The Ruling That Shook the Industry: Attorney Hyun Minseok of YK Expects a Turning Point for Win-Win Relations Between Franchisors and Franchisees

Lawsuit Over Pizza Hut Differential Franchise Fees
Securing a Ruling to Return More Than 21.4 Billion Won
The Most Important Ruling Since the Franchise Business Act Took Effect
A Difficult Case the Courts Were Handling for the First Time
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"I believe this is the most important ruling since the Franchise Business Act came into effect in 2002."

There is a case that has turned the domestic franchise industry upside down: the Pizza Hut "differential franchise fee" lawsuit. In December 2020, 108 Pizza Hut franchisees raised objections to the prices of mandatory items they had been paying to headquarters for decades without question. After reviewing the disclosure document made public under the amended Franchise Business Act, they discovered that the prices of various supplies and food ingredients, which the headquarters had purchased from third parties and supplied to franchisees, were far higher than prevailing wholesale market prices.

On the 2nd, at the YK Law Firm Gangnam main office in Gangnam-gu, Seoul, lawyer Hyun Minseok poses after finishing an interview with The Asia Business Daily. Photo by Yoon Dongju

Although the lawsuit began, it was not easy for the franchisees to fight against the franchisor. At the time, there was little understanding of differential franchise fees (the difference between the consideration received by the franchisor for supplying various goods to franchisees and the appropriate wholesale price, i.e., the distribution margin). Because it was the first such case, even the court was unfamiliar not only with the concept of differential franchise fees but with the Franchise Business Act itself.

In the first instance, which was handled by small law firms, Pizza Hut headquarters argued in principle that "since differential franchise fees are a type of franchise fee recognized under the Franchise Business Act, the headquarters has a legal basis to receive them from the franchisees." The first-instance court, however, sided with the franchisees, holding that "to receive differential franchise fees, an agreement is required, and there was no such agreement or implied agreement between Pizza Hut headquarters and the franchisees." However, the scope of unjust enrichment that the headquarters had to return to the franchisees was limited to the differential franchise fees for 2019–2020 (about 7.5 billion won), which had been confirmed via the disclosure document.

Having lost in the first instance, Korea Pizza Hut appointed Bae, Kim & Lee LLC, the second-largest law firm in Korea by last year's revenue, for the appeal. The Bae, Kim & Lee attorneys persistently challenged the need for an agreement, asking why an agreement was necessary for receiving differential franchise fees, which they characterized as a type of margin. The atmosphere in court gradually shifted in favor of headquarters. Sensing a crisis that "if this continues, the outcome will be reversed," the plaintiff franchisees began searching for new representation.

At that point, the person who gave the anxious franchisees hope that "we can win" was attorney Hyun Minseok (45, 39th class of the Judicial Research and Training Institute), a partner at YK Law Firm. Attorney Hyun recalled, "After reading the preparatory brief submitted by Bae, Kim & Lee, I became confident that I could break their legal reasoning. It appeared that, with respect to differential franchise fees, the Franchise Business Act granted a distinct legal status separate from purchase costs, unlike ordinary distribution margins."

Starting with the submission of his first 50-page preparatory brief, attorney Hyun successfully persuaded the court that "since differential franchise fees are a type of franchise fee recognized by law, they constitute an essential part of the franchise agreement, and therefore headquarters can only receive them if there is a 'specific agreement' between headquarters and the franchisees."

He also went to great lengths by personally visiting Pizza Hut's document storage, which had failed to submit the materials needed to calculate the differential franchise fees to be returned to the franchisees despite the court's order to submit documents. As a result of these efforts, he enabled the franchisees to recover a total of more than 21.4 billion won, including the differential franchise fees for 2016–2018, which had been dismissed in the first instance, and the unjust enrichment that arose during the litigation period (2021–2022).

After the appellate decision, franchisors pleaded that "the franchise industry will collapse due to a wave of bankruptcies," but on January 15 the Supreme Court dismissed Pizza Hut's appeal and finalized the judgment in favor of the plaintiffs.

