Franchising in Taiwan: Defining Contractual Penalties and Avoiding Double Recovery

When developing an existing business into a franchise network in Taiwan, franchisors often look to contractual penalties to maintain operational discipline. But charging a fixed amount for every breach can easily lead to disputes unless the terms clearly define the breach, explain the basis for anticipated losses and set limits on the calculation. This article focuses on setting and settling contractual penalties, rather than breach notices or procedures for putting matters right.

1. Distinguish contractual penalties from outstanding charges and damages

Before drafting a franchise agreement, classify the payments you may seek to recover rather than calling them all ‘fines’. A franchisor is not a public authority, and a contractual penalty is not the same as a government-imposed fine.

• Amounts already payable: Overdue royalties, for example, remain an existing payment obligation.
• Additional service charges: If a franchisee requests extra training, the charge should reflect the service provided and the agreed price. It should not subsequently be relabelled as a penalty.
• Contractual penalties: Payment obligations arising under the agreement from a specified breach.
• Damages: Claims for losses caused by a breach, which require consideration of the legal basis, causation and evidence.

Start by preparing an internal reference table listing each triggering event, the nature of the payment, the calculation method and the supporting documents. Where one event gives rise to several charges, you must be able to explain the distinct liability each addresses. Charges should not simply be added together because different departments have their own fee schedules.

2. Understand Taiwan’s legal boundaries

Taiwan has no single dedicated franchise statute, but franchising is not unregulated. Contractual penalties primarily fall under the Civil Code. Disclosure of material information during franchise recruitment and fairness in trading also involve the Fair Trade Act and the Taiwan Fair Trade Commission’s guidelines for handling cases concerning franchisors’ business practices. Those guidelines govern the Commission’s handling of relevant cases; they do not establish a franchise licensing or contract approval system.

Under Article 250 of the Civil Code, parties may agree that a contractual penalty is payable if an obligation is not performed. Unless otherwise agreed, the penalty is treated as the total compensation for the loss arising from that non-performance. Specific rules also apply where the penalty concerns a failure to perform at the proper time or in the proper manner. Franchisors therefore cannot assume that collecting a contractual penalty leaves them free to make unlimited additional claims for the same loss.

Article 252 of the Civil Code also allows a court to reduce an excessively high contractual penalty to a reasonable amount. There is no statutory ‘safe percentage’ applicable to every franchise agreement, nor does a franchisee’s signature prevent them from challenging the amount.

Where liability for breach constitutes a material operating restriction or a condition for termination, it should be clearly disclosed before the agreement is entered into. It should not be hidden in operating rules issued only after signing. The Fair Trade Commission has handled franchise cases involving inadequate disclosure of fees, purchasing requirements and penalty criteria. Older materials may refer to Article 24 of the Fair Trade Act; the relevant general prohibition is now in Article 25, so check which version applies when reading past cases.

3. Set amounts using a defensible basis

Do not work backwards from the assumption that a penalty must be high enough to deter breaches. First identify the likely effects of a breach, then choose a calculation method that reasonably reflects the risk.

For example, late submission of operating reports may increase checking costs, but that does not necessarily justify charging a fixed percentage of a shop’s entire monthly turnover. Early withdrawal from the franchise may involve support expenditure that has not yet been amortised, but all future revenue cannot simply be treated as a certain loss. Initial estimates can draw on staff hours, outsourced costs and case-handling records from company-owned outlets or pilot operations, while separating out costs already covered by the franchise fee.

Each clause should answer at least four questions:

1. What triggers the charge? Describe conduct that can be verified, rather than relying solely on wording such as ‘damaging the brand’s image’.
2. How are breaches counted? If the same problem continues for several days, does it count as one breach or accrue a daily charge?
3. When does the amount stop accruing? Specify objective milestones, such as completing remedial action, ceasing use or returning items.
4. Is there an overall cap? Assess the total liability arising from one event to avoid daily charges accumulating to a plainly disproportionate amount.

These are contract-design principles, not fixed formulas endorsed by law. Different risks, including early termination, confidentiality and non-compete obligations, should each be reviewed by a lawyer familiar with Taiwanese law.

4. Use a settlement statement to prevent double recovery

Before finalising the agreement, test the calculations against several hypothetical scenarios. If a franchisee ends the relationship early, for example, the franchisor might list outstanding payments, a contractual penalty, signage removal costs and other damages. Check each item to identify existing debts, actual expenditure and amounts already covered by the contractual penalty.

The settlement statement should show the event date, contractual basis, calculation period, quantity, amount and supporting evidence. If you intend to deduct an amount from a security deposit, show the balance before and after the deduction. Do not deduct a sum and then list that same sum in full as still outstanding. Keep receipts for actual expenditure rather than using a vague ‘administration fee’ to make up a shortfall.

Internally, operations staff can confirm the facts, finance staff can check the calculations, and a designated manager can approve the outcome. Record the reasons for any reduction or waiver as well, such as delays caused by the franchisor, a problem caused jointly by both parties, or harm that has already been remedied. This helps ensure consistent treatment of comparable situations.

Practical takeaway: Before offering franchises, prepare a four-column table covering ‘breach event’, ‘basis for the amount’, ‘accrual limits’ and ‘double-recovery check’. Being able to explain why each payment arises does more to maintain trust across your franchise network than putting large penalties in the agreement.