The franchising business in Korea has experienced continued growth in the past few years. According to statistics from the Korea Fair Trade Commission (KFTC), there were 2,405 franchisors and 2,947 brands in 2011. Since then, the market has been on the rise and as of 2016 it boasted 4,268 franchisors and 5,273 brands.2 In 2014, franchisors recorded total sales revenue of 50.9 trillion South Korean won3 and franchisees recorded total sales revenue of 42.9 trillion South Korean won.4 In sum, the franchise business accounted for 6.3 per cent of the nominal GDP of Korea in 2014.
The franchise business sector in Korea can be broadly categorised into food service business, service business and wholesale–retail business. As of 2016, in terms of the number of franchisors, the franchise market in Korea is composed of franchisors involved in the food service business (75.4 per cent), service business (18 per cent) and wholesale–retail business (6.6 per cent), and, therefore, the food service business share is high.5
Based on the data from 2014, 6.8 per cent of franchisors have entered foreign markets, such as China, the Philippines and Singapore, with the Chinese market being the primary target.6 Overseas expansion by Korean franchisors is anticipated to continue into the future.
In 1998, franchisors founded the Korea Franchise Association (KFA) to promote the advancement of franchise businesses in Korea. The KFA performs diverse tasks, such as hosting exhibitions to advance the Korean franchise industry, presenting awards to outstanding companies and franchisees that have contributed to the advancement of the franchise industry, and offering educational programmes to train a professional franchise workforce.
II MARKET ENTRY
There is no specific regulation of franchising in respect of the entry of foreign franchisors into the Korean market. Foreign entities also face no limitations on granting master franchises or development rights to local entities.
Under the Foreign Investment Promotion Act (FIPA), if a foreign investor acquires shares in a Korean company, an ex ante or ex post report may be required, depending on the method of the relevant stock acquisition. With respect to a foreigner’s acquisition of real property, the Foreigner’s Land Acquisition Act, the FIPA and the Foreign Exchange Transactions Act (FETA) apply. However, unless the relevant real property requires a government permit, a foreigner may, in principle, acquire real property based on simple reporting pursuant to certain procedures.
ii Foreign exchange and tax
The framework law applied to foreign exchange issues is the FETA. There is no regulation specific only to franchise businesses with respect to foreign exchange, and there is no tax regulation specific to franchising; these issues will be discussed further in Section V.
III INTELLECTUAL PROPERTY
i Brand search
In Korea, the Fair Transactions in Franchise Business Act (the Franchise Business Act) regulates franchising in Korea, while the government authority in charge of enforcing the relevant statute is the KFTC. The KFTC has launched a separate website that allows the public to access information related to the trademark and business mark of each franchisor and the status of the franchise business of the relevant franchisor.7
Moreover, through the website operated by the Korean Intellectual Property Office (KIPO), the public can access information on the specific details of a trademark, such as its shape, to verify the trademark owner of the relevant business mark within Korea.8
ii Brand protection
To obtain stable trademark protection in Korea, a franchisor has to register its trademarks with the trademark register. Since Korea is a first-to-file jurisdiction, when two or more applications for trademark registration compete for the same or similar trademarks, the first applicant is granted the registration.
A registered trademark can be protected under the Trademark Act. Furthermore, any widely known, yet unregistered, trademark and sign can be protected under the Unfair Competition Prevention and Trade Secret Protection Act.
Once a trademark is registered, its owner may seek an injunction against a person who infringes or is likely to infringe the owner’s rights, requesting the prohibition or prevention of infringement. When seeking an injunction, the trademark owner can request the destruction of the infringing goods, the removal of facilities provided for infringement, or other necessary measures.9 Moreover, a trademark owner may make a claim for damages arising from an infringement against a person who has wilfully or negligently infringed on its trademark rights.10
iv Data protection, cybercrime, social media and e-commerce
With respect to data protection, since the Personal Information Protection Act (PIPA) is enforced in Korea, a franchisor or franchisee has to comply with the PIPA in respect of the handling and protection of personal information in the course of operating a franchise business.