On February 2, at the YK Law Firm Gangnam main office in Gangnam-gu, Seoul, we met with attorney Hyun to discuss the significance of the ruling in the Pizza Hut case and the remaining differential franchise fee lawsuits he is handling.

The following is a Q&A with attorney Hyun.

On the 2nd, Attorney Hyun Minseok is being interviewed by The Asia Business Daily at the YK Law Firm Gangnam main office in Gangnam-gu, Seoul. Photo by Yoon Dongju

-How do you feel about winning the first differential franchise fee case?

▲On a personal level, I believe this is the most important ruling since the Franchise Business Act came into effect in 2002. The case disputed whether the supply of goods constitutes an essential part of a franchise agreement, and this ruling has made it possible for the profit structure of franchisors to change fundamentally. It also addressed what constitutes the "principal performance" in a civil contract, so I believe it has left a highly valuable precedent in terms of civil law principles as well. As a lawyer, I am well aware of how difficult it is to secure a ruling that can determine the direction of an entire industry, so from a professional standpoint, I am deeply honored.

-Did you expect to ultimately prevail at the Supreme Court?

▲The Supreme Court proceedings went on for more than a year, and that felt extremely long to me. Associations made up of franchise company representatives kept appealing to the public that they would go bankrupt, waging a public opinion campaign, and I worried that the Supreme Court might change its decision in consideration of that. It was a continuous period of asking myself whether the legal theory I had conceived and argued was correct. Nevertheless, I was confident in the legal reasoning. Former Supreme Court Justice Kwon Soonil, our managing partner, also told me after the appellate judgment was handed down that "it would be difficult for the Supreme Court to write a decision that overturns this."

-We heard you had a hard time with the issue of document submission.

▲To calculate the amount of unjust enrichment, we needed data on the prices at which headquarters purchased raw and subsidiary materials from suppliers and the prices at which they supplied them to franchisees, so we filed a motion to compel submission of documents such as transaction statements. Pizza Hut initially claimed that the requirements for a document production order were not met and that it had no obligation to submit the documents, or that it could not submit them because they were trade secrets. After the court issued a document production order, it then said that the relevant materials did not exist. Later, it argued that the volume of data was so large that submission was difficult, so I said I would go and check it myself. When I actually went there, the volume was such that it could clearly have been submitted. The Supreme Court held that "the defendant's contradictory responses to the document production order must be actively taken into account in this case, where the relevant evidence is concentrated in the hands of the defendant," and actively accepted the plaintiffs' arguments regarding the calculation of unjust enrichment.

-What was the court's key finding in the Pizza Hut case?

▲The court held, first, that for a franchisor to receive differential franchise fees, there must be a "specific meeting of the minds" with the franchisee, that is, a "specific agreement," and second, that although such agreement need not necessarily be explicit, at a minimum the standard for calculating the fees must be established in advance. As the basis for this determination, the Supreme Court invoked its precedent on general contract principles, which holds that "with respect to the essential or important terms of a contract, there must be a specific meeting of the minds, or at least an agreement on standards and methods that can be specifically determined in the future." In other words, because payment of differential franchise fees, a type of franchise fee, is an essential and important term of the franchise agreement, an agreement is absolutely necessary. That is also the legislative choice made by the drafters of the Franchise Business Act. Meanwhile, Article 2(1) of the Franchise Business Act, which defines franchise business, provides that the franchisor permits the use of its brand to sell products and transfers its business know-how, and the franchisee pays franchise fees in return; this is the "principal performance" of the franchise agreement. The supply of goods such as ingredients or equipment is not the principal performance of a franchise agreement.

-What is your outlook on the roughly 20 other cases you are currently handling?

