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Over South Korea, a cloud, even if not of the mushroom variety


Philip Zeidman

Illustration by Jonathan Hankin

The headlines are filled with the rapid developments in the steadily deteriorating relationship between the U.S. and North Korea. By the time this column has been published the alarm could subside—or it could have accelerated into one of the most perilous and threatening periods in our lifetime.

There is something incongruous in moving from that dire observation to a discussion of more mundane matters.  But (one hopes) life goes on and with it, franchising.

Just across the demilitarized zone is South Korea. And, as one who has had the chilling experience of peering across it, I can attest to the fact that the two countries are, if not literally a stone’s throw apart, not that much further.  Within easy range of North Korea’s destructive powers reside metropolitan Seoul of 25 million people (the equivalent of Texas).  

There are few places in the world that are more active generators of economic activity ($1.5 trillion gross domestic product). And a not insignificant amount of that activity relates to franchising (estimated at $100 billion, employing 7 percent of the population).

All of which makes the legal, social and political climate as important to franchisors eyeing the South Korean market as its economic appeal.

First to regulate

The country was the first in Asia to specifically regulate franchising, albeit it started out in a limited fashion and on a largely voluntary basis. In its current situation it extensively regulates both disclosures and relationship aspects. Beyond the law itself, the larger environment has become steadily more volatile and stifling, especially to international companies.

Consider the intrusiveness of the government into such business decisions as the location of a new unit (prohibited from being closer than a certain distance from an existing operation). Or consider the requirement that effectively imposes a 10-year minimum term on franchise agreements. Or take a look at the prohibition under some circumstances from refusing franchisees’ requests to reduce operating hours.

Much of that is due to the wide dissatisfaction with activities among indigenous (and mostly small) Korean brands: sexual harassment by a founder, leading to boycott; forced purchasing of overpriced items from a relative of the founder; favors to family members, to the detriment of others; abuse of franchisees, sometimes blatantly; openly copycat brands; the quick disappearance of low-profit operations.  

This unseemly disarray has prompted industry leaders, while nominally urging “promotion more than regulation,” to call for government actions such as requiring operations of a company-owned store for a period of time before offering franchises, or requiring a royalty structure rather than profit through sales of ingredients.

Now the Korean Fair Trade Commission seems to be moving not only toward greater disclosure and revocation of the right to do business by franchisors who falsify information, but also to stringent controls to protect franchisees from “mistreatment,” including required compensation for certain losses, compensation plans written into contracts, and the like.

While it is far from certain that all of the proposed legislations and regulations will be adopted, some of them will. These reactions may be appropriate in the context of the local franchise community but they have almost nothing to do with the typical cross-border franchisor.

Consider the 2014 retroactive amendment to the Korean Franchise Law, prohibiting a requirement of remodeling or renovation in the absence of “just cause,” and even in the presence of that elusive circumstance, obligating the franchisor to share in certain costs, varying from 20 to 40 percent.

Some of these steps are clearly motivated by social and political concerns, including protectionism, with franchising serving as a convenient scapegoat. Some are simply examples of micromanagement by government bureaucrats over legitimate business decisions.

Others may be appropriate in the context of overbearing single-owner or family operations, but not in the case of international systems operating in Korea that have very sophisticated Korean franchisees.

What can be done about this distinctly unsatisfactory state of affairs? The Korean government has not exhibited much receptivity to the views of others. But the stakes are higher now, as the Korean Fair Trade Commission has franchising in its sights, and draft revisions to the franchise act are in the offing. So clearly some action should at least be considered—for example, in the case of remodeling or renovation—by the respectful but vigorous initiative of large multinational franchisors.

Perhaps the most thoughtful approach is to take a hard look at the profile of the typical South Korean franchisee of a cross-border franchisor: quite likely larger, more experienced and more sophisticated than the franchisor itself, and thus less in need of the protections steadily being extended by the long and intrusive hand of the law.

If the South Korean authorities were willing to engage in reasonable discourse about the imbalance between the legitimate needs of South Korean franchisors and the layers of legal protection afforded them, some progress could be made.

Consider, for example, advancing a proposal for exempting such relationships from the Korean Franchise Law and the myriad other regulations now cropping up like mushrooms after rain—perhaps along the lines of the sophisticated franchisee and/or large investment exceptions under U.S. law.

In the final analysis, of course, South Korean authorities will not be persuaded by logical arguments alone. What may convince them is a demonstration of the truly significant effect on the South Korean economy of a withdrawal from that market by international franchisors who opt for more welcoming environments.  

At a time of existential threats to the country, one would think them ill-advised to put further barriers in the path of inbound economic investment.

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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