The PIPA imposes the following obligations with respect to the handling and protection of personal information: (1) collection of personal information11 must be limited to the minimum extent necessary to achieve the purpose thereof; (2) the consent of the information subject is necessary for collection, use and third-party provision of the personal information; (3) any use and provision beyond the purpose for which the personal information was obtained is restricted; (4) a personal information manager12 has to take technical, administrative and physical measures necessary for the safe management of personal information; (5) upon request by, the personal information manager has to inform the information subject of the source of personal information and the purpose of handling that information when the personal information manager handles personal information about the information subject collected from a person other than the information subject; (6) the personal information manager is required to destroy any personal information in its custody without delay when the information becomes unnecessary. Any non-compliance with the foregoing obligations may be subject to criminal liability.
The recent increase in the use of social networking sites and social media has resulted in diverse issues, such as defamation of franchisors or brands by malicious posts, causing difficulties for franchisors. With respect to malicious defamation, legal responses, including criminal complaints, may be necessary on a case-by-case basis.
With respect to electronic commerce (e-commerce), the Korean government has enacted the Act on Consumer Protection in Electronic Commerce, Etc. This act provides diverse provisions to protect e-commerce consumers by prohibiting e-commerce entrepreneurs from making false or exaggerated claims, from inducing or trading with consumers by using deceptive means, or from interrupting the withdrawal of subscriptions or termination of contracts.
IV FRANCHISE LAW
In Korea, the Franchise Business Act and its Enforcement Decree regulate matters related to franchise businesses in general.
The Franchise Business Act is composed of six broad Chapters. Chapter I explains the purpose of the Franchise Business Act and provides the definitions of various terms used in the Act. Chapter II presents the fundamental principles of franchise business transactions, while Chapter III prescribes the provisions regarding the registration and provision of information disclosure statement, the franchise fee and franchise agreement and provisions concerning prohibited unfair trade practices. Chapter IV stipulates dispute resolution methods for franchise business transactions and Chapter V includes the provisions regarding the case handling procedure of the KFTC, the enforcement agency for the Franchise Business Act. Finally, Chapter VI prescribes the penalties for violations of the Franchise Business Act.
While Korea’s Monopoly Regulation and Fair Trade Act (MRFTA) (the statute that governs fair trade and antitrust issues) applies to all business transactions, the Franchise Business Act only applies to franchise business transactions. Hence, for matters regarding franchise business transactions, where the Franchise Business Act applies, some of the regulations of the MRFTA do not apply (Article 38 of the Franchise Business Act). Moreover, since franchise business transactions can also be viewed as commercial transactions, the Korean Commercial Code may also be applicable.
ii Pre-contractual disclosure
According to Article 6-2(1) of the Franchise Business Act, a franchisor is required to register an information disclosure statement13 with the KFTC. A registered information disclosure statement subsequently has to be provided to a prospective licensee.14 When providing a registered information disclosure, a franchisor has to attach the documents stating the trade names, locations and telephone numbers of the 10 franchisees closest to the future store of a prospective franchisee (documents on the status of neighbouring franchisees). Unless 14 days have elapsed since the provision of a registered information disclosure statement and the documents on the status of neighbouring franchisees, the relevant franchisor cannot execute a franchise agreement with a prospective franchisee.15
Moreover, when providing information to prospective franchisees or franchisees, franchisors are prohibited from engaging in the following acts: (1) providing information different from the facts, or exaggerated information, and (2) providing information by suppressing or reducing facts that have a material impact on the execution or maintenance of a contract. Additionally, franchisors are obligated to provide information about the past profits or the expected future profits to the prospective franchisees and franchisees in writing.16 If a franchisor provides false, exaggerated or deceptive information to its prospective franchisees or franchisees in violation of the above, it may be subject to corrective measures or surcharges by the KFTC. In addition, the relevant franchisor could also bear damages liability or criminal liability.
