* * * * * BRIGHT HORIZONS IN INTERNATIONAL FRANCHISING * * * * * NEWS FROM AROUND THE WORLD: SOUTH KOREA AND INDONESIA 1.

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1 IBA/IFA 30 th ANNUAL JOINT CONFERENCE * * * * * BRIGHT HORIZONS IN INTERNATIONAL FRANCHISING * * * * * NEWS FROM AROUND THE WORLD: SOUTH KOREA AND INDONESIA 1 May 7, 2014 Chicago, Illinois U.S.A. Will K. Woods Baker & McKenzie LLP Dallas, Texas U.S.A. 1 The author wishes to acknowledge Icay Endahayu of Hadiputranto, Hadinoto & Partners, a member of Baker & McKenzie International in Jakarta and Sun Chang of Lee & Ko in Seoul for their guidance and the background materials provided in connection with the preparation of this paper.

2 1. South Korea Amendments to Fair Franchise Transactions Act The South Korea Fair Franchise Transactions Act (the Act ), which became effective on November 1, 2002, requires that franchise disclosure be provided to prospective franchisees in South Korea at least fourteen days (7 days if the franchisee consulted an attorney or licensed franchise dealer) prior to payment of a fee by the franchisee to the franchisor or the execution by the franchisee of a franchise agreement. The Act requires that the franchise disclosure document and certain ancillary documents be filed with the Korea Fair Trade Commission ( KFTC ), and the KFTC may reject or require changes to the disclosure if it does not contain the information required by the Act and the related regulations. The Act also includes certain regulations on the franchise relationship, including prohibitions on unfairly refusing to renew or extend the franchise agreement; unjust termination; unfair restraint on prices and on a franchisee s commercial counterparties; requiring a franchisee to purchase products or services in excess of the volume necessary to engage in the franchised business; and infringement on a franchisee s territory. On August 13, 2013, the South Korea National Assembly passed legislation that revised the Act in several significant ways that impact the franchise relationship, and the Presidential Decree that implements the Act was similarly revised (together, the Amendments ). Except as noted below, the Amendments became effective on February 14, Franchised Unit Upgrades Cost-Sharing Requirements The Amendments require that franchisors have just cause in order to require franchisees to upgrade or improve their franchised units. Just cause exists (a) when the facility or equipment of the franchised unit is objectively determined to be in a state of deterioration or (b) if there are health or safety issues at the franchised unit. Significantly, franchisors are now required to share in the cost of improvements to the franchised unit that the franchisor is permitted to require (20% of the costs if the improvement does not involve relocation or expansion of the franchised unit and 40% of the costs if relocation or expansion of the franchised unit is required). However, this cost-sharing requirement does not apply to improvements that the franchisee undertakes without being required to do so (or that are suggested ) by the franchisor or if the improvement is unavoidable due to the franchisee s acts or omissions that result in health or safety hazards. These requirements apply to franchise agreements entered into after the effective date of the Amendments as well as retroactively to those franchise agreements entered into before that date. 1.2 Territorial Protections The Amendments require that the franchisee s business territory (i.e., the territory in which a franchisee sells products or services in accordance with the franchise agreement) be explicitly set forth in the applicable franchise agreement and prohibit franchisors from establishing a franchised or company-owned unit for the same type of business as the franchised business within that area without justifiable reason. The Amendments define the same type of business as a business that would be considered the same as the franchised business based on the geographical region, class of consumers, products sold, and the type of the underlying business. Most concerning is the apparent practical effect of this requirement: that franchisor must provide the franchisee with some measure of territorial protection, even if its standard practice is not to do so. The definition of same type of business appears to give some flexibility to franchisors that wish to further expand under other brands or types of businesses, but there is certainly a need for further clarification on this point, particularly in relation to franchise companies that operate similar

3 businesses under different brands but target slightly different customers (e.g., the lodging and car rental businesses). This requirement of the Amendments will become effective on August 14, 2014 and will not be applied retroactively. 1.3 Provisions of Financial Performance Projections Contrary to the franchise disclosure regimes of most of other countries, the Amendments mandate that all franchisors (except small and medium enterprises, i.e., franchisors having fewer than 100 franchisees at the end of the immediately preceding fiscal year) provide projected revenue information to prospective franchisees. The projections must be accompanied by an explanation of the bases for determining such projections, and they must be provided in writing to prospective franchisees at the time that the franchise agreement is entered into. The projections must reflect the minimum and maximum projected revenue of the particular franchised unit during the first year of its operation. Although it has not done so yet, the KFTC may issue a standard form for the provision of financial performance projections that franchisors may use. Although this requirement is wrought with potential pitfalls for franchisors, we understand that the KFTC has taken the position that, if the projections made by the franchisor are ultimately not accurate, so long as the franchisor has made the projections objectively, the franchisor would not be deemed to have provided false or exaggerated information. 1.4 Required Business Hours The Amendments also prohibit franchisors from requiring franchisees to operated their franchised units during hours that may be deemed unreasonable under customary practices for the type of franchised business. Franchisees may obtain a reduction in their mandated business hours under certain circumstances, including illness of the franchisee that prevents the franchisee from operating during nighttime hours. These requirements apply to franchise agreements entered into after the effective date of the Amendments as well as retroactively to those franchise agreements entered into before that date. 1.5 Review of Certain Relationship Provisions In what may be cold comfort to franchisors given the onerous nature of the Amendments, the Amendments require that the KFTC conduct periodic reviews of certain franchise relationship aspects of the Act to assess their impact on and reasonableness vis-à-vis the franchise industry. 2. Indonesia Additional Regulations on Franchises Effective June 18, 1997, Indonesia adopted Government Regulation No. 16 of 1997, which requires franchisors to provide pre-sale franchise disclosure to prospective franchisees and imposes other requirements, including that the franchise agreement must in the Indonesian language, that the franchise agreement be governed by Indonesian law, and that franchisors include provisions in their franchise agreements encouraging the use of domestically produced goods or materials. The franchisor must also register the disclosure document with the Indonesia Ministry of Trade ( MOT ) and obtain a franchise business registration certificate (an STPW ). A series of additional regulations related to franchising began being issued by the MOT in August These regulations contain some unusual provisions that will impact franchisors operations in Indonesia. 2

