This article is a contribution by Attorney Sanghoon Kim of Choi & Lee Law Firm. If you would like to share quality content for startups in the form of a contribution, please contact the Venture Square editor team at editor@venturesquare.net.
The franchise business is a business model that has grown based on stability and trust, and has developed mainly in the Korean food service industry, such as SPC (Paris Baguette, Paris Croissant, etc.) and BBQ. Despite the development of the franchise business, the controversy surrounding the differential franchise fee of the franchisor behind it is not a new issue in the Korean franchise industry. In 2016, 'Mr. Pizza' was suspected of collecting the so-called "cheese toll" by forcing franchisees to purchase essential ingredients such as cheese from a specific supplier at a high price, and in 2017, 'Barda Kim Seonsaeng' was embroiled in a controversy over making unfair profits by forcing franchisees to purchase sanitary masks and disinfectants.
The controversy over the franchise fee differential, which had been quiet since then, has recently become a hot topic again. In particular, the controversy has spread to the entire industry as franchisees of Pizza Hut Korea have filed a lawsuit demanding that the franchise headquarters return the unfair franchise fee they received. This incident is not simply a problem of one company, but rather reveals a structural problem that has been repeatedly raised throughout the franchise industry. In this article, we will examine the definition and characteristics of the franchise fee differential, whether it is legal to unilaterally impose this franchise fee on franchisees, and ways to respond to it.
1. Definition of difference in franchise fee and its use
The franchise fee differential refers to the profit generated from the difference between the price paid by the franchisee and the price at which the franchisor purchases the product when the franchisor supplies the product to the franchisee. This franchise fee differential has become a major source of profit in the Korean franchise business, and is particularly widely used in the food and beverage and retail industries. For example, the franchisor generates profit by providing the franchisee with ingredients that the franchisor has reduced in cost through bulk purchase and having the franchisee bear the reduced cost, or by distributing the franchisee's own brand products or products obtained through exclusive contracts at a higher price.
Since the franchise fee difference does not depend greatly on the sales performance of the franchise store from the franchisor's perspective, it provides the franchisor with a steady cash flow from the franchisee, and since the franchisor directly manages the products used by the franchise store beyond simply generating profits, it is widely used by franchisors to manage their brand image.
However, the differential franchise fee system can be a significant burden for franchisees. The structure of having to purchase products at a high cost from the franchisor even though the same product can be purchased at a lower price through other distribution channels is a major cause of the increased cost burden for franchisees. Furthermore, some franchisors operate the differential franchise fee policy in an opaque manner to pursue excessive profits, and this practice is pointed out as an example of making franchisees’ management more difficult.
Then, let's examine whether the franchisor can legally impose such a structure that is advantageous to itself and disadvantageous to the franchisee, and whether there is no way for the franchisee to effectively respond to this difference in franchise fees.
2. Legality of the differential franchise fee system
The difference in franchise fee is defined in Article 4, Paragraph 1, Appendix 1, Subparagraph 5, Item 2) of the Enforcement Decree of the Act on Fair Franchise Transactions (hereinafter referred to as the “Franchise Business Act”). According to the Enforcement Decree of the Franchise Business Act, the difference in franchise fee is stipulated in the information disclosure document that the franchisor provides to a franchisee prospective member as the price that exceeds the reasonable wholesale price among the prices paid to the franchisor for items supplied by the franchisor when the franchisor forces or encourages the franchisee to transact with the franchisor or a person designated by the franchisor in the course of operating the franchise business. Here, the Constitutional Court has ruled that the consideration exceeding the reasonable wholesale price refers to the profit obtained in relation to the items supplied by the franchisor when the franchisor forces or encourages the franchisee to transact with the franchisor or a person designated by the franchisor in the course of operating the franchise business (Constitutional Court, October 28, 2021, Decision of the Full Bench, 2019 Heon-Ma 288).
Simply put, the franchise fee differential refers to the profit that the franchisor obtains in relation to the items supplied by forcing or encouraging franchisees to transact with the franchisor or a person designated by the franchisor.
This differential franchise fee is a concept defined by law and is not illegal in itself. Therefore, the act of a franchisor forcing a franchisee to purchase a specific product and charging a differential franchise fee accordingly is also within the scope permitted by law.
3. Franchisee’s response to the differential franchise fee system
Franchisees are not completely unable to respond to the franchise fee differential from the franchisor. In response to the complaints of franchisees who have to purchase essential items from the franchisor but do not know the amount of the franchise fee differential imposed by the franchisor, the Fair Trade Commission revised the Enforcement Decree of the Franchise Business Act in April 2018 as a countermeasure.
Through this amendment, the Fair Trade Commission requires that the information disclosure document that the franchisor must prepare and provide to a franchisee prior to concluding a franchise agreement include the following: ① the franchisor’s average differential franchise fee payment amount, ② whether differential franchise fees are received by item, and ③ the upper and lower limits of the previous year’s supply price (store owner purchase price) for major items (items that account for the top 50% based on the total purchase price by item of all franchisees in the previous year).
In addition, as the revised Franchise Business Act goes into effect in July 2024, franchisors must include in their franchise agreements as well as in their information disclosure statements information related to essential items that they are forced to transact with specific businesses. In addition, as of December 2024, franchisors must consult with franchisees before changing transaction conditions related to essential items in a way that is disadvantageous to franchisees, such as expanding the range of essential items or raising prices.
The Franchise Business Act and the Enforcement Decree of the Franchise Business Act stipulate that franchisees are provided with sufficient information on essential items, and guarantee franchisees the right to prevent unfavorable adjustments related to the differential franchise fee policy through consultation with the franchisor. This is a legal device designed to enable franchisees to respond appropriately to the franchisor’s differential franchise fee policy, and can be considered an important protection device to secure the stability and fairness of franchisees’ management.
However, in reality, when a franchisee signs a franchise agreement with a franchisor, even if the content of the differential franchise fee is clearly stated in the contract, it is often the case that the franchisee is merely aware of its existence. It is not easy to clearly understand the specific calculation method or adjustment possibility of the differential franchise fee, or to negotiate with the franchisor to adjust it in a direction favorable to the franchisee. This is a problem that stems from the structure in which the negotiating power between the franchisor and the franchisee is not equal, and it leaves the question of how effectively these rights are actually guaranteed.
4. Conclusion
I think there are many readers who have signed a franchise agreement with a franchisor and are operating a franchise store or are planning to operate a franchise store in the future. The difference in franchise fee is recognized as a legal concept according to the Franchise Business Act and related laws, but in reality, the environment where franchisees can fully understand and adjust it is still insufficient. In order to avoid being in a disadvantageous position in the relationship with the franchisor when signing a franchise agreement, you should receive legal advice or use negotiation strategies to prepare to negotiate on an equal footing with the franchisor, so that you can sign a more stable and fair contract.
- See more related columns
You must be logged in to post a comment.