Legal restrictions on franchise contracts and the relationship between the parties

Franchise relationship laws

Are there specific laws regulating the ongoing relationship between franchisor and franchisee after the franchise contract comes into effect?

The Franchise Act regulates the ongoing relationship between a franchisor and its franchisee after the franchise agreement comes into effect.

Operational compliance

What mechanisms are commonly incorporated in agreements to ensure operational compliance and standards?

Generally, the franchisor includes inspection rights (eg, access to the premises of franchised units) and audit rights (eg, review of accounts, books, and records of the franchisee) in the franchise agreements as the primary mechanisms for ensuring operational compliance and standards.  Although not as prevalent, some franchisors also reserve the right to deploy mystery shoppers, and to the extent permitted under Korean privacy laws, install video surveillance as part of an overall effort to maintain brand uniformity and operational compliance.

 

Amendment of operational terms

May the franchisor unilaterally change operational terms and standards during the franchise relationship?

A franchisor may not unilaterally change operational terms and standards in a way that may be considered disadvantageous to the franchisee as such conduct could be seen as an unfair trade practice under the Franchise Act, and more generally, under the MRTFA.

Other laws affecting franchise relations

Do other laws affect the franchise relationship?

General fair trade principles under the MRFTA may affect the offer and sale of franchises.

Policy affecting franchise relations

Do other government or trade association policies affect the franchise relationship?

The guidelines provided by the KFTC may affect the franchise relationship.

Termination by franchisor

In what circumstances may a franchisor terminate a franchise relationship? What are the specific legal restrictions on a franchisor’s ability to terminate a franchise relationship?

The Franchise Act does not specify grounds for terminating a franchise agreement; it merely provides the procedure that must be observed to terminate a franchise relationship.

To terminate a franchise agreement in accordance with the Franchise Act, a franchisor is required to provide a first notice of breach (which describes the grounds for the breach, requests for a remedy of such breach, and states that failure to remedy will result in termination) to the franchisee. Once the first notice is given, a two-month remedy period begins to run (and the franchisee’s obligation to remedy arises). During the remedy period, the franchisor must send a second notice of the same breach to the franchisee. If the franchisee fails to remedy the breach, the franchisor may terminate the franchise agreement at the end of the two-month remedy period.

Meanwhile, the Presidential Decree provides for 10 exceptions to the above termination procedure, and thereby allows for immediate termination of the franchise agreement by the franchisor. No other grounds for immediate termination are permitted under the Franchise Act. The 10 exceptions are:

  • a petition for bankruptcy is filed with respect to the franchisee (either by the franchisee or by a third party), the franchisee is adjudicated bankrupt, or rehabilitation or foreclosure proceedings commence against the franchisee;
  • a suspension of payment of notes and cheques issued by the franchisee owing to insolvency, etc;
  • the franchisee cannot continue with the operation of any franchised unit in the territory owing to an event of force majeure or for significant personal reasons, etc;
  • the franchisee:
  • receives a court judgment or an administrative disposition for violation applicable laws related to the operation of a franchised unit that clearly damages the reputation and credit of the franchisor, including:
    • an administrative order requiring the franchisee to remedy the violation;
    • an administrative order imposing a penalty surcharge or fine on the franchisee for the violation; or
    • an administrative order mandating suspension of operation of the franchised business;
  • the franchisee violates laws or regulations relating to the operation of any franchised unit and receives a cancellation order of qualifications, licences, or approvals or a business suspension order exceeding 15 days or other administrative order that cannot be corrected, provided that this shall not apply where an administrative fine, etc, has been imposed on a franchisee in lieu of such administrative order pursuant to any laws or regulations;
  • if, after having remedied the breach of the franchisee agreement pursuant to the request from the franchisor, the franchisee subsequently repeats the same breach within a period of one year even if the franchisor has notified the franchisee in the notice of request to remedy the first breach that the franchise agreement could be terminated without providing the opportunity to remedy in case of same breach after the remedy;
  • if the franchisee has been subjected to a criminal punishment for an act related to the operation of a franchised unit;
  • the acts, errors or omissions of the franchisee clearly and imminently threaten public safety or health while operating any franchised unit, and it is difficult for the franchisor to await an administrative order; or
  • the franchisee suspends business operations of any franchised unit for seven or more consecutive days without justifiable cause (as determined by the franchisor acting in good faith).
Termination by franchisee

In what circumstances may a franchisee terminate a franchise relationship?

