Franchising in Hong Kong: Setting Approval Rules for Outlet Transfers and Shareholding Changes

Once a franchise outlet is trading, the franchisee may bring in investors, sell shares or hand the outlet over to another company to operate. If the franchise agreement merely states that ‘unauthorised transfers are prohibited’, the franchisor may struggle to deal clearly with these different situations. When building a franchise network, changes in operating rights and control should be treated as distinct contractual issues, rather than addressed through last-minute conditions once a buyer appears.

1. Distinguish between business transfers, share transfers and changes of management

These three seemingly similar changes can have different legal and operational consequences.

• Business transfer: The franchisee sells the outlet’s equipment, stock and business. The buyer may also wish to take over the brand licence, but buying the outlet’s assets does not automatically confer franchise rights.
• Share transfer: The contracting company remains in place, but its shareholders change. The parties to the franchise agreement may therefore remain unchanged, so a clause that only prohibits ‘assignment of the agreement’ may not cover this type of transaction.
• Change of management: The shareholders remain the same, but a new partner or third party takes over day-to-day operations. This may not amount to a legal change of control, but it could affect the operating arrangements originally approved by the franchisor.

The franchisor should first map out the franchisee company’s ownership and management structure, then ask a lawyer to define which events require prior written consent and which require notification only. A change in the ultimate controller, for example, could require approval, while a small shareholding change that does not affect control could be subject to notification.

Do not look only at direct shareholders. If the franchisee company is owned by another company, a share transaction further up the ownership chain could also change who ultimately controls it. The clauses should clearly cover indirect control, without treating every internal restructuring as a breach.

2. Define the limits of consent rights under Hong Kong law

Hong Kong has no dedicated franchising legislation, nor a general franchise-specific registration or mandatory pre-contract disclosure regime. The filing and related disclosure requirements under mainland China’s Regulations on the Administration of Commercial Franchises should not be treated as rules governing local franchises in Hong Kong.

Franchise relationships in Hong Kong are governed primarily by common law principles of contract and applicable legislation, including the Misrepresentation Ordinance. Where company shares and shareholder records are involved, the Companies Ordinance and the company’s articles of association must also be considered. Depending on the transaction structure, the Transfer of Businesses (Protection of Creditors) Ordinance and stamp duty rules may also apply; legal and tax advisers should confirm the position. Approval from the franchisor does not mean that the transaction’s other legal requirements have been met.

The agreement should specify the factors the franchisor may consider, such as the proposed successor’s financial resources, commitment to managing the business, track record of meeting contractual obligations and willingness to comply with existing brand standards. If the agreement states that consent must not be unreasonably withheld, it should also set out clear application requirements and response procedures, reducing the scope for disagreement over what is ‘reasonable’.

In particular, avoid verbally promising prospective franchisees that they will be ‘free to resell later’ while giving the franchisor broad veto rights in the formal agreement. Transfer restrictions should be explained before signing, not raised for the first time when a franchisee wishes to sell.

3. Establish an approval process with deadlines and reasons for decisions

Transfer approval should not simply repeat the franchise recruitment interview. It should focus on who is taking over, what they are taking over and how operations will continue without interruption. Consider the following process:

1. Submit a notice of intent: The existing franchisee provides details of the transaction type, proposed successor, ownership structure and expected completion date.
2. Confirm that the documentation is complete: The franchisor provides a consolidated list of outstanding information and explains when the approval period starts, so that applications are not left pending indefinitely.
3. Assess the post-transaction arrangements: Confirm who will be responsible for day-to-day operations, the sources of funding, training needs and how existing arrears or breaches will be resolved.
4. Issue a written decision: Clearly distinguish between approval in principle, conditional consent and final approval. If consent is refused, record the specific reasons.

The agreement may prohibit the franchisee from allowing the buyer to use the brand or take over the outlet in practice before final approval is obtained. Transaction documents between the franchisee and buyer should be handled by their advisers. They should consider making the franchisor’s consent a condition precedent to completion, to avoid completing the sale only to discover that the brand licence cannot be transferred.

If a transfer approval fee is charged, its calculation, the work it covers, payment timing and treatment if the application is withdrawn or refused should all be agreed in advance. Any additional training fees should be itemised separately, rather than turning the transfer into an unexplained additional franchise fee.

4. Confirm the contractual arrangements before granting approval

A share transfer and a change in the party to the franchise agreement cannot be dealt with using the same set of documents. Following a share transaction, the original company usually remains a party to the existing agreement. If another company takes over operations, a lawyer must determine whether a new agreement, a novation or another arrangement is needed. Do not assume that a consent letter alone can transfer all rights and obligations.

The approval documents should answer at least the following questions:

• Will the existing franchise term remain in place, or will a new term be agreed?
• Will the original company and any personal guarantors be released from liability, and when will that release take effect?
• Who will be responsible for pre-completion arrears, outstanding obligations and post-completion fees?
• Will approval remain valid if the buyer has not completed training or the transaction is delayed?

The franchisor should also make clear that approving the successor does not guarantee the outlet’s value or profitability, or the reasonableness of the transaction price. Brand approval documents should not be presented as an investment endorsement.

Practical takeaway: Test the agreement against two scenarios: ‘an existing shareholder sells part of their shareholding’ and ‘another company buys the entire outlet’. If the agreement does not clearly explain whether approval is required, what must be submitted and who remains responsible, strengthen the transfer clauses and approval forms before offering franchises.