4 The most significant of these regulation is Regulation No. 53/M-DAG/PER/8/2012 (the August 2012 Regulation ). The primary intent of the August 2012 Regulation is to protect local businesses and promote locally made products and broader involvement of other businesses in franchising in Indonesia. It also seeks to close perceived loopholes in other regulations where franchisees have been operating under non-modern store licenses, such as restaurant licenses, to avoid zoning and other requirements. A brief discussion of key provisions from the August 2012 Regulation follows. 2.1 Affiliates as Franchisees. The August 2012 Amendment states that franchisors are not allowed to grant franchises to franchisees that are directly or indirectly controlled by the franchisor. Consequently, affiliates cannot be appointed as franchisees. This will have an impact on certain multinationals operating in Indonesia, and prevents subfranchising arrangements with affiliates (which might otherwise be used by a group of companies to avoid certain other requirements under Indonesia s franchise regulations). 2.2 Local Content Requirement. As noted above, the original franchise regulations encouraged the use of domestic goods and/or products as long as such good/products met the quality standards required by the franchisor. Notably, the August 2012 Regulation goes much further: it requires that at least 80% of the raw materials and/or inventory used by the franchisee be locally made ("Local Content Requirement"). A description of sourcing and compliance with the Local Content Requirement must be made in the application for an STPW. The determination on local content is made at the time of application (and in respect of ongoing operations may become a condition of the STPW). Under the August 2012 Amendments, the MOT may grant an exemption from Local Content Requirement after a recommendation is given by an assessment team established by the Directorate General of Domestic Trade. In discussions that members of the author s firm have had with the MOT, the MOT has indicated that for goods such as luxury branded products, exemptions will be granted and that the Local Content Requirement is directed more at the food and beverage sector. However, policy implementation will provide further clarification. Additionally, according to the MOT, an assessment will be made based on a wide range of criteria, including the availability of local content, Indonesian employment, and corporate social responsibility commitments. Existing registered franchises will need to comply with the Local Content Requirement when seeking a renewal of the STPW. Franchisors must also appoint Indonesian small and medium enterprises, either as their franchisees or as their suppliers, as long as those enterprises meet the criteria set by franchisors. 2.3 Business Activities. Under the August 2012 Amendments, a franchised business must operate in accordance with the technical license granted to it (e.g., if the operating license is a convenience store license, its primary activity must be a convenience store, and if a restaurant license, then its primary activity must be a restaurant). Other merchandise/products, amounting to not more than 10% of the total goods sold, can be sold to support their core franchise business. This provision is intended to ensure that the underlying operating license is complied with and was introduced to prevent the perceived abuse of licensing in the convenience store sector. Franchisees, which may have structured operations to avoid zoning and other licensing requirements (such as the Modern Market Store licensing regime), will need to make an assessment of their business operations and whether they need to comply with licensing requirements. 3

5 2.4 Registered Franchise Logo. The August 2012 Amendments contemplate the issuance of a special logo to registered franchisors and franchisees to identify the franchised business. The MOT has indicated that its intention is for the logo to be displayed on all premises to indicate that the franchisee is an approved and licensed franchisee. 2.5 Franchise Termination. If a franchise agreement is terminated prior to its expiration, a franchisor may not appoint a new franchisee unless (i) the franchisor and the franchisee have reached an agreement settling all matters between them and a "clean break" agreement is issued certifying that neither party has any outstanding obligations or liabilities to the other party, or (ii) there is a final and binding court decision determining any dispute between the franchisor and the franchisee. The August 2012 Amendment does not provide for a specific time period to deliver the "clean break" agreement so until it is delivered no new franchise agreement can be registered and no new license can be issued. 4

6 WILL K. WOODS Will K. Woods is a partner in the Franchise and Distribution Group in the Dallas office of Baker & McKenzie LLP. He concentrates his practice in franchise and distribution law. He counsels clients on structuring international and domestic franchise transactions, distribution of products and services, and franchise registration and disclosure matters. He represents many of the leading hotel, lodging and hospitality franchise companies and has vast experience in negotiating complex franchise and licensing transactions both in the U.S. and in many other countries around the world and in counseling clients across industries with respect to system restructuring and related relationship issues. He is a frequent author and speaker on franchise and distribution related topics, and he has been listed in Chambers USA (Franchising) and Chambers Global (Franchising), has been named in Franchise Times Legal Eagles as one of the top 101 franchise lawyers in the US and Canada, has been listed in the International Who s Who of Franchise Lawyers, was named a Rising Star by Law and Politics, and has been named one of the Best Lawyers in Dallas by D Magazine. He is currently on the Governing Committee of the Forum on Franchising and is the Co-Chair of the Forum s annual meeting, which will be held in Seattle in October Mr. Woods received his BBA from Baylor University in 1994 and his JD, cum laude, from Baylor University School of Law in