Under the Franchise Act, no restriction or prior notice is required for the franchisees to terminate their franchise relationships. As a general principle of law, however, the franchisee may terminate the franchise agreements in the case of default by the franchisor. In addition, where the franchise agreement is seen as a ‘continuing contract’, the franchisee may terminate the franchise agreement based on the grounds that the purpose of the franchise agreement has been frustrated as a result of unforeseeable circumstances.

Renewal

How are renewals of franchise agreements usually effected? Do formal or substantive requirements apply?

There are no formal (eg, stamp duty, witnesses) or substantive requirements for renewals of franchise agreements.

Refusal to renew

May a franchisor refuse to renew the franchise agreement with a franchisee? If yes, in what circumstances may a franchisor refuse to renew?

The Franchise Act stipulates that if the franchisee requests a renewal between 180 days and 90 days prior to the expiry of the franchise agreement, the franchisor may not refuse to renew the franchise agreement without just cause. As exceptions, the franchisor is permitted to refuse renewal of the franchise agreement in the following circumstances:

  • the franchisee has failed to perform its payment obligations of franchise fees under the franchise agreement;
  • the franchisee has not accepted the terms and conditions of the franchise agreement or business policy that are generally accepted by other franchisees of the franchise network; or
  • the franchisee has failed to observe the following important business policies of the franchisor that are deemed necessary for maintaining the franchised business:
    • matters pertaining to the procurement of a store or facility that are necessary for the operation of the franchised business, or acquisition of licence, permit or approval as required by applicable laws;
    • matters pertaining to observance of production methods or service methods that are necessary for maintenance of quality of the goods or services for sale; and
    • other matters than those above that are deemed necessary for normal operations of the franchised business as determined by Presidential Decree.

 

If the franchisee requests a renewal, the notice of refusal stating the reasons for non-renewal must be provided within 15 days of receipt of the renewal request. If the notice of refusal (to the franchisee’s request for a renewal) is not provided to the franchisee, or a written notice of non-renewal or change in terms and conditions (for the renewal) is not provided to the franchisee between 90 and 180 days prior to the expiration of the franchise agreement, the franchise agreement will be deemed to have been renewed under the same terms and conditions.

As a cautionary note, even if a franchisee does not request a renewal, a franchisor must provide a written notice of non-renewal of the franchisee (between 90 and 180 days prior to the expiration of the franchise agreement) if the franchisor has no intent or does not wish to renew the franchise agreement. If the franchisor first provided a notice of non-renewal (prior to the franchisee’s request for renewal) within the above period, then the franchisee subsequently requests a renewal within the same period (despite the franchisor’s notice of non-renewal), the franchisor may not refuse to renew the franchise agreement without just cause. In other words, the franchisor’s notice of non-renewal (before the franchisee has made a request for renewal) would realistically work only as a reminder to the franchisee to decide whether to renew the franchise agreement.

The franchisee’s right to request a renewal may only be exercised for a total duration of 10 years (including the term of the initial franchise agreement and any renewal terms thereafter), and if 10 years have elapsed, the franchisor may refuse to renew the franchise agreement regardless of its reasons (as long as a written notice of non-renewal has been provided).

Transfer restrictions

May a franchisor restrict a franchisee’s ability to transfer its franchise or restrict transfers of ownership interests in a franchisee entity?

Because it can be said that the franchisor–franchisee relationship is reciprocal, where both parties are creditors as well as debtors to each other (supply obligation on the one hand and payment obligation on the other hand), the franchisee should receive consent of the franchisor prior to transferring the franchised business (transfer of its obligation) to a third party. In this regard, the Franchise Act provides that the franchisee must first obtain prior written consent of the franchisor to assign the franchised business. Thus, a franchisor may restrict a franchisee’s ability to transfer its franchised business.

However, unless the parties have specifically agreed not to allow for the transfer of ownership interests in a franchisee, there are no restrictions on the franchisee’s right to transfer ownership interests.

Fees

Are there laws or regulations affecting the nature, amount or payment of fees?

The payment and receipt of certain types of fees are strictly regulated under the Franchise Act. Specifically, the Franchise Act proscribes a franchisor from receiving ‘direct’ payment of the following from the franchisee:

  • consideration that the franchisee pays to the franchisor for management rights, such as the permission to use the business marks or the support and education for its operating activities. Such consideration may include application fees, membership fees, franchise fees, education and training fees or down payment; and
  • consideration that the franchisee pays to the franchisor to secure payment for goods supplied by the franchisor or compensation for damages.

The Franchise Act stipulates that the franchisor must require the franchisee to deposit - in escrow - the two types of fees described above to a Korean financial institution prescribed by the Presidential Decree. Thereafter, the franchisor may request payment from the financial institution at the earlier of when the franchisee has commenced operations (eg, opened its franchised unit) or two months from the date of execution of the franchise agreement.

