Pizza Hut Franchisees Unsuccessful
The long awaited decision in what has come to be known as the ‘Pizza Hut Class Action’ was published publicly on 26 February 2016. 190 Pizza Hut franchisees sued their franchisor in relation to a decision to reduce pizza prices in 2014.
The basic facts were that the Franchisor of the Pizza Hut Network, Yum Restaurants Australia Pty Ltd (Yum) decided in early 2014 to implement a new model whereby it would:
1. reduce the range of pizzas offered for sale from four to two (reducing the total number of pizzas for sale from 27 to 17); and
2. drop prices on the two remaining ranges from $9.95 to $4.95 and from $11.95 to $8.50 respectively.
This was known as the ‘Value Model’.
The Value Model
The Value Model included reductions in certain price points and was scheduled to commence on 1 July 2014. The Value Model relied on New Zealand data (in particular, the adoption of New Zealand benchmarks and labour hours) and the results of the Australian Capital Territory trial (discussed below).
The objective of the Value Model was to increase sales by 34.5 per cent. The Value Model had been trialled in eight Pizza Hut franchises in the Australian Capital Territory between February and April 2014. All eight franchises were owned by the one franchisee. As part of the trial, Yum agreed to indemnify the franchisee for any losses incurred in the trial. Yum ultimately paid the franchisee almost $200,000. There was a substantial dispute between the parties as to the success of the trial.
After franchisees had been informed of the introduction of the Value Model, 80 of them sought an urgent injunction from the Federal Court of Australia to restrain Pizza Hut’s implementation of the Value Model on 1 July 2014. The application, made on 19 June 2014 was heard and determined by the Court on 24 June 2014. The Court dismissed the franchisees’ application, clearing the path for the Value Model to be implemented on 1 July 2014.
A fresh court action was issued on 12 August 2014 which eventually proceeded to final hearing over 18 days in mid to late 2015. This second proceeding involved 190 franchisees (out of a possible 200), led by one franchisee (Diab Pty Limited and its director and majority shareholder Danny Diab) who owned and operated six franchises in the Greater Macarthur region of New South Wales and had been involved in Pizza Hut businesses since 1989.
Much of the debate turned on clauses C1 and 6.2 of the Franchise Agreement which stated:
C1 MAXIMUM RETAIL PRICE
Franchisee will not permit any Approved Product to be sold at the Outlet at any price exceeding the maximum retail prices advised by Franchisor to Franchisee from time to time.
6.2 Franchisee will participate in such national and regional advertising, promotions, research and tests as Franchisor from time to time requires and Franchisee will not have any claim or action against Franchisor in connection with the level of success of any such advertising, promotion, research or test.
The franchisees made three core allegations, namely:
1. pursuant to clause C1, Yum was obliged to set profitable prices – in other words, Yum was obliged to fix prices that would enable franchisees to make or increase its profits;
2. Yum was subject to the following implied duties owed by Yum under the Franchise Agreement to each Franchisee:
a. an implied duty to co-operate with the Franchisees to achieve the objects of the Franchise Agreement and
b. an implied duty to comply with reasonable standards of conduct, taking account of the interests of both parties to the Franchise Agreement and
3. Yum’s conduct was unconscionable within the meaning of the Competition and Consumer Act 2010 (Cth).
The Court found:
1. Yum was not obliged to fix prices for each product line so each product line was profitable. The object of the Franchise Agreement was each franchise business, not each pizza;
2. Although Yum owed a duty to co-operate with franchisees, the duty was not breached; and
3. Yum had not engaged in unconscionable conduct.
In effect, the Court found, as a whole, Yum’s decision to implement the Value Model was based on reasonable grounds and made in good faith on the belief that it would increase franchise profitability. Simply because the plan did not maintain profits or realise increased or a maintenance of profits (which were otherwise declining) did not make Yum liable for franchisees’ losses.
The evidence showed that, for the most part, Yum had carefully considered the strategy in fixing the maximum prices. No dishonesty, negligence, bad faith or recklessness had been demonstrated nor had any decisions been made capriciously or arbitrarily, although one Yum staff member involved in the analysis of the ACT trial was found to have demonstrated poor business judgment through his naivety.
The Court agreed with Yum’s submission that the Value Model included more than just price reductions. The Value Model initially included increased marketing budgets, “first to market” advantage and a consequential uplift in transactions and sales.
The Court further held that clauses C1 and 6.2 expressly made clear that:
1. Yum had complete control over promotions and fixing maximum prices; and
2. Yum’s liability for unsuccessful promotions was excluded.
In this case, the benefit of hindsight illustrated that the results of the Value Model were not as bad as predicted. However, hindsight, although beneficial, could not be used to demonstrate that a decision made in good faith, which led to what was ultimately an unsuccessful strategy, created any liability on the part of Yum franchisees.
Ultimately, the question was not whether the decision (or, in fact, the modelling underlying the decision) was right or wrong, but whether the decision was reasonable.
Critical points to take away
Some of the key points to remember, as a result of this decision, are:
1. typically (and expressly in this case), franchise agreements do not contain any promises that franchisees will make a profit.
2. there is a common law duty on parties to commercial contracts to exercise their discretionary powers (i.e. the power the set maximum prices) in good faith, honestly and with reasonable cause. In other words, clauses in franchise agreements that expressly empower one party (typically a franchisor) to make discretionary decisions must be exercised in good faith, honestly and with reasonable cause.
3. decisions that adversely affect franchisees (including, for example decisions that adversely affect sales and profitability) do not necessarily mean a franchisor has not acted in good faith or unconscionably.
MST Lawyers has over 25 years’ experience in franchising, representing clients throughout Australia and internationally in a variety of industries.
Written by Raynia Theodore, Principal and Jack Newton, Lawyer, in the Corporate Advisory and Franchising Team at MST Lawyers, please contact the Corporate Advisory and Franchising Team for assistance or further information.