“To avoid lawsuits for difference in franchise fees, disputes must be minimized by reviewing the franchise agreement.”

Interview with attorney Kim Won-sang of Daeryun Corporate Legal Group Franchise Team
Expected increase in demand for franchise fee-related laws
Daeryun provides total care for ‘legal advice and financial accounting’

Recently, it became a hot topic as it became known that Pizza Hut Korea applied to the court to initiate rehabilitation procedures. This crisis for Korea Pizza Hut, a first-generation franchise, began when it lost a 'franchise fee lawsuit' filed by franchise owners.

The difference in franchise fee is a profit attached to the price of the product provided by the head office to the franchise, and is a type of 'distribution margin'.

The court ruled that it was unfair for the head office to unfairly impose the difference in franchise fee without the consent of the franchise owner. Pizza Hut Korea is currently going through the appeal process, and if the ruling is final, it will have to return about 21 billion won to the store owners.

The impact of this ruling appears to be spreading throughout the franchise industry. The controversy continues as other franchise owners are also known to be considering related lawsuits.

While this disruption in the industry is expected to continue for the time being, Daeryun Corporate Legal Group recently announced that it will take a preemptive response by strengthening its franchise team. In relation to this, we met and spoke with attorney Kim Won-sang, head of the Rehabilitation and Bankruptcy Center, who has direct experience participating in the Korea Pizza Hut lawsuit.

The following is a Q&A with Attorney Kim.

Q. The fact that Pizza Hut Korea lost a lawsuit over franchise fees is becoming a hot topic. What caused this lawsuit to start?

A.The store owners, who previously operated Pizza Hut as direct stores, converted to a franchise (chain store) format and reviewed their financial statements due to significantly lower profits than expected. As a result, it was discovered that excessive amounts of franchise money were being paid to the headquarters, and it appears that a lawsuit was initiated as legal relief was deemed necessary.

Q. Looking at this ruling, the court found that excessive franchise fees were being charged and sided with the franchise owners. What are the court's standards for making this decision?

A.The issue in this case is not whether the difference in franchise fee is received, but whether the basis for receiving the difference in franchise fee exists in the franchise contract. However, both the first and second trials judged that there was no such basis.

In particular, the second trial court said that the reason the Franchise Business Act related to differential franchise fees was revised was to make it clear that if there is a differential franchise fee, related agreements must be entered into the contract.

However, in this case, the franchise agreement and information disclosure document did not explicitly stipulate the difference in franchise fee. Meanwhile, in a similar case, the Supreme Court ruled that even if information unfavorable to the franchise owner was included in the information disclosure statement and was provided to the franchise owner before signing the contract, it cannot be considered incorporated into the franchise contract.

Furthermore, the second trial ruled that if the head office needs to compensate for the costs incurred in supplying raw and subsidiary materials, it is necessary to take steps to establish a basis, such as concluding a contract that reflects this or presenting cost calculation data to franchise owners to obtain consent.

Q. It appears that the issue of difference in franchise fees between the headquarters and franchise owners has been a common practice. So, it appears that this lawsuit will have a big impact. What do you think about the news that other franchise owners are also preparing a group lawsuit?

A.Considering the fact that the information stated in the information disclosure statement regarding the franchise fee difference is insufficient or cannot be considered to be incorporated into the franchise contract by itself, that the contract concluded between the headquarters and the franchise owner is highly likely to not have detailed provisions on the franchise fee difference due to the existing practice, and that franchise owners tend to switch from running directly managed stores, so they can know the details of profits and expenses, etc., franchise owners are unable to obtain sufficient information through a group lawsuit. It is expected that compensation will be received.

Q. On the other hand, some franchise companies responded with embarrassment. There are also concerns that the company could become embroiled in a class action lawsuit. How should headquarters respond?

A.First of all, franchise headquarters should not enter into poor contracts with franchisees. Calculation details for cost reduction or preservation must be explained to store owners in an easy-to-understand manner and then clearly stated in the franchise agreement to minimize the possibility of disputes.

In addition, it seems necessary to claim that the contents of the difference in franchise money were included by collecting detailed conversations with store owners at the time of signing the contract, receipts and tax invoices that can reveal the circumstances under which the franchise fee was received.

Q. So, conversely, what are the things franchise owners should pay close attention to when signing a contract with the head office?

A.For franchise owners, it is important to know what contract terms and conditions they were told by the head office when signing a contract, whether they were specifically introduced to the information contained in the information disclosure statement, and whether they were given an explanation of specific details during the franchise fee payment process. Therefore, if you have an information disclosure statement, franchise agreement, and a statement of franchise fees received from the head office, you will need those statements.

The head office has a professional understanding of the business and possesses sufficient important information. Also, since this is a group of experts who are skilled in finance and accounting, it is recommended that store owners seek help from experts such as lawyers. A detailed review of the franchise agreement is necessary to minimize disputes that may arise in the business, such as whether there are any violations of related laws and regulations regarding the franchise business, what the basic regulations are to guarantee franchise owners' profits, and the extent of predictable costs to be borne.

Q. As franchise owners and franchise headquarters are very interested in unfair practices, the demand for legislation is expected to increase. In line with this, Daeryun also said that it has strengthened the franchise team within the corporate legal group. What specific preparations are being made?

A. This lawsuit began with franchise owners carefully examining their financial statements. Considering this, the Daeryun Franchise Team provides legal analysis of franchise contracts and information disclosure statements to franchise companies based on the expertise it has accumulated through consulting on various corporate accounting, finances, and taxes. In addition, we provide consulting on the financial structure of franchise owners.

Q. What legal improvements do you think are needed to balance the responsibilities of the headquarters and protect the rights of franchisees in such disputes?

A. Franchise business is a business that anyone can easily start, so it has the characteristic of being independent of the type of industry. Therefore, we believe it is necessary for authorities to quickly improve regulations in line with the development of related industries.

Q. Lastly, is there anything you would like to say to those who are experiencing franchise-related lawsuits or disputes?

A. Legal litigation may seem far away, but when you become a party to a dispute, you are bound to be involved in the dispute for a long time, which has a significant impact on your daily life. Daeryun is a total care system that provides not only legal advice but also financial and accounting advice, and can provide sufficient help to both franchise owners and headquarters.

In particular, in the case of franchise owners, a quick solution is needed because it is a problem that directly affects their livelihood and money. Daeryun has the expertise to come up with an effective solution one step ahead of a dispute before it escalates, so please contact us to diagnose the problem.

[View full article]
Jose Ilbo - "To avoid lawsuits for difference in franchise fees... Disputes must be minimized by reviewing the franchise agreement" (Shortcut)
Segye Ilbo - To avoid lawsuits for franchise fees... “Disputes must be minimized by reviewing the franchise agreement” (Shortcut)