Notwithstanding the above, the franchisor may receive both types of fees ‘directly’ from the franchisee without depositing the fees with a Korean financial institution if:

  • the franchisor subscribes to an insurance policy (with the franchisee as the beneficiary) to cover the franchisee’s risks; or
  • the franchisor and the franchisee agree that the franchisor will receive both types of fees after two months from the date of executing the franchise agreement or after the franchisee commences operation (eg, opened its franchised unit), whichever is earlier.

In practice, it is difficult, if not impossible, to find a Korean financial institution that will open an escrow account for the benefit of a foreign franchisor. Further, with regard to taking out insurance, there is only one insurance provider in Korea – Seoul Guarantee Insurance Company – that will issue an insurance policy. To subscribe, a foreign franchisor must have a guarantor located in Korea (individual or a business entity) that will guarantee the amount of the insurance policy being purchased.

Given the difficulties in finding a willing Korean financial institution and a suitable guarantor in Korea, foreign franchisors seeking to receive the two types of fees described above ‘directly’ from the franchisees often choose to defer the payment of those fees until the elapse of two months from the date of executing the franchise agreement or the franchisee commences operation of its franchised unit, whichever occurs earlier.

Usury

Are there restrictions on the amount of interest that can be charged on overdue payments?

There are no specific restrictions on the amount of interest that can be charged on overdue payments. However, if the interest is deemed excessive, it can be reduced by the Korean courts if challenged.

Foreign exchange controls

Are there laws or regulations restricting a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency?

There are no laws or regulations restricting the ability of a franchisee to make payments to a foreign franchisor in the franchisor’s domestic currency.

Confidentiality covenant enforceability

Are confidentiality covenants in franchise agreements enforceable?

In principle, confidentiality covenants in franchise agreements are enforceable.

Good-faith obligation

Is there a general legal obligation on parties to deal with each other in good faith during the term of the franchise agreement? If so, how does it affect franchise relationships?

Apart from the specific rules and regulations applicable to the conduct of a franchisor, the Franchise Act also promulgates a code of best practice. Under the Franchise Act, both parties to a franchise relationship must exercise good faith in the performance of their respective duties in connection with the management and operation of the franchised business.

Specifically, the franchisor’s duties defined under the Franchise Act are as follows:

  • business planning for the success of the franchised business;
  • continuing efforts toward quality control of goods or services and development of sales techniques;
  • installation of unit facilities and supply of goods or services to the franchisee at reasonable prices;
  • education and training of the franchisee and its employees;
  • continuing advice and support for the management and operation activities of the franchisee;
  • prohibition against establishing a franchisor’s company-owned units or establishing a franchised unit of the same type of business to that of the franchisee’s franchised unit within its business territory during the period of the franchise agreement; and
  • making efforts to resolve disputes through dialogue and negotiations with the franchisee.

Meanwhile, the franchisee’s duties are defined under article 6 of the Franchise Act as follows:

  • making efforts to maintain the uniformity of the franchised brand and the good reputation of the franchisor;
  • maintenance of inventory and display of goods in an appropriate manner in accordance with the franchisor’s supply plan and consumer demand;
  • compliance with appropriate quality standards as presented by the franchisor with regard to goods or services;
  • use of goods and services as provided by the franchisor in the event of failure to stock goods or services that meet the quality standards provided in the preceding point;
  • compliance with appropriate standards as presented by the franchisor with regard to the facilities and exterior of the place of business, as well as the means of transport;
  • consultation with the franchisor prior to effecting any changes in the goods or services in which it deals or in its operating activities;
  • maintenance and provision of the data necessary for unified business management and sales strategy formulation by the franchisor, including, but not limited to, accounting books on the purchase and sale of goods and services;
  • provision to the officers, employees or agents of the franchisor of access to its place of business for the checking and recording of its business status and the data as set out in the preceding point;
  • prohibition of any change in the location of its place of business or any transfer of franchise management rights without the consent of the franchisor;
  • prohibition of any act engaging in the same line of business as that of franchisor during the period of the franchise agreement;
  • prohibition of disclosure of sales techniques or trade secrets belonging to the franchisor; and
  • notification of any infringement of business marks by a third party to the franchisor if it becomes aware of such infringement, and appropriate cooperation with the franchisor to take necessary measures to prohibit such infringement.

The Franchise Act provides neither criminal penalties nor sanctions for failing to adhere to the above duties applicable to the franchisor and the franchisee. Therefore, we interpret most of these provisions as normative or suggested best practice rather than as mandatory standards.

