Franchising in South Korea – Changes in Franchise Law Result in Broader Protection for Franchisees
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South Korea is the world's 12th largest economy, with a highly educated and technologically advanced population. For international brands which are looking to bring their goods and services to this dynamic market, franchising is a proven expansion technique, where access to local capital and local knowledge of consumer habits, retailing practices and real estate opportunities provide the key to success.
Unfortunately, South Korea has one of the most bureaucratic regimes in Asia for regulating franchises and the law does not distinguish between "mom and pop" domestic franchises and international franchise deals between experienced and established companies and operators.
Recent amendments to South Korea's franchise laws highlight the need to take expert advice before structuring and rolling out a franchise expansion plan in South Korea.
What's new?
South Korea is already a jurisdiction which affords franchisees a high level of legal protection, with extensive pre-contractual disclosure requirements for franchisors.
Last year the Korean National Assembly passed an Amendment to the Fair Transaction in Franchise Business Act ("Amended Act"), which governs franchising relationships in South Korea. These legislative measures took full effect in August 2014 and are designed to level the bargaining power between franchisees and franchisors. Below is a brief overview of the main changes:
- Store Improvements: perhaps the most significant amendment, from a franchisor's perspective, is in relation to store improvements, which are often imposed on franchisees periodically under the franchise agreement. The Amended Act states that a franchisor may not force a franchisee to relocate or expand or remodel the interiors of their outlets without "reasonable cause". Furthermore, for retail and restaurant businesses, the new regulations stipulate that the franchisor must contribute between 20% to 40% percent of the remodelling costs and may only demand remodelling of the franchise stores once every 5 to 7 years.
- Exclusivity: whilst it is already standard to do so, it will become mandatory for franchisors to explicitly stipulate the franchisee's business territory in the franchise agreements. During the term of a franchise agreement, the franchisor cannot establish a directly owned store for the same type of business within the franchisee's territory without a justifiable reason.
- Information on Projected Sales Revenue: franchisors (but excluding those franchisors deemed "small or medium enterprise" and those franchisors having less than a certain number of franchised stores) are now obliged to provide information on projected sales revenue and the method for its calculations to prospective franchisees at the time of executing the franchise agreement.
- Franchisee Unions: the Amended Act allows franchisees belonging to the same franchise network to form a union and to collectively bargain with the franchisor regarding the terms and conditions of the franchise agreement.
- Cooling Off Period: the cooling-off period has been extended from 2 to 4 months for franchisees to make a written request for a refund of the franchise fees, starting from the date of executing the franchise agreement.
Why should international brands care about this?
The Amended Act took effect on 14 February 2014, with the exception of the amendment regarding exclusivity, which came into effect on 14 August 2014. The Amended Act applies to all franchisors doing business in South Korea, regardless of where the franchisor is located. Therefore, foreign brands (and particularly those in the food and beverage and services sectors which might use master franchise structures) should be aware of these mandatory provisions when negotiating with potential franchisees, and ensure that the terms of the franchise agreement take account of these additional responsibilities.
Some foreign brands are understandably put off by the cost and potential delay that can come with full compliance and have instead entered the market via a "licence" or "distribution" arrangement. However, if this arrangement is a business format franchise in everything but name, it is possible that the authorities will investigate such arrangements and fine the franchisor, which could cause serious damage to the brand reputation in South Korea. Perhaps of greater concern is the risk that the agreement is likely to be unenforceable in South Korea, both against the franchisee and third parties.
Conclusion
South Korea continues to be an attractive market for international brands. However, the prescriptive and restrictive rules on franchise agreements and disclosure requirements continue to make South Korea a complex jurisdiction to do business in. It is extremely important that brands take advice from experienced legal experts before entering the market in order to fully understand the requirements for legal compliance and to structure and document the deal accordingly.
If you would like further information on this topic, please contact your usual franchise team member, or otherwise Gordon Drakes (Senior Associate) or David Bond (Partner).