Regarding the Fair Transactions in the Franchise Business Act (“Franchise Act”), the major enforcement cases by the Korea Fair Trade Commission (“KFTC”) in 2023 and the contents related to the Franchise Act in the KFTC’s 2024 Major Operational Plans announced on February 8, 2024, are as follows:
I. MAJOR ENFORCEMENT CASES BY THE KFTC REGARDING THE FRANCHISE ACT IN 2023
A. Education franchisor Company N’s provision of false or exaggerated sales revenue forecast
The KFTC issued a corrective order and imposed an administrative fine of KRW 120 million for the following conduct:
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Under the Franchise Act, franchisors that meet certain requirements must provide prospective franchisees with the expected range of sales revenue and the basis for the forecast in writing. One commonly used method for calculating sales revenue forecasts involves utilizing the sales revenue of other proximate franchise. When there are more than five proximate franchise units within the metropolitan/regional district where a prospective franchisee intends to establish its business, five proximate franchise units that are closest to the prospective franchisee are selected. Among the selected units, two franchise units with the highest and the lowest sales revenue amount in the previous business year are excluded. The sales revenue forecast range is set based on the lowest and the highest sales revenue amount of the three remaining franchise units in the previous business year.
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For some prospective franchisees, Company N selected five franchise units not located within the metropolitan/regional district where the prospective franchisees planned to open their businesses. For others, despite the existence of closer franchise units, Company N arbitrarily included its own (non-franchise) stores or more distant franchises among the five units. These conducts resulted in false or exaggerated sales revenue forecasts.
B. Sandwich franchisor Company G’s provision of deceptive information, unfair coercion, and price restriction
The KFTC imposed a corrective order and an administrative fine of KRW 420 million on Company G for the following conducts, and reported Company G to the prosecutors for criminal sanctions:
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Under the Franchise Act, franchisors must provide prospective franchisees with the Information Disclosure Document, which states, among others, the monetary obligations of the franchisees. Company G received a certain amount of money for obligating or recommending franchisees to purchase essential items for the franchise business, such as coffee machines, interior decorations, kitchen utensils, and furniture, from itself or from designated suppliers. However, Company G registered and provided Information Disclosure Document which omitted this amount to prospective franchisees or franchisees.
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Company G charged franchisees a portion of their monthly sales as advertising fees unilaterally without sufficient consultation.
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At the time of signing the franchise agreement, Company G required franchisees to write a confirmation agreeing that Company G would determine the consumer price of the products. Later, despite explicit opposition from some franchisees to the price increase, Company G unilaterally raised the prices for those franchisees, citing this prior confirmation.
C. Study space rental franchisor Company P’s act of forcing franchisees to provide unfair benefits and failure to notify them of the results of promotional activities
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Company P operated the joint investment franchisees, which mean the franchisees jointly invested by the franchisor and franchisee, where the parties share the profits and losses based on the ratio of investment. When the government distributed the emergency relief funds to overcome Covid-crisis in January 2021 to small business owners, Company P forced the joint-investor franchisees to share the emergency relief funds with it. The KFTC determined that such conduct constituted an abuse of the franchisor’s superior bargaining position and imposed a corrective order, on the ground that the emergency relief funds were provided to the individual owners of small businesses.
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Furthermore, if the franchisees share the cost of advertising or promotional activities, either partially or entirely, the Franchise Act obligates the franchisor to notify the franchisee of the detailed results of promotional activities within three months after the end of the business year. However, Company P failed to notify franchisees of the results of promotional activities carried out between 2018 and 2020. The KFTC also imposed a corrective order for such failure.
D. Meal kit franchisor Company M’s act of providing deceptive information
The KFTC determined that Company M’s following conducts constituted the provision of deceptive information and imposed a corrective order:
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Despite having two franchise units in operation within the metropolitan/regional district where the prospective franchisee intended to establish its business, Company M included information of only one franchise unit operating in a different metropolitan/regional district in the Information Disclosure Document and the Information on Proximate Franchise Units.
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Since the inception of the franchise business in April 2021, Company M actively promoted the franchise to prospective franchisees stating that all menu items of the franchise were personally developed and produced by a two-time cooking competition award recipient. However, the supply contract with the two-time cooking competition award recipient would be terminated on October 31, 2021. Company M proceeded to enter into franchise agreements with the prospective franchisees without disclosing such fact, which would have served as a substantial factor for prospective franchisees in executing and maintaining the franchise agreement. Company M notified the franchisees of the termination on October 29, 2021, only two days before the termination of the supply contract.
E. KFTC’s decision correcting coffee franchisor Company H’s unfair terms and conditions in the franchise agreement
In January 2023, the KFTC corrected unfair terms and conditions in the franchise agreement of Company H that are in violation of the Fair Adhesion Contract Act (“FACA”). In addition, the KFTC stated that it plans to continuously examine other franchisors’ franchise agreements and to correct unfair provisions.
