Hello. I am Attorney Eom Sang-yun.
As the franchise market reaches saturation, transitioning franchisees in already validated areas to our brand is being attempted as an effective strategy. Additionally, since franchise headquarters have a strong incentive to attract franchisees with proven sales capabilities, they often aggressively recruit franchisees.
In fact, during consultations, representatives of the franchise headquarters frequently ask these questions.
“Attorney, if a competitor’s franchisee switches to our brand, is there no legal issue if we provide cash support?”
However, paying cash to a franchisee of a competing brand to induce a switch to our brand may violate the 'Act on Fair Transactions in Franchise Businesses' (“Franchise Business Act”). Today, we will examine the legal risks that may arise when attracting a competitor's franchisee.
[Possibility of Illegality in Attracting Competitor Franchisees]
In conclusion, offering financial benefits to attract a competitor's franchisee is not inherently illegal, but providing excessive economic benefits in return for switching to our brand when the franchise agreement is still active may violate the Franchise Business Act.
The Franchise Business Act defines that it is an unfair trade practice for a franchise headquarters to entice franchisees of competing franchisers with actions such as providing unfair incentives (Article 12), and the “Guidelines for Reviewing Unfair Trade Practices in Franchising” (“Review Guidelines”) specify concrete criteria for such inducement practices.
Franchise Business Act Article 12 (Prohibition of Unfair Trade Practices) ① A franchiser must not engage in any acts that fall under any of the following categories that may hinder fair transactions in franchise businesses, nor should they have others engage in such acts. 6. Acts that may hinder fair transactions in franchise businesses, including unfairly enticing franchisees of competing franchisers to transact with themselves. Guidelines for Reviewing Unfair Trade Practices in Franchising Even though franchisers should strategically use the value of their business identifiers, prices, or quality of goods and services, if they entice franchisees of competing franchisers to transact with them through unfair benefits, deception, or transaction interference, it is prohibited as it undermines the fair trading order of franchise businesses. (1) Target Acts (a) Acts in which a franchiser entices the franchisees of other competing franchisers to transact with themselves, causing disadvantage to their own franchisees or disadvantages to the competing franchiser’s business. (b) From the consumer's perspective, the businesses operated by each franchiser are similar or identical, allowing customers to access similar products or services, and from the perspective of franchisees, it suffices that the franchisers have a substitute relationship in a specific franchise business, without requiring each franchiser to be in a continuous and substantial competitive relationship. (c) The methods of enticing franchisees of competing franchisers can include unfair benefits, deception, or other forms of unjust inducement. (2) Criteria for Judging Illegality (a) The unfairness of the inducement of competing franchisees is judged primarily based on the unfairness of competitive means. (b) It is judged whether the competitive means are unfair based on whether excessive or unjust benefits were provided, whether deception or coercion may mislead the franchisees of competing franchisers, or whether they unduly obstructed the establishment of contracts or induced non-performance, thereby interfering with transactions. |
On the other hand, the Fair Trade Commission judged that providing cash support ranging from millions to tens of millions of won per franchise to attract competitors' franchisees constitutes 'unfair customer inducement' under the Monopoly Regulation and Fair Trade Act (“Fair Trade”) (Resolution 2012-277). This case, although addressing violations of the Fair Trade Act, is noteworthy as a reference, given that the special law of the Franchise Business Act prohibits unjust inducement of competitive franchisees.
The Fair Trade Commission’s specific reasoning is as follows.
① Businesses are expected to generate or secure customer demand through efficient competitive methods based on their product prices, quality, or services, but the respondent utilized unfair competitive means by providing cash ranging from 36,000,000 won to 200,000,000 won to convert four franchises of a competing business into their own franchisees based on the number of customers of those franchises. ② Despite the franchise agreement with the competing business not being expired, the total amount of cash paid in return for converting the four franchises to their own was 349,350,000 won, which cannot be considered as benefits compliant with normal trade practices. ③ The average annual revenue per consumer for the juice products sold by the respondent is about 453,600 won, and given that the average margin for each consumer of their franchises in the metropolitan area ranges from 243,580 won to 276,690 won, the 50,000 won provided per consumer as a payment for converting each of the four franchises amounts to approximately 18% to 20.5% of the average profit, indicating that the respondent provided excessive economic benefits to those competing franchises in exchange for conversion. ④ The amount of benefits paid by the respondent to the four franchises is 70,850,000 won to Jung-gu franchise, 200,000,000 won to Yangcheon franchise, 36,000,000 won to Mapo franchise, and 42,500,000 won to Gwangju franchise, with the proportion of the benefits paid compared to the previous year's sales for these franchises reaching approximately 29% to 44%, leading to the recognition that the respondent provided excessive economic benefits in exchange for converting competing franchises. ⑤ To achieve sales targets and expand business networks, the respondent targeted franchises with stable networks in the existing juice market or those that need their brand recognition, proposing cash incentives for conversion. This suggests that the respondent believes that competitive strength can be secured by expanding sales networks through providing economic benefits rather than by creating competition through superior pricing or products; thus, it is highly likely that the respondent will continue to engage in customer inducement towards competing franchises in the future. |
In summary, the Fair Trade Commission concluded that the cash paid as a payment for brand conversion exceeded the scope of normal promotional activities, viewing it as an attempt to capture the distribution network established by competitors solely by leveraging significant financial resources. However, this pertains to instances where cash was provided to franchisees with active agreements, and there have been no clear cases that were deemed illegal for instances where cash was provided after the expiration of franchise agreements.
Nonetheless, the Review Guidelines stipulate that the determination of illegality is made considering whether there was an attempt to obstruct the establishment of contracts or induce non-performance with competing franchisers. Therefore, offering excessive financial incentives to induce contract renewals for a franchise that is generally expected to be renewed may violate the Franchise Business Act.
Thus, when attracting franchisees of competing brands, it is advisable to refrain from direct cash payments and ensure that any economic benefits provided do not exceed the usual standards in practice.
[Check for Non-Compete Clause]
In general, franchise agreements often contain a 'non-compete' clause that prohibits operating other brands in the same field during the contract period. Therefore, if a franchisee terminates the franchise agreement with their current brand before expiration to switch to a competing brand, they may become embroiled in an investigation by the Fair Trade Commission, prohibitions on operations, or damage compensation cases.
Consequently, from the perspective of the franchisee, they must evaluate whether converting brands constitutes a breach of contract, and weigh the disadvantages of penalties or losses due to contract termination against the business benefits of brand switching. Additionally, the franchise headquarters wishing to attract franchisees also need to consult legally in advance to avoid impacts from prohibitions on operations for the franchisees they have worked hard to recruit.
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