, if the franchise company promises training but the trainers are employed by the company operating the existing outlets, the two companies should have an appropriate service arrangement covering staffing, charges, continuity of provision and what happens if the service is interrupted.

There should also be a clear legal basis for using the brand assets. If the franchisor does not own the trade mark, confirm that the rights granted to it are sufficient to support the franchise arrangements. The founder’s verbal consent alone is not enough.

Payment arrangements should align with the contracts and accounts. If another entity collects payments on the franchisor’s behalf, specify its capacity as collection agent, how payment to it discharges the franchisee’s payment obligation and who is responsible for refunds. Franchisees should not have to guess who they are dealing with from the name on a bank account.

Internal service arrangements should not become an excuse for the franchisor to avoid responsibility: the entity making a commitment in the franchise agreement should remain responsible for fulfilling it in accordance with that agreement.

4. Apply Hong Kong’s general laws rather than importing overseas rules

Hong Kong currently has no legislation specifically regulating franchising, nor any generally applicable mandatory disclosure requirements, franchise filing requirements or statutory franchise code of conduct. The eligibility and filing requirements under mainland China’s Regulations on the Administration of Commercial Franchises should not be treated as conditions for establishing a local franchise operation in Hong Kong.

However, the absence of franchise-specific legislation does not mean that franchising is unregulated. Franchisors must still consider their obligations under general contract law and the Misrepresentation Ordinance. Limited companies must comply with the Companies Ordinance, while partnerships fall within the scope of the Partnership Ordinance. Business registration is governed by the Business Registration Ordinance. Branding, data handling and market arrangements may also fall within the scope of the Trade Marks Ordinance, the Personal Data (Privacy) Ordinance and the Competition Ordinance respectively. Professional advisers should assess which requirements apply to the proposed structure.

Before formally recruiting franchisees, ask a solicitor and an accountant to review the operating entity, resource arrangements, payment processes and contractual responsibilities together. In particular, do not assume that forming a new company transfers the old company’s contracts to it. Any necessary consents, assignments or novations must be dealt with separately.

Practical takeaway: First map out “who owns the resources, who collects payments, who fulfils the commitments and who bears liability”, then decide which entity should offer the franchises. A clearly structured and properly resourced franchisor matters more than simply incorporating another company.