1. Provision compelling an agreement to change the business territory
Under the Franchise Act, a franchisor should guarantee a franchisee’s business territory. A franchisee’s business territory may be changed when a certain cause prescribed by the law arises in the course of renewing the franchise agreement, but, even in this case, the franchisee’s consent is required. In the franchise agreement, Company H required the franchisee to consent to changes in the business territory, which violates the FACA. Thus, it unfairly restricts the franchisee’s business rights. Accordingly, the KFTC revised the relevant provision as follows:
2. Provision on the submission of certain data, including accounting data
There are ongoing franchise fees (fees that a franchisee pays to a franchisor on a regular basis to maintain the right to operate a franchise business) under Company H’s franchise agreement. These are calculated based on certain data, including the revenue of a franchisee. Therefore, there is a need for Company H to receive certain data (such as the franchisee’s revenue) for the settlement of accounts. However, Company H arranged the franchise agreement stipulating the franchisee to submit data which was arbitrarily designated by Company H (such as accounting materials or accounting books) without specifying the type, content, scope of data to be submitted, and time of submission of such data. Thus, it unfairly infringed on the franchisee’s trade secret. Accordingly, the KFTC revised the relevant provision as follows:
3. Provision on advertisement and promotion activities without obtaining franchisees’ prior consent
The Franchise Act provides that where a franchisor conducts advertisements and promotional activities for which franchisees should bear part of the expenses, the franchisor shall enter into an agreement with the franchisees in advance, or where it is difficult to enter into an agreement, the franchisor shall obtain prior consent from the franchisees. The ratio of the franchisees for the franchisor to obtain consent from is at least 50% for an advertisement, and at least 70% for promotional activities.
It was stipulated in the franchise agreement that the franchisor (Company H) decides whether to proceed with the advertisement and promotional activities regardless of the franchisees’ consent and that the franchisees shall be notified and share the expenses after the execution thereof at the franchisor’s discretion, which is unfair. Accordingly, the KFTC revised the relevant provision as follows:
4. Provision on the performance of all monetary obligations immediately upon the termination of the franchise agreement
The period for performance of an obligation under the Civil Act is “the date on which the performance period expires” in the case where the performance period of an obligation does exist and “the date on which a demand for performance is received” in the case where the performance period of an obligation does not exist. Company H stipulated in the franchise agreement, an immediate performance of all monetary obligations by the franchisee to Company H regardless of the performance period of each obligation, upon the termination of the franchise agreement. This is unjust as it deprives the franchisees of the benefit of the performance period under the Civil Act without justifiable grounds. Accordingly, the KFTC corrected the franchise agreement to clearly specify the franchisee’s obligation for immediate restoration and the expenses to be mutually settled, in alignment with the standard franchise agreement.
5. Provision on non-compete obligation
Non-compete agreement is to protect a franchisor’s trademark right, business secrets, technology, etc. for a certain period of time, and, in the event of such an agreement, the equity should be maintained in the level of interests of the franchisee and the franchisor. Nonetheless, Company H prohibited franchisees from engaging in the same or similar business even after the termination of the contract en bloc without specifying the need for non-compete obligation, such as trade secrets. This is an unfair clause as it infringes upon the franchisee’s freedom to choose an occupation and freedom of choice of business. Therefore, the KTFC revised the relevant provision as follows:
II. KFTC’S 2024 MAJOR OPERATIONAL PLANS RELATING TO THE FRANCHISE ACT
A. Improvement to practices related to mobile gift vouchers
The KFTC announced its intention to improve the practices related to mobile gift vouchers, which impose a significant burden on franchisees and other small businesses due to high commission rates and lengthy settlement cycles compared to other payment methods. Specifically, it was stated that the KFTC would form a council consisting of platform operators, gift voucher issuers, franchisors, franchisees, and the government to develop reasonable measures.
B. Prevention of unfair trade practices related to mandatory items
In December 2023, the KFTC announced a plan for the amendment to the Enforcement Decree of the Franchise Act, which obligates consultations with franchisees if a franchisor intends to change trading conditions unfavorably to the franchisees, for example by increasing the number of mandatory items. Additionally, effective July 3, 2024, the amended Franchise Act introduces a new requirement for franchise agreements to specify the type of mandatory items and their supply price calculation methods.
Furthermore, this requirement must be incorporated in existing franchise agreements within six months from the effective date. In light of these changes, the KFTC has announced plans to issue guidelines detailing methods for calculating the supply prices of mandatory items, as well as to revise standard franchise agreements, aiming to facilitate the early implementation of the revised Franchise Act.
Moreover, the KFTC announced that it will inspect and correct unfair practices by franchisors (e.g., the food service franchisors), that pose a risk of unjust enrichment, and to share relevant information with the industry to encourage voluntary improvements in trading practices. The KFTC also outlined the following major types of unfair trade practices in the franchise sector:
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Excessively designating mandatory items and forcing franchisees to purchase these items from the franchisor.
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Conducting promotional activities without obtaining franchisees’ prior consent and making them to bear the expenses.
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Giving franchisees’ disadvantages for forming, joining, or participating in franchisee associations.
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Signing franchise agreements with prospective franchisees without providing an Information Disclosure Document.
Meanwhile, the KFTC has announced its plans to expand the application of Production Order System, which has already been applied to the Monopoly Regulation and Fair Trade Act and the Subcontracting Act, to include the Franchise Act, the Large Retail Business Act, and the Agency Act. The Production Order System is a mechanism by which the court can order parties involved in a lawsuit to submit documents necessary to prove damages or to calculate damages.
III. IMPLICATIONS TO FRANCHISORS
The KFTC is likely to focus on investigating and sanctioning franchisors not only for providing false, exaggerated, or deceptive information which has been recurrent issues, but also for forcing purchases of mandatory items and trade practices which pose a risk of franchisors’ unjust enrichment. Meanwhile, the KFTC has announced its plans to conduct ex officio investigations in 2024, particularly targeting franchises owned/invested by private equities, regarding the practice of passing various expenses onto franchisees. The KFTC intends to take strict measures should any illegal activities be confirmed. It is advisable for franchisors to consider conducting compliance checks accordingly.
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