In June 2024, the Korea Fair Trade Commission (“KFTC”) issued a set of Guidelines on the Method for Specifying Mandatory Purchase Items in Franchise Agreements (“Guidelines”). The new Guidelines aim to facilitate the implementation of a related amendment to the Fair Franchise Transactions Act (“Amended FFTA”), which was carried out as part of the KFTC’s plan to improve customary practices in the franchise industry regarding mandatory purchase items (i.e., items designated by franchisors that are required, as an ongoing obligation, to be purchased by franchisees from the franchisor or from a third party).
In particular, the Guidelines explain how to specify in franchise agreements the list of mandatory purchase items and the method for determining the supply price of each item, which are information franchisors are required to include in new agreements as well as agreements that are being renewed, as per Article 11 (2) 12 of the Amended FFTA (which became effective on July 3, 2024). The Amended FFTA also requires franchisors to update existing franchise agreements by January 2, 2025. Failure to satisfy these new obligations may result in the KFTC issuing a corrective order or imposing an administrative fine in accordance with the Amended FFTA.
A summary of the key details of the Guidelines are as follows.
Key Details of the KFTC’s Guidelines for Specifying Mandatory Purchase Items in Franchise Agreements
|
(1)
|
Detailed list of mandatory purchase items
Mandatory purchase items refer to items (e.g., real estate, services, facilities, products, raw ingredient/materials, supplies, leases) designated by franchisors that are required, as an ongoing obligation, to be purchased by franchisees from the franchisor or from a third party.
Under the Guidelines, franchise agreements should specify the full list of mandatory purchase items, the reasons for their designation, the party from which each item should be purchased, reasons for making changes to the list and the frequency of such updates. In particular, the list should include details of each mandatory purchase item, including the product/service type, and specifications of such item.
|
|
(2)
|
Supply price calculation method
While acknowledging the difficulty in specifying a fixed method for calculating the supply price of mandatory purchase items, the Guidelines set forth the appropriate method for the same based on the principle that a franchise agreement should offer prospective franchisees a minimum level of predictability regarding how the supply price is set and changed. It also serves as a safeguard against the franchisor unilaterally and substantially raising supply prices.
Accordingly, franchise agreements should specify the supply price of every mandatory purchase item, the base date/time and criteria for setting the supply price, and reasons for and frequency of making changes to the supply price. Further, franchise agreements should also provide distinct criteria for setting and adjusting the supply price depending on the item’s supply method, whether the items are (i) directly manufactured by the franchisor (including, through subcontractors), (ii) initially purchased by the franchisor and then resold to franchisees, and (iii) supplied by a designated third party.
|
Examples of Different Criteria for Setting the Supply Price by Supply Method
|
Supply Method
|
Sample Criteria for Setting/Changing Supply Price
|
|
Items Directly Manufactured by the Franchisor (including, through subcontractors)
|
-
The supply price is the sum of the direct manufacturing costs (e.g., for purchasing raw materials), indirect manufacturing costs (e.g., for R&D, labor, electricity, logistics), selling and administrative expenses, and a profit margin of between OO% and OO%.
-
The supply price is determined so the production cost rate (i.e., rate of productions costs as a percentage of the supply price) does not exceed OO%.
-
The supply price is the sum of direct and indirect manufacturing costs, and a profit margin for the franchisor. Changes to the supply price are made less than OO times per year, and each time, the change shall not exceed OO% of the current supply price.
|
|
Items Purchased by the Franchisor and Resold to Franchisees
|
-
The supply price is the sum of the purchase price of the franchisor, selling and administrative expenses (“SG&A”) and a resale margin of up to OO%.
-
The supply price shall not exceed OO% of the market price of the same product.
|
|
Items Supplied by a Designated Third Party
|
-
The supply price includes a profit margin of OO% for the supplier, and is determined so that the production cost rate for the products sold by the franchisees does not exceed OO%.
-
The supply price is determined through negotiations between the franchisor and the supplier, and shall not exceed OO% of the market price of the same or similar products.
|
|
(3)
|
Base date for calculating the supply price, reasons for and frequency of making changes to the supply price or its determination criteria
Under the Guidelines, the supply price for all mandatory purchase items should be specified at the time of signing a new agreement. Any subsequent adjustments to the supply price must be explicitly detailed in the agreement, along with the effective date of the change.
Although it would be difficult to specify the reasons for and the frequency of making changes to the criteria for setting the supply price, franchise agreements should at least specify the circumstances under which such changes could be made (e.g., changes in production costs or logistics costs), and, if appropriate, the expected frequency of such changes.
|
|
2.
|
Use of Point of Sale (“POS”) System and Examples of Improper Listing of Required Information
|
|
(1)
|
Use of franchise POS system
According to the Guidelines, the franchisor may specify the list of mandatory purchase items and their supply price calculation method either in the main body of the agreement or as annex to the franchise agreement, or specify the required information in a notification on the franchise POS system (or similar electronic medium) with a provision in the franchise agreement to refer to such notification.
|
|
(2)
|
Examples of improper listing of required information
To further clarify the intent of the Amended FFTA and prevent the use of unclear terms as a mere formality in franchise agreements, the Guidelines also provide the following examples of how not to specify mandatory purchase items or their supply price calculation method in a franchise agreement.
|
Examples of Improper Listing of Required Information
|
Category
|
Examples of Improper Listing of Required Information
|
|
Types of Mandatory Items
|
-
Listing only broad categories (e.g. sauces, beverages) instead of specifying each mandatory purchase item
-
When listing the required information through the franchise POS system, failing to clearly differentiate between mandatory purchase items and other items, thus creating confusion for franchisees in identifying which items are mandatory purchase items.
|
|
Supply Price Calculation Method
|
-
Failure to mention any criteria for determining the supply price of mandatory purchase items.
-
When the listed criteria allows the franchisor to make a significant change in the supply price at its own discretion, and thus fails to serve as a control to prevent the franchisor from unilaterally and significantly increasing the supply price (e.g., “the price may be adjusted at franchisor’s discretion”).
|
[Korean Version]
