Hello, I am Attorney Eom Sang-yun from Cheongchul Law Firm.
Recently, due to the Supreme Court ruling on the differential franchise fee case against Korea Pizza Hut, differential franchise fees have emerged as significant issues in the franchise transaction sector. Following this ruling, it is known that lawsuits regarding differential franchise fees have been filed or are being prepared against other franchise headquarters, and as the domestic franchise business is active, a large impact is expected.
Today, we will look into the concept of differential franchise fees and the background in which related lawsuits have been frequent.
[What is a differential franchise fee?]
Article 2, Paragraph 6 of the Law on Fair Transactions in Franchise Businesses (“Franchise Business Act”) and Article 3 of the Enforcement Decree of the same law define the concept of franchise fees, and the specific provisions are as follows.
Franchise Business Act Article 2 (Definitions) The definitions of the terms used in this law are as follows: 6. “Franchise Fee” refers to any compensation that falls under any of the following items, regardless of the name or payment form. However, it does not include compensation that is not attributable to the franchise headquarters as specified by presidential decree. a. The compensation that the franchisee pays to the franchise headquarters for receiving support or training in the use of the trade name or for the operation rights of the franchise. b. The compensation that the franchisee pays to the franchise headquarters to secure payment for the debts or damages related to the price of goods supplied by the franchise headquarters. c. The compensation that the franchisee pays to the franchise headquarters for goods, equipment, or real estate rental at the time of obtaining the franchise operation rights needed to commence franchise operations. d. The compensation that is paid regularly or irregularly to the franchise headquarters regarding the authorized use of trademarks and support/education related to business activities as defined by presidential decree. e. Any compensation that franchisees or franchise applicants pay to the franchise headquarters to acquire or maintain franchise operation rights.
Article 3 (Definition of Franchise Fee) ① The term “compensation as defined by presidential decree” in the exceptions of Article 2, Paragraph 6 of the Act refers to the compensation that corresponds to any of the following items. 1. In cases where a consumer purchases goods or services from a franchisee using a credit card, the fee that the franchisee pays the credit card company. 2. In cases where a consumer purchases goods or services from a franchisee using a gift certificate, the fee or discount that the franchisee pays to the gift certificate issuance company. 3. In cases where a consumer uses a debit electronic payment method or prepaid electronic payment method as defined in Article 2, Item 11 of the Electronic Financial Transactions Act, or uses an electronic payment settlement agency defined in Article 2, Item 19 of the same act to purchase goods or services from a franchisee, the commission or discount paid by the franchisee to the issuing company of the payment method or the agency. 4. The reasonable wholesale price among the compensation paid to the franchise headquarters as stipulated in Article 2, Item 6, sub-item d of the Act (if there is no established wholesale price, it refers to the price at which the franchisee can normally purchase, rent, or exchange the relevant goods or services through a normal trading relationship, and in cases where the franchise headquarters purchases and supplies the goods or services from other businesses, it refers to the purchase price). This also applies here. 5. Other money that is not attributable to the franchise headquarters, where the consumer pays a third institution and the franchise headquarters acts as an agent. ② The terms “as determined by presidential decree” in Paragraph 6, sub-item d of the Act refers to any of the following compensations: 1. The compensation that the franchisee regularly or irregularly pays to the franchise headquarters based on a set amount or a percentage of sales or operating profits under the name of royalty, lease fees, advertising shares, training expenses, rental fees for signs, etc. 2. The compensation that the franchisee regularly or irregularly pays to the franchise headquarters that exceeds the reasonable wholesale price for the goods, raw materials, subsidiary materials, fixtures, equipment, and raw materials supplied by the franchise headquarters. However, compensation related to rights under the Patent Act for the products acquired by the franchise headquarters is excluded. ③ The Fair Trade Commission may establish and publicly announce the reasonable wholesale price set forth in Item 4 of Paragraph 1 and Item 2 of Paragraph 2. |
A differential franchise fee means the margin that exceeds the reasonable wholesale price among the amounts received by the franchise headquarters as compensation for supplying items or services necessary for business activities to the franchisee. Moreover, when the franchise headquarters purchases and supplies those items or services from other businesses, the purchase price can be considered the 'reasonable wholesale price' applicable as a standard for differential franchise fees (Enforcement Decree of the Franchise Business Act, Article 3, Paragraph 1, Sub-item 4).
