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Could Pizza Hut force franchisees to sell pizzas at a loss? Or is that unconscionable conduct? Which case won?
09 Jan | Which Case Won

Could Pizza Hut force franchisees to sell pizzas at a loss? Or is that unconscionable conduct? Which case won?

By Anneka Frayne, Tamworth

The Facts

Pizza franchisor implements nationwide price-cutting strategy

In 2014, the franchisor of the Pizza Hut system in Australia devised a new “value strategy”, first to reduce the number of pizza ranges on offer from four to two and secondly, to reduce the price of one range from $9.95 to $4.95 and the other from $11.95 to $8.50. The strategy was devised in the wake of similar measures introduced by rival pizza chain, Dominos, and on the back of several years of declining sales at Pizza Hut.

The franchisor undertook some testing of the value strategy in the ACT market, with promising results, and determined to implement the strategy Australia-wide. Franchisees were required to adopt the strategy because the franchise agreements they had signed gave the franchisor the discretion to change the product range at their outlets and to set maximum prices.

Franchisees bring class action against pizza franchisor

Unfortunately, the value strategy was a failure. Some Pizza Hut franchisees saw their businesses collapse and others incurred substantial losses. Consequently, a group of 190 franchisees brought a class action against the franchisor in the Federal Court seeking to recover their losses.

The franchisees claimed that the franchisor had been negligent in its design of the value strategy, had breached the franchise agreement by requiring them to adopt it and had otherwise engaged in conduct that was unconscionable in breach of the Australian Consumer Law. The franchisor rejected these claims.

casea
The case for the franchisees
  • The aim of the franchise agreement is to generate profits, so when the franchisor sets a new pricing structure it must act reasonably and in good faith toward helping franchisees achieve that aim.
  • On the contrary, the value strategy ruined our profitability.
  • The evidence establishes a lack of any reasoned or considered case for implementation of the strategy. It was negligently designed, and no reasonable business person would have required us to implement it.
  • The value strategy was also unfair. The franchisor stood to gain far more from it than we ever did, while we took all the risk.
  • In setting the new prices, the franchisor did not properly consult with us and did not have proper regard to the impact the strategy would have on us.
  • We have suffered significant losses and should be compensated by the franchisor.
caseb
The case for the franchisor
  • The franchise agreement requires that franchisees aim to develop their businesses and increase revenues. However, there is no term in the agreement – express or implied – that requires us to make decisions that produce a profit for each franchisee.
  • The profitability of individual franchisees is unknown to us and outside our control. Trying to set prices to ensure profits at every store would be commercially unworkable because every store is in a different position.
  • Uniform pricing is a key element of the national Pizza Hut system and the franchisees knew this when they signed the franchise agreement. It’s not for the court to change the commercial bargain between the parties in the franchise agreement.
  • As participants in a competitive market we must be free to respond to price competition, which is a matter for business judgment. We did consult with franchisees and we exercised our judgment properly and in the genuine belief that the strategy would increase sales for both the franchisees and the overall business.
  • Any loss suffered by the franchisees is due to competition and is not our fault.

So, which case won?

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Case B won. You were right!

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Expert commentary on the court's decision

Anneka FrayneManaging Solicitor
“It was the court’s view that if, in hindsight, the price-cutting strategy was a bad judgment call, that did not, in this case, equate to unconscionable conduct or the franchisor acting in bad faith.”
Franchisor’s duty to act in good faith and with reasonable cause

In the case Diab Pty Ltd v YUM! Restaurants Australia Pty Ltd [2016] FCA 43, despite the franchisees making a loss on the sale of pizzas after the price-cutting strategy was implemented, the court found in favour of the franchisor.

In reaching its decision, the court examined the exercise of discretion by the franchisor in setting the new value strategy. The court considered that this discretion was not unfettered and that it could not be exercised arbitrarily, capriciously or unreasonably. Rather, the franchisor had:

…an obligation to act honestly and with a fidelity to the bargain; an obligation not to act dishonestly and not to act to undermine the bargain entered or the substance of the contractual benefit bargained for; and an obligation to act reasonably and with fair dealing having regard to the interests of the parties (which will, inevitably, at times conflict) and to the provisions, aims and purposes of the contract, objectively ascertained.

Court finds in favour of franchisor due to explicit conditions in franchise agreement

The franchise agreement in this case expressly stated that no profit was guaranteed to franchisees and gave the franchisor the exclusive power to change pricing and products from time to time. The court found that in exercising its discretion, the franchisor genuinely believed that the marketing campaign would generate profits for the franchisees in the long run and did act properly and in good faith. It was under no contractual obligation to consult with franchisees before exercising the powers.

It was the court’s view that if, in hindsight, the price-cutting strategy was a bad judgment call, that did not, in this case, equate to unconscionable conduct or a breach of contract. While it’s likely that the interests of a franchisor and its franchisees would diverge from time to time, that did not mean that a party had to subordinate their own interests to those of the counterparty.

The franchisees ultimately failed to show that any loss or damage they had suffered occurred because of a breach of contract, breach of duty, or due to the unconscionable conduct of the franchisor.

Lessons for anyone contemplating becoming a franchisee

This result may seem unfair to franchisees who had no say in a marketing strategy that resulted in substantial losses for them. However, the court took the view that this was a risk that was part of the commercial bargain accepted by franchisees when they entered in the franchise agreement.

If you are a potential franchisee, this case reinforces the importance of taking the time to understand fully the risks you will be accepting if you enter into a franchise agreement, as well as what the franchisor’s obligations are and what the limits to those obligations are. Don’t let the excitement of anticipating running your own business eclipse your good judgment.

For anyone contemplating becoming a franchisee, the best time to get legal advice about the franchise agreement is before you sign it. As an unknown wit once said: “Caution is a most valuable asset in fishing, especially if you are the fish.”

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