By Kent Wong, Senior Foreign Attorney (Partner) at APEX LLC
Korea’s franchising industry has rapidly developed in recent years, led primarily by fast food restaurant chains. This growth has expanded to include family restaurants, retailing and retail stores, hotels, clothing, mailing services, cleaning services, as well as educational institutions.
There are no specific legal requirements for overseas franchises to operate in the Korean market, nor is there a requirement for government approval with respect to international franchise agreements. However, franchisees need to comply with various Korean laws, including the Korean Civil Act and Korean Commercial Code, the Fairness in Franchise Transactions in Franchise Business Act (Franchise Act) and the Sub-franchisee’s Fair Trade Act (which closely parallels the rules that exist for sub-franchisees in the US). Below is an overview of some of the questions commonly faced by international franchisors and foreign investors looking to enter the Korean market.
Legal definition of a franchise
Under the Fairness in Franchise Transactions in Franchise Business Act (Franchise Act), a ‘franchise’ is defined as:
... a continuous business relationship in which the franchisor allows the franchisee to sell goods (including raw and auxiliary materials) or services under certain quality standards and business methods using its trademarks, service marks, trade name, signs and other business marks (collectively, “Business Marks”), and supports, educates and controls the franchisee with regard to relevant management and operating activities, and in which the franchisee pays franchise fees to the franchisor in return for the use of the Business Marks and the support and education concerning the management and operating activities.
Laws governing the offer and sale of franchises
The Franchise Act, which was enacted on 1 November 2002 and most recently amended on 3 August 2007, and its accompanying Presidential Decree, taking effect on 6 November 2002 is the primary statute applicable to the franchisor-franchisee relationship. Additionally, the Monopoly Regulation and Fair Trade Act (MRFTA) and regulations promulgated by the Korea Fair Trade Commission (KFTC) are generally applicable to the relationship. Notable are the KFTC’s 1997 Guidelines on International Contracts which remain in effect and could potentially impact the franchisor-franchisee relationship where one of the parties is not a Korean resident.The KFTC regulates franchises in Korea. The KFTC has a franchise-related department and has the authority to impose administrative measures against those who engage in unfair activities.
Forms of business entities
A chusik hoesa (stock company) and a yuhan hoesa (limited liability company) are the business forms in Korea that would be relevant to the typical franchisor. About 90% of all Korean companies are chusik hoesa, which are similar to American stock companies. Only this legal entity, plus occasionally yuhan hoesa, is recommended for foreign investors and businesses.
Laws and agencies which govern the formation of business entities
Primarily, the Korean Civil Act and Korean Commercial Code govern the formation of business entities. In addition, the Foreign Investment Promotion Act relates to the formation of business entities from foreign investment.
The Korean Court Commercial Registrar, National Tax Service and Ministry of Strategy and Finance are the main agencies that have authority relating to the formation of business entities.
Methods of establishing a franchise
A foreign franchisor intending to expand their franchise in Korea may consider a variety of methods. While a single unit franchise or area development franchise is occasionally used, the more popular method is to use a master franchise arrangement. In Korea, international franchising typically entails a foreign ‘master franchisor’ working with a domestic ‘master franchisee’. Master franchisees can either be a 100% subsidiary of the master franchisor or a joint venture company with a local partner; a pure Korean company may also become a master franchisee. The master franchisee then relies on “sub-franchisees” for running the franchise outlets, which are either directly owned and operated by a master franchisee or owned and operated by an independent person or entity – ‘a pure sub-franchisee’.
Tax for foreign business and individuals
The principal taxes affecting businesses in Korea include corporate tax, individual income tax, value added tax, customs duties and inhabitant and education tax levied on corporate tax, income tax and other taxes.
The franchisor has a duty to pay taxes (corporate tax or individual income tax) on royalty incomes. However, the tax rates are limited to the rate stipulated in the tax treaty between Korea and the state in which the franchisor resides. In this regard, the franchisee has a duty to withhold such taxes from the royalties it pays to the franchisor.
Relevant labor and employment considerations
Under the Korean Civil Code, an employer is liable for a tort committed against a third party by an employee who is under the employee’s actual direction or supervision, in relation to the performance of a work that is directed or supervised by the employer. Therefore, if a franchisee or an employee of a franchisee is deemed an employee of the franchisor, the franchisor may be held liable for damages to a third party caused by the franchisor or the employee of the franchisee during performance of his or her work.
About the author Kent Wong is a senior foreign attorney and partner at Apex Law LLC, based in its Seoul office. Kent handles a range of corporate and commercial matters, with a particular emphasis on investment and doing business in Korea. Kent undertakes domestic and international private equity work in addition to general M&A, corporate and corporate finance transactions and advisory mandates. He has published articles and given lectures on foreign investment, project financing and international tax regimes.