'21 Billion Won Compensation' Unpaid, Rehabilitation Process... What Happened to Korea Pizza Hut? [Why&Next]

Franchise Owner's Unjust Enrichment Refund Lawsuit
Appeal Court Orders Headquarters to Pay 21 Billion KRW
Temporary Difficulties Due to Account Seizure... Business Normalized
"Attempting Amicable Negotiation Through Voluntary Restructuring"

Korea Pizza Hut, which opened as the first-generation pizza specialty store in Korea in 1985 and has maintained its presence for nearly 40 years, has filed for corporate rehabilitation with the court. This comes as some franchisees have filed lawsuits pointing out issues with the franchisor's unjust profits, and the company's operations have temporarily faced difficulties. Korea Pizza Hut stated that there is no problem for consumers to use the stores normally and that they intend to reach an amicable agreement with the parties involved in the lawsuits. However, since they have consecutively lost in the first and second trials, they may have to return hundreds of billions of won depending on the Supreme Court's ruling.

A Pizza Hut store in Seoul. Photo by Yonhap News

"Double Payment of Fees"... What is the Difference Franchise Fee?

According to the legal community on the 6th, Korea Pizza Hut applied for the commencement of rehabilitation proceedings at the Seoul Rehabilitation Court on the 4th. The Seoul Rehabilitation Court's Rehabilitation Division 12 (Chief Judge Oh Byung-hee), which was assigned the case, issued a preservation order and a comprehensive injunction against Korea Pizza Hut on the same day. The preservation order is a measure that prevents the applying company from disposing of assets to repay only specific creditors. The comprehensive injunction freezes claims to prevent creditors from securing the company's major assets through compulsory execution, provisional seizure, or auction before the commencement of rehabilitation proceedings. This is to prevent specific creditors from receiving preferential repayment and to secure time to prepare a rehabilitation plan.

The Korea Pizza Hut franchisor explained, "Franchisees participating in the lawsuit have been carrying out seizure and collection measures on the franchisor's bank accounts since the 4th of last month, causing difficulties in paying employee wages, supplier payments, and major raw material supplies," adding, "This application for the commencement of rehabilitation proceedings is an unavoidable measure to lift the account freeze and normalize the company's cash flow."

Korea Pizza Hut also applied for the Autonomous Restructuring Support (ARS) program. This system postpones the commencement of rehabilitation proceedings for a certain period, allowing the company to conduct normal business activities while negotiating amicable adjustments with creditors.

The conflict between the two sides dates back to 2018. The spark of the conflict was the 'difference franchise fee,' where the headquarters supplied raw and subsidiary materials with an added margin without the consent of the franchisees. The difference franchise fee is a kind of margin added by the franchisor to essential items supplied to franchisees. In April of the same year, the Enforcement Decree of the Franchise Business Act was revised to require franchisors to mandatorily disclose in the information disclosure document submitted to the Fair Trade Commission the average amount of difference franchise fees paid per franchisee in the previous business year and the ratio of difference franchise fees to sales per franchisee in the previous business year.

Accordingly, some Korea Pizza Hut franchisees who were unaware of the difference franchise fee filed lawsuits in 2020, claiming that they were not properly informed that the headquarters added a margin to essential items supplied and that the collection of difference franchise fees constituted unjust profits.

Until then, the difference franchise fee was regarded as a customary practice in the franchise industry. However, the franchisees participating in the lawsuit argued that since they pay fixed fees and advertising fees to the headquarters every month, adding a margin to raw materials constitutes double fees. According to the information disclosure document registered by Korea Pizza Hut with the Fair Trade Commission, as of last year, franchisees paid the headquarters 6% and 5% of net sales monthly as fixed fees (royalties) and advertising fees, respectively.

Regarding this lawsuit, in the first trial held in June 2022, the Seoul Central District Court ruled partially in favor of the plaintiffs, ordering Korea Pizza Hut to return approximately 7.5 billion won in unjust profits equivalent to the difference franchise fees. The court accepted the franchisees' claims that they were not properly informed about the imposition of difference franchise fees and that there was no prior agreement or basis for collecting them. Subsequently, in the second trial in September this year, the court again ruled in favor of the franchisees, increasing the refund amount to 21 billion won. While the first trial ordered the return of difference franchise fees for 2019-2020 only, the second trial reflected fees from 2016 to 2022.

"Measures for Survival"... Eyes on the Supreme Court Ruling

Korea Pizza Hut has filed an appeal against the appellate court's ruling. The company stated, "There are parts where Korea Pizza Hut's position has not been sufficiently explained, and we will seek legal judgment again through the Supreme Court appeal." A representative from the Seoul Rehabilitation Court explained, "Korea Pizza Hut applied for the ARS program to amicably resolve the forced execution issues with franchisees and seems to want to reach procedural agreements with the franchisees until the Supreme Court ruling."

The Supreme Court ruling surrounding Korea Pizza Hut could cause ripples in the domestic food service industry, which has regarded the collection of difference franchise fees as customary practice. An industry insider predicted, "If the final conclusion is that the franchisor obtained unjust profits, disputes between franchisees and franchisors over this issue will expand in other franchise industries."

Pizza Hut licensed from the United States opened its first store in Itaewon, Seoul, in 1985, and established Korea Pizza Hut in June 1991 to officially enter the food and beverage business. At the time of establishment, several shareholders participated, including PepsiCo, Ferramaco International, and domestic investors. It led the domestic pizza industry until 2009 but then declined as the popularity of pizza franchises waned and convenience foods like frozen pizza expanded. After several changes in shareholding, the investment company Orchard One currently holds 100% of the shares.

The company posted an operating profit of 44.295 million won until 2021 but recorded losses in the past two years. The operating loss in 2022 was 25.612 million won, and last year, the deficit increased more than 20 times to 4.5224 billion won within a year. Last year's sales also fell below 100 billion won, reaching 86.9 billion won, a 25% decrease compared to 2019. The number of franchise stores was 297 at the end of last year, down by more than 40 from 340 in 2021 over two years.

As of last year, Korea Pizza Hut's total equity, excluding liabilities from total assets, was 9.64597 billion won. This is larger than the capital of 603 million won paid at the company's establishment but decreased by 62% compared to 25.716 billion won in 2020. While cash and cash equivalents were about 3.8 billion won last year, current liabilities reached 12.2 billion won. Due to this, it is speculated that Korea Pizza Hut, which is in poor management condition, sought to buy time until the Supreme Court's judgment due to the burden of refunding more than 20 billion won.

However, Korea Pizza Hut claims, "There is no problem with the fundamental operation of the Pizza Hut business, and consumers can use Pizza Hut as usual," adding, "There are only temporary difficulties caused by the freezing of accounts due to forced execution by some plaintiffs after the second trial ruling."