If Sales Are Worse Than Expected, Franchisees Can Close Stores After One Year Without Penalty Fees

'Enforcement Decree Amendment of the Franchise Business Act' Passed at the Cabinet Meeting

Cho Sung-wook, Chairman of the Korea Fair Trade Commission. (File photo)

[Asia Economy Reporter Joo Sang-don] In the future, if a franchise store's sales one year after opening are lower than the minimum amount proposed by the franchisor, the franchisee will not be charged a penalty fee for early closure.

On the 21st, the Fair Trade Commission announced that the "Amendment to the Enforcement Decree of the Franchise Business Act," which includes this provision, has passed the Cabinet meeting. This was a matter announced for legislative notice last October and will be implemented immediately.

There have been ongoing disputes between franchisors and franchisees due to differences between the expected sales figures provided by franchisors when encouraging start-ups and the actual sales generated. According to the Fair Trade Commission, in 2018, there were 111 dispute mediation cases related to false or exaggerated information on expected sales, accounting for 14% of the total. Additionally, 74 cases involved disputes over penalty fees.

Accordingly, the Fair Trade Commission decided to prohibit the imposition of business penalty fees when a franchise store closes early due to sales during the first year after opening being below the lower limit of the expected sales provided by the franchisor. This aims to prevent disputes caused by penalty fees upon early closure and to alleviate the burden on franchisees who inevitably close their stores. However, this penalty fee refers to compensation for the franchisor’s loss of future expected profits (such as royalty income) due to early termination of the franchise contract and is separate from penalty fees related to facility investments (facility penalty fees).

Specifically, if the average sales generated during the first year after opening do not reach the lower limit of the expected sales provided by the franchisor, imposing a business penalty fee upon early closure is deemed unfair. The franchisor provides expected sales in the form of upper and lower limits based on three out of five nearby franchise stores, excluding the highest and lowest.

A Fair Trade Commission official stated, "This considers that the franchisor bears some responsibility when sales are poor despite no fault of the franchisee," adding, "It is expected that the burden on franchisees closing stores due to poor sales caused by the impact of COVID-19 and other factors will be reduced."

The amendment also strengthens the franchisor’s obligation to provide start-up information. It requires that the average operating period of franchise stores be recorded in the disclosure document so that prospective franchisees can understand the sustainability of store operations, the franchisor’s soundness, and the brand’s market evaluation. Additionally, to allow franchisees to check and compare support measures in case of poor sales due to early start-up or changes in commercial districts, management support details for stable store operation must be included in the disclosure document. The basis for expected profit situations must include the distance between the store used as the basis for calculating expected or current profits and the prospective store location.

Reasons for immediate termination that are abstract or unclear and may cause disputes, such as spreading false information that clearly damages the franchisor’s reputation or credit, or leaking trade secrets or important information, have been deleted. Conversely, immediate termination is now possible after a court ruling confirms a violation of the law, and a new reason for immediate termination has been added for cases where the franchisee violates laws related to store operation and receives a court judgment.

However, the "urgent reasons for public health or safety hazards," which were intended to be deleted during the legislative notice, have been retained, with added requirements for "clarity and urgency" to enhance objectivity in immediate termination.

The criteria for judging the unfairness of contract renewal refusals have been specified. The Fair Trade Commission has defined refusal to renew a contract for the purpose of converting a franchise store into a directly managed store without justifiable reasons for the franchisor’s profit increase as a type of unfair contract renewal refusal. Additionally, discriminatory contract renewal refusals against specific franchisees and refusals to renew contracts before sufficient time has passed to recover costs borne by franchisees for store environment improvements are prohibited.

The amended enforcement decree will take effect immediately. However, the expanded disclosure document requirements will be implemented from January 1 of next year.

The Fair Trade Commission plans to revise the "Notice on the Standard Form of Franchise Business Transaction Disclosure Documents" to reflect the contents of the amended enforcement decree.

This content was produced with the assistance of AI translation services.