Other than the registration of the information disclosure statement discussed in Section IV.ii, no separate specific registration process is required for a franchisor or for a franchisee.
iv Mandatory clauses
According to Article 11(2) of the Franchise Business Act, a franchise agreement must cover each of the following matters:
- a grant of licence for business marks;
- b terms and conditions of the business activities of the franchisee;
- c education, training and business guidance for the franchisee;
- d payment of franchise and other fees;
- e demarcation of business territory;
- f term of the agreement;
- g transfer of business;
- h grounds for termination of the agreement;
- i the fact that a franchise deposit shall be deposited in the depository for two months from the date on which the prospective franchisee or franchisee executes a franchise agreement;
- j if the perspective franchisee has consulted an attorney or a franchise trader with regard to the information disclosure statement, the fact that it has done so; and
- k other matters specified by Presidential Decree concerning the rights and obligations of parties to a franchise business.17
v Guarantees and protection
Typically, guarantees from individuals and companies to the franchisor are enforceable. It is generally a common practice for local franchisors to require a franchisee to guarantee the franchisee’s obligations under the franchise agreement.
i Franchisor tax liabilities
As mentioned above, with respect to tax issues, the Korean Tax Code applies, with no specially applied regulation for franchises. The primary taxes relevant to business entrepreneurs in Korea are corporate tax, value added tax, individual income tax, customs duties and inhabitant tax levied on corporate tax, income tax and other taxes.
If a franchisor is a corporation, a Korean company has the duty to pay corporate tax on all income generated in and outside Korea, while a foreign company has a duty to pay this tax only on domestic-sourced income. Company income in each fiscal year is charged with a ‘corporate tax on income from each fiscal year’, and if the company transfers land and buildings, housing and adjacent land located in a specific area, or non-business-purpose land, it is subject to a ‘corporate tax on income from transfer of land and other real properties’. If a domestic company is dissolved, ‘corporate tax on income from liquidation’ is levied; however, a foreign company is not subject to the duty to pay tax on income from liquidation.
ii Franchisee tax liabilities
If a franchisee is a corporation, the same tax rule applies as in Section V.i. However, if a franchisee is a natural person, the main tax issue would be the income tax levied on the business income in lieu of corporate tax. While a resident bears the duty to pay income tax on all income generated in and outside Korea, a non-resident, conversely, only has the obligation to pay income tax on domestic-sourced income. However, if a non-resident becomes a resident, such as through the method of dwelling in Korea for at least one year, income tax is imposed only on the domestic-sourced income generated up to the day before the non-resident’s transition to resident and any income, both foreign or domestic, generated from the date of residency will be subject to income tax.
iii Tax-efficient structures
While there are both advantages and disadvantages depending on the business entity and the business structure, no single, optimal tax-efficient structure exists specially for franchise businesses.
VI IMPACT OF GENERAL LAW
i Good faith and guarantees
In Chapter (II), as a fundamental principle of the franchise business transaction, the Franchise Business Act requires the parties engaged in the franchise business to carry out each of their duties in good faith.18 By specifying this fundamental principle, the Franchise Business Act prescribes the obligations of the franchisors (Article 5) and those of the franchisees (Article 6). However, the Franchise Business Act does not separately prescribe sanctions for violations of the above fundamental principle and the obligations of the franchisors and of the franchisees. Therefore, these provisions can be viewed to have significance as best-practice standards rather than as mandatory rules. However, under the Franchise Business Act, any breach of these obligations may be regulated under other provisions within the Franchise Business Act. Hence, it is worth noting that any breach of the above obligations may trigger civil or criminal liabilities.
ii Agency distributor model
In principle, a franchisee governed by the Franchise Business Act and an agency distributor are distinguished pursuant to the actual details of the business, regardless of the term used. However, since in many respects a franchisee and an agency distributor engage in similar transactions, distinguishing between the two business models is not easy. This is because an agency distributor, like a franchisee, also pays contract fees or deposits, and purchases various types of products or goods to resell them to end customers.
The actual standard for distinguishing a franchisee governed by the Franchises Business Act from an agency distributor is the ‘payment of compensation for use of business marks and assistance or training for business activities’. In other words, if compensation for use of business marks and assistance or training for business activities is paid separately, the business operator should be viewed, reasonably, as a franchisee. Conversely, if such compensation is not paid, but rather only deposits are paid to engage in business, the business operator should be termed, reasonably, an agency distributor. Although the Franchise Business Act is not applicable to dealings with an agency distributor, the MRFTA remains applicable.
iii Employment law
The term ‘worker’ refers to a person, regardless of the occupational type, who offers labour to a business or workplace for the purpose of earning wages.19 The Supreme Court determines whether a person falls within the definition of a worker under the Labour Standards Act based on whether the person has actually provided labour to an employer under a subordinate relationship at a business or workplace for the purpose of earning wages.
