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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[Answer]

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.

1. 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.

2. 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).

3. 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:

   1. Real estate, services, equipment, goods, raw materials, or auxiliary materials are objectively recognized as essential for managing the franchise business.

   2. 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.

   3. 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).

4. 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.

Cheongchul Law Firm consists solely of attorneys from Korea's top five law firms, including Kim & Chang, Bae, Kim & Lee, Lee & Ko, Shin & Kim, and Yulchon, and is composed of specialized attorneys relevant to each case rather than a single attorney. Cheongchul provides comprehensive solutions for businesses beyond merely resolving specific issues, focusing on ultimately achieving what the clients desire. If you need assistance in achieving your goals, please do not hesitate to reach out to Cheongchul.

[Fair Trade, Agency Law] Sanctions by the Fair Trade Commission against the Headquarters' Improper Interference in Agency Management

Hello, this is Attorney Eom Sang-yun from Cheongchul Law Firm.

Recently, the Fair Trade Commission imposed corrective orders against a tire supplier for improperly interfering in the management activities of its agencies. This action serves as a wake-up call to suppliers (headquarters) that use their superior trading position to restrict the autonomous management activities of agencies, providing important implications for agency contracts and operations.

[Violations of Agency Law Targeted by the Fair Trade Commission]

The main legal violations identified by the Fair Trade Commission include the following:

1. Demand for Agency Sales Price Information: The supplier required all agencies, without reasonable grounds, to input sales price information of products sold to consumers into a computerized program developed and provided by the headquarters. The sales amount of the agencies is a core business secret directly linked to margins (selling price - supply price), and if this is exposed to the headquarters, the agencies may find themselves in a disadvantaged position in future supply price negotiations. The Fair Trade Commission judged this as an improper demand for information.

2. Limitation on Sources of Consumables: The supplier restricted certain types of agencies through a trade contract to procure consumables, such as batteries, filters, and wipers, only through specific suppliers designated by the headquarters. If agencies wanted to procure consumables from sources other than those designated by the headquarters, they were required to obtain prior approval, and the contract even specified provisions allowing for the suspension of supply of certain products in case of a violation, infringing on the autonomy of the agencies.

[Criteria for Judging Improper Interference in Management Activities under Agency Law]

The Fair Trade Commission deemed that actions of the kind described above fall under the 'acts of interfering in management activities' prohibited by Article 10, Paragraph 1 of the Act on the Fairness of Agency Transactions.

Act on the Fairness of Agency Transactions (hereinafter referred to as “Agency Act”)

Article 10 (Prohibition of Interference in Management Activities)

① Suppliers shall not engage in behaviors that improperly interfere with the management activities of agencies by abusing their superior trading position or allow affiliated companies or other businesses to do so.

Enforcement Decree of the Act on the Fairness of Agency Transactions

Article 7 (Types or Standards of Interfering in Management Activities) Acts prohibited under Article 10, Paragraph 1 of the Act are defined as any of the following:

1. (Omitted)

2. Demanding that agencies provide information related to trade status, sales details, etc., that constitutes business secrets without reasonable grounds

3. Unilaterally determining and requiring agencies to comply with their customers, operating hours, sales areas, promotional activities, etc.

4. (Omitted)

The Fair Trade Commission found that the supplier improperly interfered in the management activities of the agencies by abusing their superior trading position. In particular, Article 7 of the Enforcement Decree of the Agency Act specifies the types of prohibited acts of interfering in management activities, and this case corresponds to the following types.

• Demand for Business Secret Information Without Reasonable Grounds (Enforcement Decree Article 7, Clause 2): The demand for agencies' sales price information, which constitutes a business secret, was made without a reasonable reason.

• Unilaterally Determining Customers and Requiring Compliance (Enforcement Decree Article 7, Clause 3): The headquarters unilaterally designated and restricted suppliers that agencies should autonomously decide.

[Implications and Precautions]

This decision by the Fair Trade Commission clearly shows that suppliers (headquarters) requesting sensitive sales price information from agencies or restricting the sources of other items (consumables, etc.) beyond the main products they supply may fall under improper management interference according to the Agency Act.

According to the Agency Act, agencies enjoy the autonomy of management activities as independent businesses, and headquarters must be cautious not to improperly intervene in key management decisions such as price setting and customer selection of the agencies by abusing their superior trading position.

The supplier voluntarily rectified the problematic contract clauses and made system modifications after the Fair Trade Commission opened an investigation. However, just because they self-corrected afterward does not mean that the violations themselves disappear. Therefore, it is advisable for suppliers (headquarters) to regularly check that the content and operation mode of agency contracts do not violate the Agency Act and to ensure not to infringe upon the management autonomy of the agencies.

Cheongchul Law Firm consists solely of attorneys from South Korea's top five law firms (Kim & Chang, Bae Kim & Lee, Pacific, Sejong, and Yulchon) and from corporate legal teams of large companies, with attorneys specializing in relevant fields forming teams for each case rather than a single lawyer handling matters. Cheongchul offers comprehensive solutions beyond resolving specific issues, focusing ultimately on achieving what the client desires. If you need assistance in achieving your goals, please feel free to contact Cheongchul.