Additionally, Article 4, Paragraph 1 of the Enforcement Decree of the Franchise Business Act [Appendix 1] stipulates that the amount exceeding the reasonable wholesale price among compensations paid by the franchise headquarters to the franchisee for items that the franchise headquarters requires or recommends the franchisee to purchase from the headquarters or a designated party must be recorded in the information disclosure statement as “differential franchise fees.”
[Background of Differential Franchise Fee Lawsuits]
Originally, the profit model of franchises is ideally based on receiving a percentage of sales as royalties, however, in the domestic market, franchisees had significant psychological resistance to this percentage-based royalty. Consequently, many franchise headquarters have adopted a model of generating profits by attaching a profit margin when supplying raw materials to franchisees, instead of exempting or lowering the apparent royalties.
However, this method of collecting differential franchise fees has three significant legal and structural vulnerabilities.
First, there are often no explicit agreements with franchisees. Since differential franchise fees are also a kind of franchise fee, clear mutual consent is required to collect them. However, many franchise agreements only contain clauses requiring the purchase of necessary items specified by the headquarters, while the fact that the price of the items includes a margin for the headquarters is omitted or the method of calculation is not documented. Therefore, it has become possible to argue that the collection of franchise fees without agreement constitutes unjust enrichment without a legal cause.
Second, there are issues with abusive designation of necessary items and high prices. Franchise headquarters often require various items to be designated as necessary items under the pretext of maintaining brand image consistency. However, many items unrelated to franchise business uniformity are included, and there are cases where they are supplied at prices significantly higher than those of similar items in the market. This habitual behavior combined with the legal concept of franchise fees and lack of explicit consensus on differential franchise fees has become a catalyst for lawsuits.
Finally, the strengthening of information disclosure obligations is also a factor. The system was strengthened to require the average payment scale of differential franchise fees per franchisee and the upper/lower limits of supply prices by item to be clearly recorded in the information disclosure statement. As a result, the previously hard-to-clarify supply margins of franchise headquarters have become known, prompting franchisees who realize this to pursue legal action.
Furthermore, in the case of Korea Pizza Hut, the Supreme Court did not recognize the establishment of implicit consent regarding the agreement on differential franchise fees, thereby making the return of undue enrichment regarding differential franchise fees a significant issue throughout the franchise industry. However, when looking at the Supreme Court rulings in the related cases of Korea Pizza Hut and Mom's Touch, the precedents do not imply that differential franchise fees cannot be collected in all franchise transactions but rather indicate that it is difficult to recognize the establishment of consent for the payment of differential franchise fees depending on the wording of franchise contracts and factual circumstances, so conclusions may vary for each franchise headquarters.
[Points for Franchise Headquarters to Note]
According to the Supreme Court ruling, specific mutual consent among parties is essential for the collection of differential franchise fees by the franchise headquarters, and amounts unilaterally decided and collected by the headquarters without explicit contractual terms or implicit consent may be subject to return.
In particular, it is insufficient to simply include differential franchise fees in the information disclosure statement, and it is necessary to refine practices to clearly define the facts of collecting differential franchise fees and the methods of calculation in the documentation.
Moreover, taking retaliatory actions against franchisees who have filed lawsuits can lead to separate liability for damages; therefore, actions that provide disadvantages such as refusal to renew contracts due to legitimate exercise of rights or franchisee group activities should be avoided.
Cheongchul Law Firm is providing comprehensive advice related to franchise businesses to numerous companies based on expertise and experience accumulated through large domestic law firms such as Kimjang Law Office, Taepyeongyang, Gwangjang, Sejong, and Yulchon. By working with Cheongchul, you will have a reliable ally who accurately grasps the essence of the case and effectively conveys the client's position.
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