Since a franchisee independently engages in a business upon its own initiative and bears the risks itself, and because the franchisee obtains a separate business licence for tax return purposes under the actual business practice, a franchisee is not viewed as a worker. Rather, a franchisee is generally treated as a separate, independent entrepreneur.
iv Consumer protection
According to the Framework Act on Consumers, the term ‘consumers’ refers to those who use goods or services provided by entrepreneurs for their daily consumption or for their production activities as designated by Presidential Decree.20 With respect to the scope of those who use goods or services for production activities, the Presidential Decree stipulates the following: (1) an end consumer of the goods or services provided (provided that those who use the furnished goods, etc. as raw materials, capital goods or other equivalents for production activities are excluded), and (2) a person who uses furnished goods, etc. for agricultural activities (including in the livestock industry) and fishery activities (excluding those engaged in deep-sea fishing).21
Since franchisees are not end consumers of the goods furnished by the franchisor, but rather persons that use the furnished goods, etc. as raw materials, capital goods or other equivalents, they are difficult to treat as consumers.
v Competition law
The Franchise Business Act prohibits a franchisor from engaging in, or causing any other business entity to engage in, acts that are likely to impede fair franchise business transactions and enumerates the following five types of prohibited acts:22
- a suspending or refusing the supply of goods or services or business assistance to a franchisee or placing significant limitations thereon;
- b imposing unreasonable restraints or limitations on the prices of goods or services that a franchisee handles, its transacting counterparty, transacting territory or the business activities of a franchisee;
- c imposing unreasonable disadvantages on a franchisee by abusing a franchisor’s superior trading position;
- d imposing on a franchisee unreasonable obligations to pay damages, such as imposition of penalties that are excessive in relation to the object and content of the contract, the size of the potential damages, the existence and extent of the faults between the parties and the normal trade practice in that type of business; and
- e any act that does not fall under (a) through (d) above that is likely to interfere with fair franchise business transactions, such as the franchisor unreasonably inducing the franchisees of a competing franchisor to conduct transactions with it instead.
Moreover, the Franchise Business Act prohibits the franchisor from providing false or exaggerated information to franchisees, unreasonably pressuring franchisees to improve store environments, unreasonably restricting business hours and unreasonably infringing on the franchisees’ sales territory.23
Further, any area where the Franchise Business Act is inapplicable may be governed by the MRFTA, which governs fair trade and antitrust issues.
vi Restrictive covenants
A franchisor is permitted to include a provision in the franchise agreement that prohibits its franchisee from engaging in a business that competes with the franchise business during the term of the franchise agreement under the franchisee’s own name or the name of a third party without the consent of the franchisor. For reference, the standard form franchise agreement distributed by the KFTC via its website also includes such a non-compete clause. In the event of a franchisee’s breach of the non-compete clause, a franchisor can seek an injunction against the breaching franchisee requesting the suspension of business, and further the franchisor can claim any damages arising from the breach.
There is no clear consensus on whether a non-compete duty can be held to be binding even after the expiration of the franchise agreement. However, when the KFTC previously investigated whether a franchise agreement used by chicken and pizza franchisors violated the Act on the Regulation of Terms and Conditions, it held that a non-compete clause has to be reviewed by comparing and balancing the franchisor’s interests in protecting its trade secrets against the franchisee’s freedom of occupation choice. Based on this premise, the KFTC decided that, since chicken and pizza franchises can be opened without particularly special know-how from the franchisors, chicken and pizza franchisors cannot be found to have significant interests in protecting their trade secrets, if any. Accordingly, the KFTC ordered the non-compete clause in the franchise agreement to be removed or substituted with a clause that specifically protects trade secrets.24 In light of the foregoing standard presented by the KFTC, if special know-how is transferred in a franchise business, which substantiates the need to protect trade secrets of the franchisor, a short-term non-compete obligation may be extended beyond the expiration of the contract term.
In connection with the confidential clauses in franchise agreements, a franchisor can include a clause that prohibits a franchisee from disclosing to a third party a franchisor’s trade secrets acquired in the process of executing the franchise agreement and of operating a franchise business. If a franchisee breaches the clause, a franchisor can apply for an injunction against the breaching franchisee barring the infringement of trade secrets, and can claim compensation for damage that the franchisor incurred because of the infringement.
