Hello, this is attorney Kim Kwang-sik of Cheongchul Law Firm.

One of the most frequent issues in franchise disputes is "what information the franchisor provided to the prospective franchisee before concluding the contract." In particular, information such as estimated sales, net income, payback period, trade area analysis, and sales data of nearby franchise stores has a direct impact on the prospective franchisee's decision to enter into the contract.

In practice, franchisees often claim damages on the grounds that "the franchisor exaggerated the projected sales or profitability," "the franchisor failed to properly provide information on neighboring stores or the basis for calculating estimated sales," or "actual sales were significantly lower than the explanation given." The key issue in such cases is not simply whether actual sales fell below the estimate, but whether the information the franchisor provided at the time of the franchise contract was supported by objective grounds, and whether such information had a material influence on the prospective franchisee's decision to enter into the contract.

[Question]

If a franchisor has misrepresented estimated sales or profitability, to what extent can a franchisee claim damages against the franchisor?

[Answer]

1. The starting point of damages claims under the Korean Franchise Act is 'information disclosure at the time of contract'

The Korean Fair Transactions in Franchise Business Act (가맹사업법) provides several mechanisms to ensure that prospective franchisees can decide whether to enter into a franchise agreement after receiving and reviewing sufficient information.

The franchisor must provide the registered Information Disclosure Statement in a manner that allows the time of provision to be objectively verified, and must also provide a Neighboring Franchise Status Document listing the trade names, addresses, and phone numbers of the 10 closest franchise stores to the prospective business site. Furthermore, in principle, no franchise fee may be received and no franchise agreement may be concluded before 14 days have passed from the date of providing the Information Disclosure Statement and the Neighboring Franchise Status Document. This period is shortened to 7 days if the prospective franchisee has consulted a lawyer or franchise transaction specialist.

This procedure is not merely a formal requirement. The prospective franchisee reviews projected sales, payback feasibility, the trade area, and the operational status of nearby stores based on the materials provided by the franchisor. Therefore, if the information provided at this stage is inaccurate, key information is omitted, or it is exaggerated without objective grounds, this can become the starting point of liability for damages.

In actual disputes, courts do not recognize the franchisor's liability based solely on the result that "sales were low." Rather, they focus on what materials the franchisor provided at the time of the contract, what the basis of the explanation was, and whether the prospective franchisee can be deemed to have entered into the contract in reliance on that explanation.

2. The most common ground for illegality is false, exaggerated, or deceptive information regarding estimated sales and profitability

Article 9 of the Franchise Business Act prohibits the franchisor from providing false information, inflating facts, or concealing or downplaying facts that have a material impact on the conclusion or maintenance of a contract when providing information to prospective franchisees or franchisees. In particular, information regarding future expected profit conditions, such as estimated sales, profit, gross margin, and net income, must be provided in writing, and the materials supporting their calculation must be kept on file.

The types of issues that arise in practice are largely similar. Typical examples include presenting only the high sales of a particular store or particular period as if they were a general level of profitability, using expressions such as "guaranteed net income," "short-term recovery of investment," or "high profitability possible even in small floor area" without objective grounds, and emphasizing high-sales examples through blogs, brochures, or consultation materials without presenting the actual basis of calculation.

Sales and net income at a franchise store can vary greatly depending on store location, trade area, foot traffic, rent, labor costs, the operator's management capability, and the appearance of competing stores. Nevertheless, generalizing future profitability based solely on peak-season sales of a particular store or selected success stories may be evaluated as false, exaggerated, or deceptive provision of information.

Therefore, when a franchisor explains "this level of sales is achievable," "the monthly net income is around this much," or "the investment can be recovered within several months," they must always present objective calculation grounds and limitations together. Even if regarded as a mere business promotion, such statements may lead to legal liability if they influenced the prospective franchisee's decision to enter into the contract.

3. For the Estimated Sales Statement and Neighboring Franchise Status Document, 'accuracy of content' may matter more than 'whether they were provided'

Franchisors above a certain scale must provide prospective franchisees with the range of estimated sales and the basis of calculation in writing, namely an Estimated Sales Statement. The range of estimated sales must, in principle, be presented as the minimum and maximum sales expected to occur during the year following the start of operation, and the maximum may not exceed 1.7 times the minimum.

Therefore, simply having "provided" the Estimated Sales Statement is not sufficient. Issues that may arise include which stores were used as comparison subjects, whether the sales data of the closest franchise stores were used as the standard, whether the criteria for excluded and included stores were reasonable, whether company-operated store data and franchise store data were not mixed together, and whether the sales range in the statement complies with statutory methodology.

In particular, problems may arise when the franchisor arbitrarily selects comparison stores, presents the sales of a uniquely located store as if they were the estimated sales of a general store, or unreasonably extrapolates from sales of stores with short actual operating periods. In addition, if the figures recorded in the Estimated Sales Statement do not match the actual calculation materials, or if supporting calculation materials are not adequately preserved, this may also operate unfavorably in subsequent disputes.

Ultimately, when preparing the Estimated Sales Statement, franchisors must go beyond simply filling out the form and manage the calculation criteria, comparison stores, distances, sales conversion methods, exclusion grounds, and preservation of supporting materials together. In future disputes, what matters is whether records remain that can explain "why that sales figure was presented at that time."

