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Rain falls on just and unjust alike in South Korea, as in everywhere else


Philip Zeidman

Illustration by Jonathan Hankin

A year ago I wrote in this space about the continuing upheaval in franchise relations, government regulation and private disputes in South Korea. Since then the flow of proposals to increase regulation seemed to have slowed somewhat. Many franchisors have assumed that the roiling waters have now calmed.

Not so fast. Many of the developments since that column echo the themes raised a year ago.

Inequality, and concerns about it, can have unintended side effects. The rewards of the Korean economy are heavily slanted toward those at the top, much the same as the recurring refrain we hear in American politics. The clamor for recalibration has found its way into franchising.

That movement and a number of judicial decisions are taking place on a playing field sharply favorable to franchisees. And that environment must be taken into consideration by franchisors entering from abroad, even those whose practices are free of the taint at which these measures and decisions are directed.  

An example: Efforts to reserve certain rights to small and medium-size businesses clearly disadvantage many U.S. companies seeking to enter the market.

Abuse of franchisees can reverberate. This allegation recurs throughout the discussions of franchising in recent years. Recent examples include the Korean Fair Trade Commission’s fining of a prominent franchisor for violating the obligation to share with its franchisees the burden of renovating their stores (a governmental obligation that itself reflects the government’s unusually intrusive involvement in the workings of the franchised relationship).

Outrage was heightened by the fact the company only the month before had made a public vow to share its profits with franchisees. The company’s largest shareholder, an American private equity firm, thus finds itself drawn into the dispute and its after-effects, and is now having difficulty exiting.

In a similar intervention in a franchisor’s affairs, a Seoul court probed the employment practices by Paris Baguette (French name, but Korean owned, and now expanding in the United States).  Also, Korean franchisees have challenged Subway contract provisions before the commission’s Mediation Agency, and the association has called the terms unprecedented.

So widely shared is the concern about the disparity of bargaining power between the franchisor and the franchisee that the term “gapjil” (the conduct of a party who asserts dominance over another by abusing its position) has begun to be applied routinely to franchising.

A string of allegations

Perhaps the most contentious area of the relationship is that of franchisor-imposed purchasing requirements. This issue, present in many relationships, takes on heightened importance in South Korea because the majority of franchisors do not charge a royalty and thus rely almost entirely on the mark-up they make on goods purchased by the franchisee.

This has led to a seemingly endless string of well-publicized allegations of coercion, forced purchasing, unreasonable profits and the like. A number of judicial decisions have dealt with this problem and the legislature has reacted. Earlier this year the National Assembly promulgated an amendment to expand the scope of disclosure so that prospective franchisees will receive information on the mark-ups, the average charged by the franchisor in the previous year, and minimum and maximum market prices of certain mandatory purchase items.

In addition, the franchisor must make disclosures as to any related companies engaging in selling these products, and their sales revenue, and payments or benefits accruing to franchisors from designated suppliers and distributors. It is a safe bet this will be a fertile area for disputes in the future.

Bad behavior by insiders

Franchise disputes, and litigation or legislation dealing with them, involve the franchisor entity itself. Where franchisor executives join the dramatis personae, it is typically when they are alleged to be the agents through which some action of the franchisor is implemented.

In South Korea, franchisor insiders are alleged to have assumed another and quite different role: that they engage in embezzlement and mistreatment, facilitated by their positions of authority; that they divert the benefits of what we would think of as “corporate assets” (by, for example, registering trademarks in their own names, a practice now requiring a showing of justification); that they appropriate favorable locations to themselves or their families, and the like. I have written about this distasteful aspect of Korean life, the privileged lives of the “princelings,” but it seems to have persisted despite efforts to limit or eradicate it, and it is responsible for an outsized share of franchising’s bad publicity.

The Korean Franchise Association has been drawn into many of these disputes, and has struggled with how to handle them. Most recently, it acknowledged the serious abuses afflicting the industry, apologized for “unfair business practices” and vowed to “reform” the way franchisors do business. But the government and the press criticize these efforts as “vague promises.” One senses the association is still seeking to find its most effective role.

And how all this can affect even those who are pure in heart. The indigenous franchise community has always been unstable, with a good deal of turnover. And the current uneasiness has taken its toll: last year one sixth of the association’s members closed their doors.

Incoming U.S. franchisors, even those with the cleanest of hands, can expect to confront some skepticism (“the rain falls on the just and unjust alike”). And this is a useful reminder beyond Korea itself: bad conduct can provoke what may be disproportionate public and governmental reaction.

Philip Zeidman is a partner in DLA Piper’s Washington, D.C., office. Reach him at 202.799.4272 or philip.zeidman@dlapiper.com.

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