Where a franchisee requests to renew the franchise agreement during the period from 180 days to 90 days prior to the expiration of the franchise agreement, a franchisor cannot reject the request without justifiable reasons. A franchisee’s right to request the renewal of the agreement may be exercised only when the total term of the franchise agreement, including the initial term, does not exceed 10 years.25
Furthermore, apart from the exceptional grounds for immediate termination26 prescribed by the Franchise Business Act, if a franchisor seeks to terminate the franchise agreement, it must clearly state the fact of the franchisee’s breach during the grace period of not less than two months, and give a written notice at least twice indicating its intent to terminate the agreement unless the breach is corrected during the grace period. If this procedure is not complied with, the termination of the franchise agreement is not effective.27
After the expiration of the franchise agreement, the shares, assets or business of franchisees can be acquired by the franchisor pursuant to the agreement between the parties; the Franchise Business Act does not provide specific regulation of such transfers.
viii Anti-corruption and anti-terrorism regulation
With respect to anti-corruption and anti-terrorism regulations, there is no regulation specifically applicable to franchising. Generally, the relevant laws that govern the bribery of domestic government officials include (1) the Korean Criminal Code, (2) the Act Concerning Aggravated Punishment of Specific Crimes, and (3) the Act on the Prohibition of Improper Solicitation and Provision or Receipt of Money and Valuables. In connection with the issue of bribery of foreign public officials, based on the OECD Convention, Korea enacted the Act on Prevention of Bribery to Foreign Public Officials in International Business Transactions.
ix Dispute resolution
In principle, a franchise agreement can designate a foreign court as the applicable jurisdictional court. However, an exclusive jurisdiction agreement, excluding the jurisdiction of the Korean court and recognising only the jurisdiction of a foreign court, is valid if the relevant case does not come under the exclusive jurisdiction of the Korean court and the jurisdiction of the designated foreign court can be established in addition to the existence of a reasonable connection between the relevant case and the designated foreign court. Furthermore, the exclusive jurisdiction agreement should not constitute a legal act that is significantly unreasonable and unfair to the extent that it is adverse to public order and good morals.28 Moreover, any agreement that sets a foreign law as the governing law is valid, unless there is a justifiable basis for the claim that the agreement causes a significantly unreasonable or unfair consequence.29
Most franchise disputes are addressed or resolved before the courts, or through mediation or arbitration, like most other commercial disputes in Korea. However, Korea has also established the Franchise Business Dispute Mediation Council under the Korea Fair Trade Mediation Agency as an agency in charge of mediating disputes related to franchise businesses. Both parties to a dispute can apply for mediation in cases involving franchise business disputes. Also, the KFTC can request mediation in cases that the KFTC is handling or investigating.
As discussed earlier, if a franchisee breaches the non-compete clause during the term of the franchise agreement or if a former franchisee uses the franchisor’s trademarks even after the expiration of the franchise agreement or breaches the confidentiality clauses in connection with the franchisor’s trade secrets, the franchisor can file a motion for injunctive relief against the infringements and claim compensation for any damage suffered. In Korea, property damages arising from tortious acts are calculated based on proprietary disadvantages suffered because of the harmful act (i.e., the discrepancy between the financial condition in the absence of the tortious act and the financial condition after the tortious act).
With respect to recognition and enforcement of foreign arbitral awards, Korea recognises or enforces any domestic arbitral award made in Korea pursuant to the Arbitration Act. Any foreign arbitral award made in jurisdictions other than Korea is recognised and enforced pursuant to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention).30
VII CURRENT DEVELOPMENTS
An amendment to the Franchise Business Act in 2017 introduced the system of punitive damages (treble damages).
In principle, if a franchisor harms a franchisee by violating the Franchise Business Act, the franchisor is liable to the franchisee for damages. However, if the franchisor were to successfully prove that it lacked intent or negligence, the liability would not be established. Nonetheless, (1) provision of false and exaggerated information, and (2) unreasonable refusal to deal (i.e., unreasonable refusal to renew the underlying franchise agreement, or termination of the agreement, etc.) by the franchisor are deemed to show significant malevolent intent and to cause harm through loss of considerable sums in investment and the potential exit of the franchisee from the market. In the light of this deemed malicious intent and its effects, the punitive damages system was introduced to sanction such behaviour by imposing on the franchisor liability for damages of up to treble the amount of the costs incurred as a result of the damage suffered by the franchisee.31
1 Kenneth T Kim is a senior foreign attorney and partner, Jason Sangoh Jeon is a partner and Jin Woo Hwang is a senior associate at Yoon & Yang LLC.