Some Korean franchise agreements explicitly stipulate that a franchisor and a franchisee shall perform their duties in good faith. Even if there is no explicit provision in the franchise agreement that mandates good faith dealing, however, the implied covenant of good faith and fair dealing under the Korean Civil Act would apply to the franchise relationship.

Franchisees as consumers

Does any law treat franchisees as consumers for the purposes of consumer protection or other legislation?

In principle, franchisees are deemed to be independent commercial entities, and therefore there are no laws that specifically treat franchisees as consumers for the purposes of consumer protection.

Language of the agreement

Must disclosure documents and franchise agreements be in the language of your country?

Under the Franchise Act, there are no requirements that the disclosure documents be prepared in Korean. However, because the Franchise Act prescribes that the disclosure documents (that will be provided to the prospective franchisee) be registered with the Korean Fair Trade Commission (KFTC), in practice the KFTC requires the disclosure documents to be prepared in Korean.

The Franchise Act does not require that the franchise agreement be written in Korean either. However, it is advisable for foreign franchisors to critically evaluate the English language capabilities of any prospective franchisees and be prepared to offer a Korean translation of franchise agreement if the franchisee does not comprehend English or is not using consultants, who are competent to assist with any language deficiency. In addition, when filing an application for registration of the disclosure document with the KFTC, a copy of the template franchise agreement must be submitted, and if the template franchise agreement is in another language, a Korean translation must also be submitted. Therefore, it is necessary to prepare a Korean translation of the template franchise agreement to register the disclosure document.

Restrictions on franchisees

Describe the types of restrictions placed on the franchisees in franchise contracts.

The main restrictions on provisions in franchise agreements under the Franchise Act relate to the receipt of certain types of franchise fees, duration and renewal of the franchise agreement, exclusive business territories of each franchised unit and procedures for terminating the franchise agreement. Aside from those just mentioned, there are no notable restrictions imposed by the Franchise Act on provisions in franchise contracts.

Competition law

Describe the aspects of competition law in your country that are relevant to the typical franchisor. How are they enforced?

The Franchise Act was originally drafted to adapt the provisions of the MRFTA into the franchise context. Therefore, the Franchise Act is the primary law that is applicable to franchised businesses (the MRFTA would not generally apply to franchised business since the Franchise Act is more specific to the franchise context).

Courts and dispute resolution

Describe the court system. What types of dispute resolution procedures are available relevant to franchising?

The Korean legal system is a civil law system, originally adopting the European civil law system and Japanese legal system. The Korean judiciary system is three-tiered and consists of the Supreme Court (the highest court), the high courts (the intermediate appellate courts) and the regional district courts (the courts of first instance). There are five high courts and 18 district courts, divided into geographical districts.

Alternatively, the parties in dispute may resolve disputes relating to the franchise agreement through mediation or arbitration. In particular, the Franchise Act provides that a franchise transaction dispute mediation committee may mediate matters related to disputes over franchise transactions if requested by the KFTC or by the parties in dispute. The franchisor is free to reject a mediation request. However, if mediation is requested due to an alleged violation of the MRFTA or the Franchise Act, it is advisable for the franchisor to comply with the request, because upon refusal, the franchisor may find itself subject to corrective measures under the Franchise Act.

The Korean Commercial Arbitration Board (KCAB) is the main institution of arbitration in Korea. The KCAB is dedicated to the settlement of commercial disputes as a neutral, unbiased and independent institution for administering and conducting arbitration, conciliation and mediation. Arbitration before the KCAB is an alternative way of producing impartial and fair resolutions to commercial disputes.

 

Arbitration – advantages for franchisors

Describe the principal advantages and disadvantages of arbitration for foreign franchisors considering doing business in your jurisdiction.

Unlike litigation before the Korean courts, arbitration awards are not appealable, and, therefore, may resolve a dispute through a single proceeding. In addition, because arbitration procedures are not public, important information regarding the franchise transaction may be kept confidential.

However, arbitral proceedings may take longer than adjudication before the court of first instance (in many cases, the dispute practically comes to an end when the judgment of the court of first instance has been given), and, therefore, the dispute could be unnecessarily prolonged.

National treatment

In what respects, if at all, are foreign franchisors treated differently from domestic franchisors?

Aside from minor differences in connection with the obligation to report real estate acquisitions and the restrictions imposed by the Foreign Investment Promotion Act, foreign franchisors are not treated any differently from domestic franchisors.

Law stated date

Correct on

Give the date on which the above content is accurate.

21 April 2020.