[Noteworthy Ruling] Franchise Owner Who Canceled 86 Orders Due to Financial Hardship Exempted from Penalty with Legal Aid

A small franchise owner who was unable to purchase food ingredients due to financial difficulties and consequently had to cancel multiple orders, resulting in the termination of their franchise agreement by the franchisor (hereafter referred to as the company) and a subsequent claim for damages, has been exempted from paying a penalty thanks to legal assistance from the Korea Legal Aid Corporation (Chairman Kim Youngjin, hereafter referred to as the Corporation).

According to the Corporation on June 17, Judge Jo Miok of the Jeonju District Court dismissed all of the company's claims the previous day in a damages lawsuit in which a franchise company sought 20 million won in penalties from a young franchise owner, ruling in favor of the defendant.

Korea Legal Aid Corporation. Yonhap News

Judge Jo explained, "The penalty clause cited by the company pertains to penalties in cases where the franchise agreement is terminated by mutual consent during the contract period. Therefore, it is difficult to consider that this clause applies to this case, where the company is seeking damages for terminating the franchise agreement due to the franchise owner's breach of contract obligations."

The franchise owner, who was operating a franchise restaurant under a contract with the company, was unable to purchase food ingredients on time due to worsening business conditions, and as a result, had to cancel a total of 86 orders from November 2023 to January of the previous year.

In response, the company issued two corrective demands, citing "insincere business practices," and subsequently terminated the franchise agreement with the owner.

The company then filed a lawsuit against the franchise owner, demanding payment of 20 million won in penalties for the termination of the franchise agreement. The franchise owner sought assistance from the Corporation.

In court, the company argued, "The franchise owner's order cancellations were not due to ingredient shortages caused by financial difficulties, but were intentional. Therefore, these actions constitute insincere business practices, and the termination of the agreement and penalty claim under the franchise contract are justified."

In contrast, the Corporation, representing the franchise owner, argued that ▲ the penalty clause in question applies only in cases of "mutual agreement to terminate" the contract, and ▲ the company's notice of termination to the franchise owner was procedurally invalid because it failed to comply with the "two-month grace period procedure" stipulated in Article 14 of the Franchise Business Act, rendering the termination itself invalid.

Ultimately, the key issue was whether there was a legal basis for the penalty claim under the franchise agreement as asserted by the franchisor.

The franchise agreement signed between the company and the franchise owner included a provision stating, "In addition to contractual remedies, damages may be claimed separately for losses caused by the other party's breach of contract or illegal acts."

Another clause stated, "The franchisee (franchise owner) may terminate the agreement by mutual written consent with the franchisor (company) during the contract period. However, the party wishing to terminate must pay a penalty of 20 million won to the other party, within the limits not violating Article 8 of the Act on the Regulation of Terms and Conditions (stipulated damages), and this constitutes predetermined damages."

The court accepted the Corporation's argument that such penalty clauses are premised on termination by mutual consent, and therefore cannot be applied in cases where the agreement is terminated unilaterally due to a breach of contract.

Judge Jo stated, "The penalty provision in the franchise agreement signed by the plaintiff and defendant applies only in cases of mutual agreement to terminate the contract, and it is difficult to apply it to claims for damages arising from termination due to a breach of franchise agreement obligations, as in this case."

Jung Jinbaek, an attorney with the Corporation who represented the franchise owner in this case, stated, "This ruling demonstrates that penalty claims upon franchise agreement termination must be based on clear contractual grounds, and that relevant regulations such as the Franchise Business Act must be strictly observed."

He added, "This is a meaningful case in which we supported a small business franchise owner, who is relatively vulnerable in legal disputes with franchisors, and protected their legitimate legal rights. The Corporation will continue to provide legal aid to protect the legitimate rights of socially disadvantaged individuals."