[Choi Seok-jin's Law & Biz] From Closure to Rehabilitation Application... Pizza Hut Franchisees Frustrated Despite Winning Lawsuits (Part 1)

Editor's NoteIt has already been six months since last September when Pizza Hut franchisees won the second trial in the lawsuit against the headquarters (franchise headquarters) for the return of the differential franchise fees. However, with the company filing for corporate rehabilitation, Pizza Hut franchisees are facing difficult circumstances once again. The number of closed franchises continues to rise, and several franchisees have filed for personal rehabilitation. What has happened at Pizza Hut before and after the lawsuit began in December 2020? We heard from both the franchisees and the company.

Pizza Hut franchisees who won the second trial in the lawsuit against the headquarters for the return of differential franchise fees are struggling in an uncertain situation where it is unclear whether they will be able to recover the money recognized by the court as unjust enrichment due to the company's corporate rehabilitation filing. In particular, franchisees are outraged that the company, which had promised to return the differential franchise fees to franchisees who did not participate in the lawsuit once the Supreme Court's final ruling is made, suddenly changed its stance and filed for rehabilitation. They are demanding practical measures to be taken.

On September 11 last year, the Seoul High Court ruled in the second trial of the lawsuit filed by Pizza Hut franchisees against the headquarters for the return of differential franchise fees that the company must return a much larger amount (21 billion KRW) to the franchisees than the amount recognized in the first trial (about 7.5 billion KRW).

After the franchisees won in both the first and second trials, franchisees from various franchise sectors, including several chicken brands, rushed to file lawsuits against their headquarters. The Pizza Hut case became an opportunity to bring to light the differential franchise fees, which franchise headquarters had not clearly disclosed in terms of items and amounts, leaving franchisees unaware.

A Pizza Hut store that is closed and undergoing demolition work. Provided by the Korea Pizza Hut Franchisee Association

Promised to Pay Even Non-Participating Franchisees, Then Suddenly Filed for Rehabilitation

However, the joy of the Pizza Hut franchisees who won the lawsuit did not last long. Right after losing the first trial, the company, which had publicly declared that it would return the differential franchise fees under the same conditions to franchisees who did not participate in the lawsuit if it lost the final trial, suddenly filed for corporate rehabilitation. This happened just two months after losing the second trial.

After losing the first trial on June 3, 2022, the company sent an official letter to franchisees under the name of then Head of Sales Kim, stating the company's official position on the differential franchise fee lawsuit: "The franchise headquarters will apply the Supreme Court's final confirmed ruling equally to all franchises regardless of individual franchisees' participation in the lawsuit." Furthermore, it encouraged franchisees to focus on sales by saying, "Rather than additional participation in the lawsuit, please do your best to satisfy customers and grow your business through new products launched ahead of the summer peak season."

Franchisees who directly participated as plaintiffs and won the lawsuit, as well as those who did not file additional lawsuits trusting the company's stance, could not understand the company's sudden rehabilitation filing but had no way to stop it. The company reported the debts to be repaid to the court, including franchisees who did not participate in the lawsuit as creditors. However, if the rehabilitation approval is granted, franchisees will be repaid from the limited assets of the rehabilitated debtor at a certain ratio along with other creditors, resulting in amounts far less than the total differential franchise fees and interest recognized by the court. Moreover, franchisees who did not participate as plaintiffs may not even be recognized as creditors if they did not go through a separate reporting process.

Regarding the reason for filing for corporate rehabilitation after the second trial ruling, franchisees and the company have conflicting views. Franchisees believe the company filed for rehabilitation to avoid paying the differential franchise fees ordered by the court. Since the second trial ruling states that provisional execution can be applied to the amount recognized in the first trial, additional amount, and interest, the company should have made a deposit to avoid provisional execution. Filing for rehabilitation without such a deposit is seen as using the rehabilitation system as a means to avoid paying the money owed.

One franchisee said, "According to the court ruling that allows provisional execution on unjust enrichment, the plaintiffs exercised their rightful provisional execution. The deposit ordered by the court to prevent this provisional or compulsory execution was not made, and instead, the company filed for rehabilitation."

He added, "Due to this rehabilitation filing, the property rights of franchises that invested between 200 million and 400 million KRW in their businesses were wiped out all at once."

On the other hand, the company claims that franchisees caused the situation that left no choice but to file for rehabilitation. Some franchisees applied for provisional seizure, freezing the company's accounts, making it impossible to operate normally, leaving no option other than rehabilitation.

Pizza Hut stated, "Korea Pizza Hut franchise headquarters filed for corporate rehabilitation because the franchise headquarters' accounts and supplier claims were frozen due to provisional seizures by franchisees involved in the lawsuit, making it impossible to supply normal raw materials to franchises and operate the company normally. This measure was unavoidable to allow all Pizza Hut franchises, including those not participating in the lawsuit, to operate normally."

It is true that some franchisees applied for provisional seizure after the second trial ruling. A representative of the Korea Pizza Hut Franchisee Association said, "After the second trial ruling, the headquarters' legal team told us that there was cash deposited but difficulties with the surety insurance. They said if only the cash excluding the surety insurance was put into escrow, they would not enforce compulsory execution. However, the headquarters withdrew all amounts into a CMA account, and only the amount mentioned was left."

