[Legal Issue Check] Supreme Court Appeal Over Mom's Touch "Thigh Patty" Supply Price Increase Case

"Raw Material Purchase Prices Fell, But Supply Prices Were Raised"
Unfair Distribution Margin Practices Using "Mandatory Items" Under Scrutiny
Supreme Court Ruling Expected to Set Precedent

The Supreme Court is currently reviewing the final appeal in a lawsuit filed by Mom's Touch franchisees, who are seeking the return of unjust enrichment, claiming that the headquarters of Mom's Touch & Company unlawfully raised the supply price of the Cyburger patty (hereafter referred to as "Cy Patty") in 2020 and 2022.

The franchisees initiated this lawsuit, arguing that at the time of the price increases, the headquarters deceived them by claiming it was "difficult to withstand cost pressures," even though the purchase price of the main ingredient, Brazilian Cy Patty, was continuously declining. They assert that the headquarters obtained undue profits through this deception. In contrast, the headquarters maintains that there were sufficient grounds for the price increases and that all procedures stipulated in the franchise agreement were followed. Both the first and second trials ruled in favor of the headquarters.

Mom's Touch Gangnam Branch. Mom's Touch

This case includes legal issues that may serve as precedents for other franchise businesses in Korea, such as the interpretation of standardized franchise agreements and the authority of the headquarters to set product prices. Attention is focused on whether the appellate court's decision, which recognized the unilateral authority of the headquarters to set product prices, will be upheld.

"Raw material prices dropped, but headquarters concealed this and raised patty prices"

The aspect of this lawsuit that most enraged the plaintiff franchisees is that, despite a decline in the purchase price of raw materials, the headquarters concealed this fact and instead raised the supply price to franchisees. They argue that the supply price should have naturally decreased in line with the lower purchase price, but instead, the supply price moved in the opposite direction, maximizing the headquarters' profits.

The products at issue are the "Brazilian Cy Patty" and the "domestic chicken breast patty," both essential ingredients for Mom's Touch's signature menu item, the "Cy Burger." Franchisees are required to purchase these items exclusively from the headquarters.

According to the rulings of the first and second trials, the purchase price that Mom's Touch headquarters paid to its supplier, CKF Food System, for the Cy Patty dropped steadily from 6,490 won per pack on January 1, 2020, to 6,160 won, and then to 5,990 won in January 2021. Over two years, the cost was reduced by 500 won.

However, the invoices received by franchisees told a different story. In October 2020, the headquarters raised the supply price of the Cy Patty by 1,370 won per pack, from 8,330 won to 9,700 won. In February 2022, the price was increased again by 800 won, from 9,700 won to 10,500 won. While the cost dropped by 500 won, the supply price to franchisees rose by 2,170 won.

The purchase price for the domestic chicken breast patty also decreased, from 5,770 won per pack in January 2020 to 5,480 won (a drop of 290 won), and again to 4,500 won in January 2021 (a further drop of 980 won). Even though the headquarters' purchase price fell by 1,270 won per pack, Mom's Touch raised the supply price to franchisees by 800 won, from 7,370 won to 8,170 won per pack in February 2022.

At the time of the first Cy Patty price increase, the headquarters posted an internal notice stating, "The supply price will be raised by 150 won per unit," explaining that "due to environmental changes and accumulated cost increases, it has become inevitable to adjust the Cy Patty supply price," and "it is no longer possible to endure the cost pressure accumulated over six years."

The franchisees argue that, since the actual purchase price fell, the headquarters' claim that costs had increased was a deception and thus the price increase is invalid. In reality, after raising the Cy Patty supply price in 2020, the headquarters recorded a net profit of 23.3 billion won, its highest ever, and after the second price increase in 2022, it recorded a net profit of 32 billion won. Contrary to the headquarters' explanation of "cost pressure accumulated over six years," its net profit continued to rise.

Industry observers believe that KL&Partners, the private equity fund that acquired Mom's Touch in December 2019, is behind these measures. There is suspicion that, following the acquisition, the franchisees became victims of an "exit" strategy, where the company maximizes short-term value by cutting costs or squeezing sales to boost net profits before selling the business.

