[Choi Seokjin's Law & Biz] From Closures to Rehabilitation Applications... Pizza Hut Franchise Owners Still Suffering Despite Court Victory (Part 2)

Editor's NoteIt has already been six months since Pizza Hut franchise owners won their appeal in the second trial against the headquarters (franchisor) for the return of the difference in franchise fees last September. However, with the company filing for corporate rehabilitation, Pizza Hut franchise owners have once again found themselves in a difficult situation. The number of franchise stores closing continues to rise, and several owners have reportedly filed for personal bankruptcy. What has happened at Pizza Hut before and after December 2020, when the lawsuit began? We listened to the stories of both franchise owners and the company.

Pizza Hut Product Discount Promotion.

Ongoing '3040' and '1+1' Discount Promotions... The Burden Falls on Franchise Owners

Why has Pizza Hut, which held the number one spot for brand power in Korea's pizza industry for quite some time, ended up facing such difficulties?

Some analysts point to the overall decline in sales across the pizza industry and the unique situation of Pizza Hut, which had a significant number of large restaurant-style stores. An industry insider said, "The shift of the pizza business from dine-in to delivery has been a major cause of the sales decline," and added, "Unlike Domino's Pizza, which has focused on delivery from the start, or new entrants in the pizza market, Pizza Hut still has a considerable number of franchise stores with large dining areas."

This means that as the number of customers visiting Pizza Hut stores in person sharply declined, franchise owners operating large restaurant spaces likely faced a significant burden from rent costs.

However, the franchise owners had a different perspective. They cited the headquarters' virtually mandatory, never-ending discount promotions as the primary cause of declining sales.

Pizza Hut franchise owner A said, "Since 2014, Pizza Hut also shifted its focus from restaurant-based business to delivery-based operations," and added, "Because this transition began a decade ago, it is hard to say that the change in consumer patterns to delivery is what caused the sales decline."

He continued, "In particular, by 2017, when Orchard One acquired all shares of Korea Pizza Hut, the conversion to delivery-focused stores was almost complete, and even the remaining restaurant stores were mostly offering delivery as well."

Another franchise owner said, "The ongoing and excessive discounts have caused customers to lose trust in our prices, and the lack of marketing strategies beyond discounts are the reasons for the sales decline."

In reality, Pizza Hut has consistently run various discount promotions, such as the '3040' promotion, which offers a 30% discount on delivery and a 40% discount on takeout, and the '1+1' event, where customers receive two pizzas for the price of one.

For example, in the case of the '1+1' event, franchise owners sell two pizzas but only receive revenue equivalent to the price of one, while still having to use ingredients for two pizzas, resulting in a loss. Meanwhile, from the franchisor's perspective, these promotions increase pizza sales and the volume of ingredients supplied to franchisees, allowing the headquarters to collect more difference in franchise fees and thus increase profits. This is the argument put forth by franchise owners.

One franchise owner remarked, "The company's next strategy might even be '5060.' Honestly, when they first did the '2030' promotion, no one imagined a '3040,' but now that they're doing '4050,' '5060' doesn't seem impossible either."

He went on to say, "The problem is that with these discount promotions, most of the discount costs are borne by the franchise owners. Not only with price discount promotions, but also with telecom company partnership promotions and delivery app discount events, the headquarters has only covered a tiny portion of the costs, leaving the rest to the franchisees."

Organization Change Notice Sent by Headquarters to Franchise Owners in July 2022. An Excel file is attached at the top left.

Managing Franchisee Approval Rates for Each Promotion... "Blacklist" vs. "Due to 70% Consent Requirement"

The Pizza Hut headquarters has managed statistics on the approval or opposition rates of each franchise store for these frequent discount promotions.

The company stated, "In order to run a discount promotion, the Franchise Business Act and its Enforcement Decree require the consent of at least 70% of franchise owners. Therefore, it is inevitable to manage statistics on which franchisees approved or opposed each promotion to verify compliance with this requirement."

In fact, the Franchise Business Act stipulates that if the franchisor intends to hold a promotional event where franchisees bear all or part of the costs, the franchisor must obtain the consent of at least 70% of all franchisees, as specified by Presidential Decree.

On the other hand, franchise owners believe that the company used these statistics to identify and pressure those who opposed the discount promotions, essentially creating a "blacklist" of franchisees under management.

Franchise owners have their reasons for making this claim. By sheer coincidence, an internal confidential file managed by Pizza Hut headquarters was accidentally attached to an Excel file sent by email to franchisees to notify them of an organizational change. That file contained information that raised suspicions of such practices. After confirming that confidential internal materials had been leaked due to an employee's mistake, the company reportedly sent two subsequent correction notices.

In July 2022, the company sent an email to all headquarters staff, company-owned stores, and franchisees to notify them of organizational changes effective August 1, 2022, with an Excel file titled 'OPS Organization Chart' attached. In addition to the 'OPS Organization Chart 220801' sheet, which detailed organizational changes at each branch nationwide, there was a hidden tab labeled 'Joint Visit.' This sheet contained data classifying all franchise stores nationwide into five categories-▲Very Negative ▲Negative ▲Neutral ▲Positive ▲Very Positive-based on their approval or opposition rates to promotions.