▲Because the legal principle that "a specific agreement is required to receive differential franchise fees" will apply as is, the trials will mainly focus on fact-finding regarding whether such agreements exist. Although each franchise brand has a different profit structure and specific contractual terms, in broad terms, the fact that differential franchise fees received by headquarters without an agreement constitute unjust enrichment cannot change. For example, even if, unlike Pizza Hut, a franchisor does not charge separate royalties and instead uses differential franchise fees as its main source of income, that fact alone cannot overturn the legal principle that "a specific agreement is required to receive differential franchise fees." In addition, unlike in the case of Pizza Hut, for other companies most of the differential franchise fees collected by headquarters during the five years prior to the filing of the lawsuit have already been disclosed, so I believe the franchisees will be able to recover the exact amounts without having to estimate the unjust enrichment.

On the 2nd, Attorney Hyun Minseok is being interviewed by The Asia Business Daily at the YK Law Firm Gangnam main office in Gangnam-gu, Seoul. Photo by Yoon Dongju

-Despite winning the case, is there anything you find regrettable?

▲Because Pizza Hut filed for rehabilitation, the franchisees have found it difficult to recover the full amount recognized by the court despite winning the lawsuit. Headquarters claimed that this was because some franchisees who had won in the appellate court had seized its accounts, but it could have blocked provisional enforcement of the appellate judgment by posting a cash deposit. Filing for rehabilitation without making proper efforts to repay its debts is fully deserving of criticism in terms of shareholder moral hazard and corporate social responsibility.

-Right after the Supreme Court ruling, the Korea Franchise Association said it was "a decision that shakes up existing practices" and that "this ruling has put the industry on the brink of collapse."

▲This ruling does not say that franchisors must not receive differential franchise fees; it says that they must fully inform franchisees about differential franchise fees and obtain their agreement before receiving them. If, merely because a franchise agreement has been signed, a franchisor can arbitrarily designate mandatory items, require that they be purchased only through the franchisor, and furthermore arbitrarily set prices (margins) and sell them at higher prices than normal wholesale prices, that is what is truly unfair. Unfair practices that exceed the limits of the principle of freedom of contract cannot be justified simply on the grounds that they are customary.

Through this ruling, the judiciary has finally confirmed the legislative decision embodied in the Franchise Business Act that "there is no such thing as an automatic margin." It can be seen as a stern command from the judiciary for franchisors and franchisees to meet again on the basis of "transparent contracts."

I believe this case has served as an opportunity to improve the backward system under which franchisors collected differential franchise fees without the knowledge of franchisees. More fundamentally, I hope it will become a turning point for moving away from an antagonistic structure in which franchisors bind franchisees within the framework of franchise agreements and extract economic benefits from them, and toward a mutually beneficial partnership in which the sales profits generated by franchisees are shared between franchisors and franchisees.

-Many franchisees worry they will suffer disadvantages if they sue headquarters.

▲The Franchise Business Act allows franchisees to request renewal of their franchise agreements for ten years from the time the initial agreement is signed. Because of this, there are many cases in which headquarters pressures franchisees whose contract period has exceeded ten years by saying, "If you join the lawsuit, we will not renew your contract." There are also growing numbers of cases in which franchisors conduct stricter sanitary inspections of franchisees who participate in lawsuits and then use the results as a pretext to terminate contracts or refuse renewals. Appropriate guidance and intervention by the Korea Fair Trade Commission are necessary. The Franchise Business Act prohibits franchisors from disadvantaging franchisees or making franchise agreements conditional on not joining franchisee organizations such as franchisee councils, on the grounds of forming, joining, or engaging in the activities of such organizations. If this provision is violated, the Korea Fair Trade Commission may order corrective measures or impose a surcharge of up to 2% of the related sales.

He is...

Jeju Jeil High School

Seoul National University, School of Law

Passed the 49th National Bar Examination

Completed the 39th class of the Judicial Research and Training Institute

Lee & Ko

Master of Laws (LL.M.), University of Southern California (USC) Gould School of Law

Passed the New York State Bar Examination

YK Law Firm

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