The South Korea Fair Trade Commission (“SKFTC”) recently imposed the maximum possible penalty—1.9 billion won (approximately US$1.88 million)—on a South Korean franchise for violating the Fair Transactions in Franchise Business Act (the “Act”).  Caffe Bene, a company with over 1,860 stores in fourteen countries and valued at 176.2 billion won (approximately $171 million), incurred the fine for passing disallowed costs on to its franchisees.

The penalty—the largest ever imposed by the SKFTC—demonstrates its intent to aggressively pursue Act violations and comes soon after major amendments to the Act early this year.

Copyright: monkeydluffy123rf / 123RF Stock Photo
Copyright: monkeydluffy123rf / 123RF Stock Photo

The violation stemmed from a partnership inked between Caffe Bene and KT Corporation (formerly Korea Telecom; “KT”).  The agreement offered 10% discounts to KT subscribers and split the costs equally between Caffe Bene and KT.  Despite opposition to the promotion by 40% of its franchisees, Caffe Bene forced its franchisees to implement the promotion and absorb the losses.  According to the SKFTC, Caffe Bene’s actions violated by the Act and its franchise agreements, which allocated marketing and promotion costs equally between Caffe Bene and its franchisees.

The SKFTC’s investigation further revealed that Caffe Bene required franchisees to redesign their stores, pay for “necessary equipment” from headquarters or a designated third-party, and purchase items that the franchise agreements designated as “optional.”  These practices generated 181.3 billion (approximately $176 million) in interior remodeling and equipment sales to franchisees between November 2008 and April 2012, accounting for nearly 56% of Caffe Bene’s total sales during that period.

This case is clearly an egregious case because the SKFTC’s findings were that the franchisor violated both the Act and its own franchise agreements. That said, it also highlights the risk/reward inherent in international franchising. We’ve all heard it before, but it bears repeating:  the failure to work with experienced local counsel, whether you are a domestic franchisor going abroad or an international franchisor coming to the United States, is dangerous. Here, it appears that significant changes to the South Korean Act were missed. While good counsel does not ensure success, it definitely helps to manage that risk.