The Supreme Court ruled that the so-called "differential franchise fee" that Korea Pizza Hut added when supplying materials and supplies to franchisees was unfair. Under the final ruling, the Pizza Hut headquarters must return 21.5 billion won in differential franchise fees collected from franchise owners from 2016 to 2022. The decision is expected to have a major impact on the franchise industry.
The Supreme Court's Third Division (presiding Justice Lee Heung-gu) on the morning of the 15th dismissed an appeal and upheld a lower court ruling that partially accepted the claims of 94 people, including a person surnamed Yang, who sued Korea Pizza Hut LLC's headquarters to return the amount equivalent to the "differential franchise fee" collected without legal or contractual basis from 2016 to 2022.
A differential franchise fee is the amount the franchise headquarters (head office) receives in excess of a "reasonable wholesale price" when supplying materials and supplies to franchise owners. In the franchise industry, it has generally been regarded as a type of distribution margin.
Earlier, in Dec. 2020, 94 franchise owners filed a lawsuit arguing that the differential franchise fees the Korea Pizza Hut headquarters collected without specifying them in the franchise agreement constituted unjust enrichment and must be returned.
Under the franchise agreement, the Pizza Hut headquarters receives a fixed fee equal to 6% of total revenue from franchise owners. Separately, when franchise owners purchased materials and supplies from the headquarters, they paid amounts with an additional differential franchise fee attached, which they argued was unfair.
Franchise owners argue the differential franchise fee violates the franchise agreement, which stipulates sharing total revenue. They also said that because the franchise headquarters mandates the purchase of materials and supplies it designates, it should not add a distribution margin (differential franchise fee) as in ordinary commercial transactions.
The Pizza Hut headquarters countered that under the Fair Transactions in Franchise Business Act, it did not need to include the differential franchise fee in the franchise agreement and that it did not take unjust enrichment from the owners. It also argued that if the differential franchise fee is not recognized, it would justify franchise owners' use of materials and supplies without any consideration.
Both the first and second trials found that Pizza Hut unjustly benefited because the franchise agreement did not contain an explicit clause requiring payment of a differential franchise fee. Under the Fair Transactions in Franchise Business Act, a franchise headquarters must have an agreement between the parties to receive franchise fees from owners.
The first-instance court recognized unjust enrichment only for payments made in 2019–2020, when the Pizza Hut headquarters disclosed information on the rate used to calculate the differential franchise fee.
The appeals court calculated the compensation Pizza Hut must pay by accepting the owners' calculation method even for the 2016–2018 differential franchise fees for which information had not been disclosed. It also ruled that Pizza Hut must additionally return payments made in 2021–2022, for which additional calculation-rate information was disclosed during the trial. The court thus ordered a partial return of the amount equivalent to the differential franchise fees the headquarters received over the seven years from 2016 to 2022.
The appeals court said, "When a franchise owner is supplied with specified raw and subsidiary materials designated by the headquarters, there is no room to choose the subject, counterparty, or price of the transaction, making it different from ordinary goods transactions." It continued, "If the defendant (Pizza Hut headquarters) needs to offset the expense (differential franchise fee) incurred in supplying raw and subsidiary materials, it must either enter into a contract reflecting that content or present the basis of the cost calculation to franchise owners and go through a process to obtain their consent."
The Supreme Court found that the lower court's calculation of unjust enrichment was not unreasonable and did not misinterpret the law.
Hyun Min-seok, an attorney at Law Firm YK (Judicial Research and Training Institute Class 39), who represented the franchise owners in this case, said, "This ruling reins in a backward practice in which the headquarters abused its authority to designate mandatory items and collected an unfair 'toll,'" adding, "The franchise industry needs a full paradigm shift from a differential franchise fee structure with opaque margins to a 'royalty-based model' that transparently shares sales profits."
Two months after the appeals ruling, in Nov. 2024, the Korea Pizza Hut headquarters applied for the commencement of corporate rehabilitation proceedings and received a comprehensive stay order from the court. The measure prevents creditors from enforcing assets, and franchise owners protested that it was "an attempt to evade legal responsibility."
Following this ruling, the franchise industry must correct its practices and will be significantly affected. After the appeals ruling, lawsuits seeking the return of differential franchise fees have been filed in other sectors such as chicken, coffee, and ice cream.