Franchise sector rattled after Pizza Hut loses margin-fee lawsuit

(News1)

South Korea’s franchise industry is voicing deep concern after the Supreme Court ruled in favor of franchisees in a landmark lawsuit ordering Pizza Hut Korea to return so-called margin-based franchise fees, raising fears that similar legal battles could spread across the sector.

With Pizza Hut now excluded following the final ruling, 16 franchise operators — including Kyochon Chicken, bhc, Mom’s Touch, Lotte Super and Myeongnyun Jinsa Galbi — are currently engaged in similar lawsuits with franchisees, according to industry officials on Thursday. Of these, six are chicken brands, three operate pizza or burger chains, and seven fall into other categories such as cafes and ice cream shops.

At the heart of the dispute is the margin-based franchise fee, a practice in which franchisors earn profits by supplying raw or semi-processed ingredients to franchisees at marked-up prices. Franchisees argue that these distribution margins were routinely passed on without being clearly specified in contracts, making them unlawful.

Franchise headquarters counter that such margins were disclosed at the time of contract signing and have long been accepted as a commercial practice in logistics and food supply. They also stress that, unlike U.S.-based franchises such as Pizza Hut — which collect both royalties for brand usage and margin-based fees, sparking controversy over “double charging” — many Korean franchises collect only margin-based fees and do not charge royalties.

A senior executive at a major domestic franchise operator said many Korean brands have historically relied solely on logistics margins without charging royalties. Another industry official added that while contracts may not explicitly use the term “margin-based franchise fee,” franchisees were informed in advance that distribution margins would arise through transactions with headquarters.

According to a Korea Fair Trade Commission survey released last year, 29.5 percent of franchisors collect only ongoing franchise fees in the form of royalties, while 22.9 percent rely solely on margin-based franchise fees. Another 38.6 percent collect both, meaning nearly four out of 10 franchisors operate a structure similar to Pizza Hut’s, fueling concerns that litigation could expand further.

Franchisees dispute the industry’s claims, arguing that margin-based franchise fees were never mutually agreed upon. Even if distribution margins were mentioned before contracts were signed, they say the absence of a clear contractual clause specifying such fees makes the practice invalid.

In franchise contracts, ongoing franchise fees refer to payments made regularly to franchisors in exchange for the use of trademarks, operating systems or access to ingredients. These include both royalties and margin-based franchise fees. Margin-based franchise fees, in particular, are profits earned by franchisors through the procurement and supply of ingredients and materials to franchisees.

Industry watchers warn that if lawsuits over such fees proliferate, the largely small- and medium-sized franchise sector could face cascading closures, job losses and mounting operational difficulties.