Hello, this is attorney Kim Kwang-sik from Cheongchul Law Firm.
Franchising is a business model that grows based on trust between the franchisor and the franchisee. To this end, the franchisor establishes certain standards and operating policies, but during this process, issues may arise where the autonomy of the franchisee is excessively restricted. To prevent this, the "Act on Fairness in Franchise Transactions (Franchise Act)" regulates various unfair trading practices, and particularly imposes strict prohibitions on 'conditional trading acts.' In this article, we will specifically examine the significance and legal basis of conditional trading acts, their main types, standards for determining illegality, and practical issues.
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A conditional trading act refers to acts in which the franchisor unjustly restricts the business activities of the franchisee or imposes specific trading conditions. Article 12(1)(2) of the Franchise Act prohibits "acts that unjustly bind or restrict the price of goods or services handled by the franchisee, the counterparty, the trading area, or the business activities of the franchisee," and the same law’s enforcement ordinance Article 13(1) and [Appendix 2] specify the detailed types and criteria for judgment of conditional trading acts. These regulations are intended to prevent franchisors from infringing upon autonomy under the pretext of maintaining brand uniformity and quality, which we will examine in detail below.
Specific Types of Conditional Trading Acts
Conditional trading acts can be broadly categorized into four types.
First, restrictions on prices. This refers to acts of unreasonably setting the price of goods or services sold by the franchisee and forcing them to maintain that price, or unduly binding the franchisee's freedom to set prices. This includes cases where the franchisor unilaterally determines the prices of goods or services sold by the franchisee or unjustly restricts their freedom to determine prices. The court recognized that forcing the franchisee to maintain the basic delivery fee at 0 won without defining the mandatory period, cost-sharing by the franchisor, or exceptions in an agreement with a special provision on the franchise agreement, constitutes price restrictions prohibited by the Franchise Act (Suwon District Court case 2023Gadan568009).
Second, restrictions on trading counterparts. This refers to acts that unjustly force the franchisee to trade with a specific counterparty (including the franchisor) related to the purchase, sale, or lease of real estate, services, equipment, goods, raw materials, or auxiliary materials. A prominent example is when the franchisor designates a particular trading partner and prevents the franchisee from using other suppliers. The court has previously judged a case where a chicken franchise franchisor forced franchisees to produce flyers only through a specified company as a restriction on trading counterparts (Seoul High Court case 2021Nu52572).
Third, restrictions on trading areas. This refers to acts of establishing directly managed stores or franchise stores of the same industry as the franchisee within the franchisee's business area without justifiable reasons, or limiting the franchisee's trading area without justifiable reasons, and establishing directly managed stores or other franchises in that area. Such acts can severely infringe upon the business freedom of the franchisee.
Fourth, restrictions on business activities. This occurs when the franchisor unjustly restricts business operations related to working hours, days, marketing methods, etc. This can severely hinder the management freedom that a franchisee can have as an independent business operator.
Criteria for Determining Illegality of Conditional Trading Acts
Whether a conditional trading act violates the Franchise Act is judged primarily based on 'unfairness,' and regarding the general criteria for judgment, the court stated, “Its legal effect should not be judged abstractly and uniformly, but should be determined individually in consideration of the legislative intent and nature of the Franchise Act, the content of each prohibition, the degree to which the act violated the Franchise Act, and the degree of confusion caused in the legal relations if it is rendered void,” indicating that this method of individual assessment is appropriate (Suwon District Court case 2023Gadan568009).
More specifically, regarding the judgment of unfairness in restrictions on trading counterparts, it is determined whether the act of forcing franchisees to purchase promotional materials such as advertising flyers only from themselves or specific counterparts constitutes unfair trading counterpart restrictions, considering various factors such as the content of the franchise agreement, the payment method of franchise fees or purchase prices, general trading practices in the same industry, the necessity to maintain a uniform image of the franchise business and protect the franchisor's trademark rights or maintain the uniformity of goods or services, and whether it was informed to the franchisee through an information disclosure document prior to concluding the contract that they must trade with a specific trading counterpart (Seoul Central District Court case 2023Na40122).
Exceptionally Allowed Conditional Trading Acts
The enforcement ordinance of the Franchise Act [Appendix 2] Article 2 (2) stipulates situations where restrictions on trading counterparts are exceptionally allowed as follows:
Real estate, services, equipment, goods, raw materials, or auxiliary materials are objectively recognized as essential for managing the franchise business.
It is objectively recognized that if there is no trading with a specific trading counterpart, it would be difficult to protect the franchisor's trademark rights and maintain the uniformity of goods or services.
The franchisor must inform the franchisee of the relevant fact in advance through an information disclosure document and conclude the contract with the franchisee.
In practice, the court has ruled that requiring franchisors to conduct advertising only through specific companies constitutes an exceptional allowed reason, considering that ① advertising is essential for managing the franchise business, ② there is a need to unify advertising responsibility to secure a uniform image for the franchise business, and ③ the fact that a specific company handles the franchise's advertising is stated in the information disclosure document and franchise agreement (Seoul Central District Court case 2023Na40122). Moreover, in the case of a franchisor requiring the franchisees to source meat exclusively from a designated supplier, it has been judged that given the importance of maintaining identical quality of meat among franchisees, such a requirement could be significantly justified (Seoul High Court case 2018Na2021119).
Conclusion: Practical Implications of Regulating Conditional Trading Acts
As can be seen through the Franchise Act and related cases examined above, the regulation of conditional trading acts is a key mechanism to maintain balance between franchisors and franchisees. While franchisors may seek to achieve legitimate purposes of maintaining brand image and quality, they should also operate cautiously without infringing upon the management autonomy of franchisees.
In particular, when it is necessary to designate essential items or restrict trading counterparts, they must ensure transparency through prior information disclosure and clear contract documentation, and restrictions can only be justified if there are specific and reasonable grounds.
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