The issue was that the data included more than just statistics on franchisees' approval or opposition to discount promotions. The file also contained a specific "Action Plan & Tool" detailing how to respond to 92 stores with high opposition rates, with the ultimate goal of achieving "over 70% promotion consent after July."

Among the listed measures were positive actions such as ▲joint visits by headquarters managers or branch managers and ▲special LSM (Local Store Marketing) support, but also negative actions, including ▲consulting for transfer of business rights, which appears to refer to franchise transfers, and ▲Store checklist ▲internal audits, which refer to frequent store inspections by regional managers. Franchise owners claim these were considered or used by the company to pressure those with high opposition rates to discount promotions.

In fact, one franchise owner who was frequently classified as "Very Negative" due to opposition to company promotions was offered a "conditional one-year contract" by the company. The company cited reasons such as the need to improve customer service (GES: Guest Experience Survey), management of FA (platform orders via Baemin or Coupang Eats), and non-compliance with operational standards. However, considering that Pizza Hut franchise contracts are typically signed for five-year terms, this was highly unusual.

Meanwhile, the company has denied all allegations of a "blacklist," stating, "There is absolutely no truth to these claims."

On December 10 last year, Pizza Hut franchise owners were protesting in front of the Pizza Hut headquarters in Yeouido, Seoul, demanding the return of the difference in franchise fees. Provided by the Korea Pizza Hut Franchisee Association

Franchisees Hope for Swift Supreme Court Ruling and Rejection of Rehabilitation Application... "Ultimate Owner Kwangho Kim Must Show Responsibility"

For more than four years since December 2020, Pizza Hut franchise owners have been fighting the company in court and are now hoping the Supreme Court will deliver a prompt verdict. Even though it is uncertain whether they will be able to recover the unjust enrichment recognized by the court if they win, given the company's corporate rehabilitation application, they believe a Supreme Court ruling is the first step toward reducing uncertainty.

The company maintains that the difference in franchise fees is not considered a franchise fee under the Franchise Business Act. Therefore, even if it was not specified in the contract or agreed upon with franchisees, the company claims it was entitled to receive it and has no obligation to return it-a consistent argument from the first trial through the Supreme Court appeal.

In contrast, the franchise owners argue that the company took money it should not have received without proper disclosure or consultation, and thus must return it. They point out that when Pizza Hut headquarters was previously ordered by the Fair Trade Commission to correct its practices for collecting an administration fee, the company claimed, "Unlike other brands, Pizza Hut headquarters does not add a margin to raw materials," and received a reduced fine. Yet, behind the scenes, it secretly collected the difference in franchise fees, which franchisees see as deceitful.

They also claim that the company used the rehabilitation process as a means to reduce its liability for returning the difference in franchise fees after losing the second trial, and therefore the rehabilitation application should not be accepted. The company appealed to the court, arguing that its "going-concern value is high," but franchisees believe this is only true if the company can continue collecting the difference in franchise fees from them as before. If the Supreme Court rules that the company can no longer collect these fees, they argue, the requirements for rehabilitation approval will not be met. They also note that the master franchise agreement (MFA) between Korea Pizza Hut and Orchard One is valid until September 2027, which should be taken into account.

In particular, franchise owners expect Kwangho Kim, chairman of KHI (KHI), who is considered the de facto owner of Pizza Hut, to take active responsibility for resolving the situation. Given that the company has continued discount promotions at the expense of franchisees and increased profits by collecting the difference in franchise fees, they argue that Kim should focus not only on the listing of Daehan Shipbuilding but also on efforts to normalize Pizza Hut.

In the past, Kim reportedly made profits by supplying frozen shrimp used as pizza ingredients through a related company, Dongil Nongsusan, without notifying the Fair Trade Commission or franchisees. The company explained, "We temporarily sourced products through Dongil Nongsusan because we determined the shrimp prices from the existing supplier were not reasonable. After strengthening our internal purchasing team for overseas suppliers, we stopped transactions with Dongil Nongsusan." However, according to franchisees' records of supply prices at the time, the cost actually increased after switching to Dongil Nongsusan.

Franchise owners also believe that the endless discount promotions at Pizza Hut were due to the professional managers appointed by Kim, who did not establish long-term development plans for the company but instead focused on maximizing the majority shareholder's interests and their own performance. As a result, they would boost sales through short-term projects, receive incentives, and be replaced after only one or two years.

The Supreme Court's final ruling and the company's response to the Pizza Hut case are likely to set a precedent for other franchise lawsuits and company responses in the future. This is why the outcome of this situation is drawing significant attention.

*Difference in Franchise Fees

This refers to the margin that the franchisor earns by supplying various goods to franchisees, calculated as the difference between the price paid by franchisees and the appropriate wholesale price. It is also known as a logistics margin.