The Supreme Court on the 15th sided with franchisees in a lawsuit to return differential franchise fees against Korea Pizza Hut. The reason was that the franchise agreement did not contain clauses related to differential franchise fees. Observers say the ruling by the Supreme Court will change the revenue structure of the domestic franchise industry and overall transaction practices with franchisees. With franchisees of 17 franchise brands already having filed lawsuits over differential franchise fees, the likelihood of a wave of lawsuits has grown.
The Supreme Court's 3rd Petty Bench (presiding Justice Lee Heung-gu) on this day finalized a lower-court ruling partially in favor of the plaintiffs in an appeal of a lawsuit filed by 94 Korea Pizza Hut franchisees seeking the return of unjust enrichment from headquarters. Pizza Hut is known to generally charge a royalty of 7% to 10% of sales in the United States. Korea Pizza Hut, instead of higher royalties, had a structure that used differential franchise fees as a key revenue source. Differential franchise fees refer to the margin (profit) a franchisor takes by supplying raw and subsidiary materials to franchisees at prices higher than the wholesale price.
When entering into franchise agreements with franchisees, Korea Pizza Hut collected an initial franchise fee and required franchisees to pay a fixed monthly fee (6% of total revenue) and advertising expenses (5% of total revenue) to the franchisor. In addition, the franchisor collected differential franchise fees each month while supplying pizza raw and subsidiary ingredients.
Franchisees argued that Korea Pizza Hut collected differential franchise fees without a basis specified in the contract even while receiving royalties, and that the fees should be returned as unjust enrichment. Headquarters for Korea Pizza Hut countered, saying, "Differential franchise fees are a normal supply margin permitted under the Fair Franchise Transactions Act," and "no separate prior agreement is necessary."
Earlier, in a second-instance ruling in Nov. 2024, the Seoul High Court found that because the franchise agreement lacked relevant clauses, it could not be considered that the franchisor and franchisees had agreed on differential franchise fees. It then viewed the franchisor as having taken unjust enrichment through differential franchise fees. The Supreme Court on this day affirmed the Seoul High Court's decision as is. Korea Pizza Hut must return a total of 21.5 billion won to franchisees. Hyun Min-seok, an attorney at Law Firm YK who represented the franchisees in this case, said, "It is time for a paradigm shift from a differential franchise fee structure—much like a 'black-box margin'—to a royalty-based model that transparently shares sales profit."
Following the Supreme Court ruling, a wave of lawsuits is expected. In the process, many small and midsize franchisors could face bankruptcy, some note. Korea Pizza Hut filed for rehabilitation proceedings after the Seoul High Court's second-instance ruling in Nov. 2024, citing a cash crunch.
Already, franchise sectors such as chicken, coffee and ice cream are seeing a series of lawsuits by franchisees demanding "return the differential franchise fees." According to ChosunBiz reporting, franchisees of bhc, Kyochon Chicken, BBQ Chiken, Baskin-Robbins, A TWOSOME PLACE, Lotte Super, Lotte Fresh, Puradak, Goobne Chicken, Cheogajip, Dujjim, Gcova Chicken, Mom's Touch, Burger King, Photoism, Ttang Ttang Chicken and Won Halmeoni Bossam Jokbal are pursuing similar lawsuits.
The Korea Franchise Association issued a statement the same day saying, "Shaking up existing practices raises concerns about industry collapse," and added, "In lawsuits currently underway or to be filed, we earnestly ask the judiciary to deliver reasonable judgments that take into account industry realities and common sense in ordinary commercial transactions." A source at one franchise headquarters said, "Small and midsize franchises with weak fundamentals may struggle to manage risk," adding, "Consumers' negative perceptions of the franchise industry itself will also be a blow."
Some, however, say Korea Pizza Hut's case differs from typical situations. The view is that Korea Pizza Hut collected differential franchise fees without properly informing franchisees while also charging royalties, which caused the problem. By contrast, many domestic companies collect only differential franchise fees without royalties. A source at a restaurant franchise headquarters said, "Usually there are no royalties or they are at a very low level," adding, "Korea Pizza Hut's contract structure differs from other franchises' contracts."
Some say the ruling should be used as an opportunity to change the structure of the Korean franchise business model. Seo Yong-gu, a professor in the School of Business at Sookmyung Women's University, said, "Switching to a royalty model is ideal, but unlike the United States, Korea's domestic market is small, so the transition is not easy. It is time for government-level discussions that consider the state of the franchise industry and the particularities of its business model." Lee Jong-woo, a professor in the Department of Business Administration at Ajou University, also said, "Given the domestic market environment, it is hard to unilaterally mandate a royalty model, so in-depth discussions are needed."