4. The scope of damages is based not on 'projected sales' but on 'losses incurred due to unlawful information disclosure'

The amount that franchisees frequently claim when seeking damages is "the difference between the sales figures the franchisor stated and the actual sales." However, courts do not calculate damages so simply. Estimated sales are, in principle, projection materials regarding future profits, and they are not directly construed as meaning that the franchisor guaranteed any specific level of sales.

Generally, courts first examine whether, absent the franchisor's unlawful information disclosure, the franchisee would not have entered into the franchise agreement or opened the store, that is, the causal link between contract conclusion and store-opening expenditures. Once causation is recognized, expenditures incurred in the opening process, such as franchise fees, training fees, interior costs, facility costs, initial supplies, key money, HVAC installation costs, and use-conversion expenses, may be at issue as damages.

However, even where the franchisor's illegality is recognized, the entire amount invested is not automatically recognized as damages. Courts hold that the franchisee, as an independent business operator, also bears responsibility for personally reviewing the trade area, location, lease conditions, scale of investment, and business risks.

Therefore, courts often limit the amount of damages by comprehensively considering the actual expenses incurred by the franchisee, recoverable asset value, whether the business was closed, the period of operation, operational factors attributable to the operator, and the degree of illegality in the franchisor's explanation. In other words, the scope of damages is limited not to "the total loss claimed by the franchisee," but to the range with proximate causal connection to the franchisor's unlawful provision of information.

5. Even when operating losses and lost future profits are recognized, proof and causation are very strict

Franchisees often also claim deficits incurred in the actual operation, operating losses, and lost expected profits. However, the threshold for recognizing operating losses is higher than that for opening costs. This is because poor sales are influenced not only by the franchisor's information disclosure violation but also by various factors such as store location, rent, labor costs, operational capability, the appearance of competing stores, economic conditions, and external factors such as COVID-19.

Accordingly, courts do not automatically include operating losses as damages. Apart from the fact that the information provided at the time of contract was unlawful, it must be separately proven that the actual operating losses arose because of that unlawful information disclosure.

From the franchisee's perspective, simply claiming that "business was bad" is insufficient. They must specifically prove what information was provided at the time of contract, whether they would not have entered into the contract without that information, how much they actually spent, whether any residual asset value or recoverable amounts remain, and whether the operating losses resulted from the franchisor's unlawful conduct.

Conversely, from the franchisor's perspective, it is necessary to actively organize arguments that the estimated sales materials were not a guarantee of sales, that the franchisee, as an independent business operator, had the opportunity to review the trade area and costs, that operational and external factors were involved in the poor sales, and that some expenses are recoverable or retain residual asset value.

6. The franchisor's core defense is not 'profit explanation' but 'a well-grounded explanation process'

In franchise act disputes, all of the following may serve as evidence: consultation materials at the time of contract, text messages, briefing session materials, blog advertisements, the Estimated Sales Statement, records of providing the Information Disclosure Statement, the Neighboring Franchise Status Document, the franchise agreement, and the explanations of the consultation staff. Once a dispute arises, what becomes more important is not "what was actually said," but "whether materials remain to support what was said."

When franchisors explain estimated sales or profitability ratios, they must always specify the calculation grounds and the reference stores. They must not present peak-season sales, uniquely located stores, company-operated store sales, or selected success stories as if they were ordinary expected profits. Expressions such as "guaranteed net income," "guaranteed return of principal," or "more than X in monthly sales possible" must be used very cautiously, and where profitability data must unavoidably be presented, the assumptions and limitations should be clearly disclosed.

It is also necessary to clearly record the order of the dates of providing the Information Disclosure Statement and the Neighboring Franchise Status Document, the date of providing the Estimated Sales Statement, the date of receiving franchise fees, and the date of contract conclusion. Whether the prospective franchisee had sufficient time to review the materials after receiving them is also important. Failure to comply with statutory waiting periods can itself become the central issue in a dispute.

Pre-contract due diligence is also necessary for franchisees. Rather than trusting solely the franchisor's explanation, they should personally conduct visits to nearby franchise stores, review of lease conditions, calculation of labor and material costs, projected profit and loss, and review of financing costs. Courts also tend not to view franchisees as wholly passive consumers, but to recognize that they bear a certain degree of self-responsibility as independent business operators.

A violation of the duty to disclose information under the Franchise Business Act is not merely a regulatory violation but may lead to a damages claim by the franchisee. In particular, explanations regarding estimated sales, net income margins, payback periods, and sales data of nearby franchise stores are core decisional factors in concluding a franchise agreement and must be managed with the utmost care.

However, the scope of damages may differ greatly depending on causation, proof of damages, comparative fault, and limitation of liability, separately from whether the franchisor's unlawful conduct is recognized. The franchisee needs materials to prove actual expenditures and losses, and the franchisor needs materials to prove the objective grounds and explanation process for the information provided at the time of contract.

Ultimately, the core of franchise disputes is not "sales were lower than expected," but "whether the information provided at the time of contract was lawful and objective." Franchisors must align the entire process from franchisee recruitment to material provision, profit explanation, contract conclusion, and franchise fee receipt with the law, and franchisees must carefully preserve the materials and explanations they received before concluding the contract.

Cheongchul Law Firm provides legal advice across all aspects of franchise law, from review of franchisors' Information Disclosure Statements, Estimated Sales Statements, and franchise agreements, to defense and litigation strategies for franchisees' damages claims. If a question arises regarding violation of the Franchise Business Act or the scope of damages, it is important to organize the facts and evidence from the early stage and design the response direction accordingly.