2 See statistics by the KFTC (Korean only, at http://franchise.ftc.go.kr/main/subIndex/22.do).
3 See Ministry of Trade, Industry and Energy (MOTIE) press release dated 15 January 2016.
4 See Statistics Korea, ‘Results of Service Industry Surveys in 2014’.
5 See statistics by the KFTC (Korean only, at http://franchise.ftc.go.kr/main/subIndex/22.do).
6 See MOTIE press release at footnote 3.
7 See KFTC franchise business search website (Korean only, at http://franchise.ftc.go.kr/user/extra/main/62/firMst/list/jsp/LayOutPage.do).
8 See KIPO trademark search service website (www.kipris.or.kr/khome/main.jsp).
9 See Article 107 of the Trademark Act.
10 See Article 109 of the Trademark Act.
11 The term ‘personal information’ refers to information that pertains to an individual, including the full name, resident registration number, images, etc. by which the individual in question can be identified (including information that cannot be used alone to identify the individual in question but that can, when combined simply with other information, identify the individual) (Article 2(i) of the PIPA).
12 The term ‘personal information manager’ refers to a public institution, corporate body, organisation or individual, etc. who manages personal information directly or via another person to administer personal information files as part of his or her duties (Article 2(v) of the PIPA).
13 The term ‘information disclosure statement’ refers to a document that includes the general status of a franchisor; the current status of the franchise business of a franchisor; franchisee charges; conditions of and limitations on business activities; detailed procedures for the commencement of the franchise business and the duration required for the commencement of business; explanation on the management role of a franchisor; support, education and training in relation to business activities; and the relevant facts governing violations of the MRFTA or the Act on the Regulation of Terms and Conditions (Article 2(x) of the Franchise Business Act) by a franchisor or its executive.
14 To partially change the contents of a registered information disclosure statement, the relevant franchisor has to register with or (for minor changes) report to the KFTC, depending on the importance of the matters changed.
15 See Article 7 of the Franchise Business Act; a violation may be sanctioned by imprisonment of up to two years and criminal fine of up to 50 million South Korean won.
16 See Article 9 of the Franchise Business Act.
17 Article 12 of the Enforcement Decree of the Franchise Business Act mentions the following as the ‘matters prescribed by Presidential Decree’: (1) conditions regarding the return of funds, such as franchisee fees; (2) installation of equipment and fixtures, etc. for the business of a franchisee and the maintenance and repair thereof, and the bearing of these expenses; (3) measures to be taken according to the expiration and termination of a franchise agreement; (4) just cause by which a franchisor may refuse to renew a franchise agreement; (5) franchisor trade secrets; (6) compensation for loss because of violation of a franchise agreement; (7) procedures for the resolution of disputes between franchisors and franchisees; (8) in the event of transfer by a franchisor of a franchise to another franchisee, the franchise agreement with the former franchisee; and (9) measures to be taken at the expiration of the term of validity of a franchisor’s intellectual property rights.
18 See Article 4 of the Franchise Business Act.
19 See Article 2(1)(i) of the Labour Standards Act.
20 See Article 2(i) of the Framework Act on Consumers.
21 See Article 2 of the Enforcement Decree of the Framework Act on Consumers.
22 See Article 12(1) of the Franchise Business Act.
23 See Articles 9, 12-2, 12-3 and 12-4 of the Franchise Business Act.
24 See KFTC, Press Release Dated 15 September 2009.
25 See Article 13 of the Franchise Business Act.
26 See proviso of Article 14 of the Franchise Business Act and Article 15 of the Enforcement Decree of the Franchise Business Act.
27 See Article 14 of the Franchise Business Act.
28 See Supreme Court, Decision No. 96Da20093 rendered on 9 September 1997.
29 See Supreme Court, Decision No. 2010Da28185 rendered on 27 May 2010.
30 See Articles 38 and 39 of the Arbitration Act.
31 See Article 37-2 of the Franchise Business Act.