He added, "The compulsory execution was only on about 1.3 billion KRW, which came from card payments at 60 directly operated stores, and it was just a means to induce the headquarters to make a deposit."

Franchise Numbers Plummet Due to Closures... 100 Fewer Than Four Years Ago

While franchisees and the company have been engaged in a legal battle over differential franchise fees, the number of Pizza Hut franchises in Korea has sharply declined. Excluding about 60 directly operated stores run by the headquarters, the number of franchises, which was about 340 at the time the lawsuit was filed, has dropped to 240. This means 100 stores have closed over the four years during the trial.

A former Pizza Hut franchisee A, who closed during the lawsuit, said, "There is a joke that business is bad because neighboring stores haven't closed yet, which shows how difficult the situation is for franchisees." The number of franchisees filing for personal rehabilitation due to worsening management is also increasing.

Franchisees claim that the continuous decline in Pizza Hut store sales is due to the headquarters conducting excessive discount promotions at the expense of franchisees and not reinvesting royalties (trademark usage fees based on sales) or differential franchise fees collected from franchisees into new product development or fresh ingredient supply.

Unlike other domestic franchises, Pizza Hut separately charges 6% of total franchise revenue as royalties and 5% as advertising fees in addition to the franchise fee. One franchisee said, "Compared to other pizza companies, it's true that it's hard to see Pizza Hut ads on TV," expressing dissatisfaction, "The company says it advertises through SNS, but I don't know where the advertising fees are actually spent."

On the other hand, the company insists that advertising fees collected from franchisees are used properly according to their respective purposes. A company representative said, "The franchise headquarters uses 5% of marketing costs properly, and directly operated stores also bear advertising costs just like franchises. Moreover, the headquarters invests additional marketing funds from its own operating funds to secure profitability for all stores." He added, "When franchisees visit the headquarters and inquire about usage details, we provide all the information."

Regarding operations in areas where stores have closed, franchisees said, "Almost all are absorbed and operated by the headquarters' directly operated stores." However, the company denied this, stating, "This is not true at all."

On December 10 last year, Pizza Hut franchisees held a protest in front of the Seoul Rehabilitation Court in Seocho-dong, Seoul, demanding the return of the difference in franchise fees. Provided by the Korea Pizza Hut Franchisee Association

Actual Owner Kim Kwang-ho's Exit Moves... "Company Should Show Responsible Attitude as Korean Headquarters"

Franchisees are demanding that the company take responsible steps to return the unjustly collected differential franchise fees once the Supreme Court's ruling is finalized, as originally promised. They also hope that the U.S. headquarters (YUM), which has shown a passive attitude regarding the differential franchise fee lawsuit and corporate rehabilitation filing, will actively protect the brand's value and franchise survival.

A representative of the Korea Pizza Hut Franchisee Association said, "Even after losing the appeal in 2024, the company continued to collect differential franchise fees and still collects the amount recognized by the court as unjust enrichment. Filing for corporate rehabilitation does not put the company in a position to return the unjustly collected fees, yet the company irresponsibly continues to cause damage to franchisees for its own benefit."

He added, "The Master Franchise Agreement (MFA) for Korea Pizza Hut, which grants usage rights, is valid until September 2027. Despite the uncertain continuation of business activities, the rehabilitation plan for the next 10 years was approved, which is an abuse of the rehabilitation system to avoid responsibility by the actual owner."

In particular, franchisees expressed concern that Kim Kwang-ho, chairman of KHI and the actual owner of Pizza Hut, seems to be moving to exit after recovering his investment rather than normalizing company management.

Korea Pizza Hut sold all its shares to Orchard One in 2017 and signed a master franchise agreement. Orchard One had Kim's daughter, Kim Yuna, as CEO, and Kim as an inside director.

However, in 2021, the year after the differential franchise fee lawsuit began in 2020, Kim reduced Orchard One's capital, which owns 100% of Pizza Hut, from 4 billion KRW to 100 million KRW. Also, a month after losing the second trial in September last year, both Kim and his daughter resigned from the corporation simultaneously.

Kim, known as an M&A expert, operates the KHI Group, which acquired K-Shipbuilding for 250 billion KRW with United Asset Management in 2021, and handed over management rights to 'UAMCO SPC,' the largest domestic non-performing loan (NPL) investment company, at the end of last year, three years after acquisition.

Also, in 2022, he formed a consortium with Korea Investment Private Equity (PE) and SG PE to acquire management rights of Daehan Shipbuilding for about 200 billion KRW and is preparing for its listing. Industry insiders expect its valuation to reach the trillion KRW level.

Regarding this, the company stated, "The rehabilitation process is not to evade legal responsibility related to the unjust enrichment return lawsuit filed by the plaintiffs but to continue operating the company under court supervision. Korea Pizza Hut plans to normalize franchise headquarters management and work with franchisees to improve franchise profitability to sustain the business."

They added, "Furthermore, we will clarify our position on the unjust enrichment return lawsuit again at the Supreme Court and fulfill our responsibilities based on the judgment according to law and principles."

*What is Differential Franchise Fee?

It refers to the difference between the amount the franchise headquarters charges franchisees for various supplies and the appropriate wholesale price, i.e., the distribution margin. It is also called the logistics margin.