Despite the acknowledgment that the headquarters raised supply prices even as purchase prices dropped, the courts in the first and second trials found no issue with the increases in the supply prices of the Cy Patty or the chicken breast patty.

Headquarters' authority to set prices, dispute over interpretation of "in consultation"

One of the key issues in this case is whether the headquarters has the authority to unilaterally determine changes in the supply price of raw materials provided to each franchisee.

Article 28, Clause 1 of the Franchise Agreement between the Mom's Touch Franchise Headquarters and the Franchisees.

This centers on the interpretation of Article 28, Clause 1 of the franchise agreement. Article 28, Clause 1, which regulates the procurement and management of raw and subsidiary materials, states: "The details and prices of raw and subsidiary materials to be supplied by the headquarters to the franchisee shall be as specified in Attachment [3]. However, if it becomes necessary to change the supply details or prices of raw and subsidiary materials due to price increases or other changes in economic conditions, the headquarters shall present the change details, reasons, and calculation basis to the franchisee in writing, and both parties shall determine the changes in consultation."

The two sides have completely opposing interpretations of this proviso.

First, regarding the meaning of "in consultation," the franchisees argue that it refers to a process aimed at reaching an agreement, meaning that both parties' consent is required for any price change. In contrast, the headquarters claims that "consultation" simply means to discuss cooperatively, and that the authority to set prices ultimately lies with the headquarters.

The two sides also disagree on the sentence structure of the proviso, specifically the subject and predicate. The proviso states, "The headquarters shall ... present in writing, and both parties shall determine (the price change) in consultation."

The headquarters and the lower courts interpreted the subject of "shall determine" as "the headquarters." The franchisees counter that this interpretation contradicts the sentence structure, arguing that the subject of "shall present in writing" is "the headquarters," but the subject of "shall determine in consultation" should be "both parties."

Ultimately, the first and second trial courts, interpreting the meaning of "consultation" and the sentence structure of the proviso as the headquarters did, concluded that since Article 28, Clause 1 of the franchise agreement allows the headquarters to set and present the details and prices of raw materials to franchisees, the authority to determine price changes also rests with the headquarters.

However, some argue that this interpretation by the courts contradicts the fundamental "contra proferentem" principle of the Act on the Regulation of Terms and Conditions, which states that ambiguous terms should be interpreted against the drafter.

Seoul Seocho-gu Supreme Court building.

Dispute over necessity of price changes and procedural compliance

The headquarters and franchisees also differ on whether there was a genuine need to increase the supply prices of the Cy Patty or chicken breast patty, and whether the procedures for price increases set out in the franchise agreement were properly followed.

Regarding the necessity of the price changes, the headquarters cited reasons such as "operating profit remaining stagnant." The lower courts acknowledged that the headquarters' claims were not factual, but nonetheless concluded, "It cannot be determined that the first and second price increases were unjust simply because the cost of goods sold as a percentage of sales decreased and the operating profit margin increased."

In response to the appellate court's decision, the franchisees argue that this interpretation violates Article 10, Section 1 of the Act on the Regulation of Terms and Conditions, which invalidates clauses that allow a business operator to unilaterally determine or change the content of obligations without sufficient reason.

Meanwhile, the headquarters announced the first price increase through an internal notice. The appellate court recognized that there was a procedural flaw in this process. However, the court still found that the price increase could not be invalidated, citing reasons such as "there is no provision on the effect of a procedural violation" and "there is room to consider that the franchisees gave post hoc or implicit consent."

On the other hand, the franchisees maintain that "acts that violate procedures stipulated in the contract should be considered invalid, and invalid acts cannot be ratified."

For the second price increase, the appellate court found no procedural violation, citing evidence that the headquarters exchanged opinions with some franchisees and sent related official documents. However, the franchisees claim that even then, they only received unilateral notification and there was no substantive consultation.

One clear fact in this dispute is that, despite a drop in the purchase price of the "essential item" Cy Patty, which franchisees are required to buy from the headquarters, the headquarters concealed this and instead raised the price, thereby maximizing its profits from franchisees.

The franchisees hope that the Supreme Court will put an end to the headquarters' practice of collecting unjust "distribution margins" by exploiting the "essential item" system.