[Why&Next] Pizza Hut Faces Pivotal Day 'D-1'... Franchise Industry on High Alert

Supreme Court Ruling on Pizza Hut Surplus Franchise Fees
Franchise Industry Tension at Its Peak
Pervasive Pessimism Prevails
All Eyes on the Potential Shake-up of Profit Structures

Tension in the franchise industry has reached its peak ahead of the Supreme Court's ruling on the lawsuit filed by Pizza Hut franchisees against the headquarters for the return of surplus franchise fees. As the food service industry grapples with both rising costs and sluggish consumer demand, there are concerns that if the lower court rulings-where franchisees have repeatedly won-are upheld, the profit structure of the franchise sector could be fundamentally shaken. Some point to the Mom's Touch case, in which the franchisees lost, as grounds for optimism, but the prevailing sentiment is that it is difficult to be optimistic.

According to industry sources on January 14, the Supreme Court is set to deliver its ruling on the appeal regarding the lawsuit filed by Pizza Hut franchisees against the headquarters for the return of surplus franchise fees on January 15. This lawsuit began in December 2020 when Pizza Hut franchisees claimed that the headquarters had unjustly collected surplus franchise fees not specified in the contract, in addition to royalties.

Both the first and second instance courts ruled in favor of the franchisees. In particular, the Seoul High Court, in last year's appellate trial, ruled that "surplus franchise fees collected without prior agreement constitute unjust enrichment" and ordered the headquarters to return approximately 21 billion won to the franchisees. This amount is nearly three times the 7.5 billion won awarded in the first trial. As a result of this ruling, Pizza Hut faced financial pressure and filed for corporate rehabilitation in November of last year.

Pizza Hut. Yonhap News Agency

Surplus Franchise Fees: The Core Profit of Domestic Franchises... 17 Brands Facing Collective Lawsuits

Surplus franchise fees refer to the distribution margin that the franchise headquarters earns by supplying raw and subsidiary materials. For most domestic franchise headquarters, the distribution margin on essential items is a more significant source of profit than royalties linked to sales. About 90% of domestic franchise headquarters rely on surplus franchise fees, and there have been many cases where the specific margin rate was not stipulated in contracts but operated as a matter of practice.

In fact, the Franchise Business Act recognizes surplus franchise fees as a form of franchise fee. However, the appellate court ruling in the Pizza Hut case determined that the franchise headquarters must reach an agreement with franchisees to collect surplus franchise fees, which has caused disputes over surplus franchise fees to spread throughout the industry.

According to the Korea Franchise Association, a total of 2,491 franchisees across 17 brands have filed lawsuits related to surplus franchise fees to date. Starting with 94 Pizza Hut franchisees in 2020, the list includes Lotte Super and Lotte Fresh (110 franchisees), BHC (327), Baskin Robbins (417), Twosome Place (273), Mom's Touch (221), Burger King (60), and Myeongnyun Jinsa Galbi (17), among others. The association stated, "Since the Myeongnyun Jinsa Galbi lawsuit in July last year, there have been no new lawsuits filed to date."

"Different From the Mom's Touch Unjust Enrichment Lawsuit"

Some observers are speculating that, based on the Mom's Touch lawsuit, the Supreme Court may overturn the lower court's decision in this case. Mom's Touch won the lawsuit filed by some franchisees for the return of unjust enrichment in both the first trial in 2024 and the appellate court on August 21 last year.

The 14-2 Civil Division of the Seoul High Court ruled that "there were no substantive or procedural flaws in the process of raising the price of raw materials," and that "the headquarters' price increase was a rational business decision." Allegations that the headquarters had gained unjust enrichment by increasing the supply price of raw materials such as 'psy-patty' were also dismissed.

However, the Mom's Touch case is considered to be more about the legitimacy and procedure of individual raw material price increases, rather than the structure of surplus franchise fees itself. An industry insider commented, "The key issue in the Mom's Touch case was whether the price increase fell within the scope of business judgment, whereas the Pizza Hut case is about whether surplus franchise fees were sufficiently recognized as a core condition of the franchise contract. Even if both cases involve surplus franchise fees, the court's perspective on the issues is fundamentally different."

Exterior view of Mom's Touch Itaewon branch. Mom's Touch

The fact that the government views surplus franchise fees as 'hidden profits' for franchise headquarters and is tightening regulations is also a burden. The Fair Trade Commission amended the enforcement decree of the Franchise Business Act in 2018 to require disclosure of surplus franchise fee information in the franchise disclosure documents. In July of last year, the law was amended again to require that contracts specify the method for determining the supply price of essential items.

"Nothing Left Over"... Growing Sense of Crisis in the Food Service Industry

If the Supreme Court upholds the lower court's ruling on Pizza Hut's surplus franchise fees, the same principle could be applied to lawsuits involving other franchises that previously collected surplus franchise fees. With rising raw material costs and labor expenses, if distribution margins also shrink, there is a growing sense of crisis that the profit model of franchise headquarters could be shaken. An industry insider commented, "Even if sales increase, there is already nothing left over," adding, "If restrictions are placed on surplus franchise fees, headquarters will have almost no options left."

Some headquarters have already begun reviewing their contract structures, regardless of the outcome of the appeal. They are considering ways to clarify provisions related to surplus franchise fees or to strengthen explanations of the pricing methods for raw and subsidiary materials. However, industry sources note that the burden of implementation is significant. Another insider stated, "Companies with sufficient resources may be able to prepare, but for those without, the pressure will become a reality regardless of the outcome." He added, "The Pizza Hut case is not just a problem for a particular company, but an incident that reveals the vulnerable structure of the entire food service franchise industry." Another source commented, "While new lawsuits have quieted down, it is difficult to say that the potential for disputes has been completely extinguished. No headquarters can feel at ease until the Supreme Court's decision on the Pizza Hut appeal is announced."