On 5 February 2016, the Federal Court of Australia in Diab Pty Ltd v YUM! Restaurants Australia Pty Ltd [2016] FCA 43 dismissed the claims made by 190 Pizza Hut franchisees (out of a possible 200) in a class action alleging that a pricing strategy implemented by the franchisor in July 2014 amounted to breach of contract, negligence and unconscionable conduct.

The claim was brought by Diab Pty Limited (Diab), a franchisee of six Pizza Hut outlets, as the representative applicant of all persons who were franchisees under an International Franchise Agreement (IFA) with Yum! Restaurants Australia Limited (Yum) to operate Pizza Hut outlets as at 1 July 2014. The fact that the proceedings went through a lengthy hearing and on to judgment makes it a rarity but its failure on the merits puts it in the majority of cases that do proceed through the litigation process.

Yum’s Value Strategy and Diab’s claims

In June 2014, Yum announced to its franchisees that it would be implementing a new strategy known as the Value Strategy from 1 July 2014 where it would:

  • reduce the ranges of Pizza Hut pizzas from four to two; and
  • reduce the prices to two price points - $4.95 for “Classics” pizzas (previously $9.95) and $8.50 for “Favourites” pizzas (previously $11.95).

These price points were predicated on various iterations of a model prepared by Yum personnel (the Yum Model), on the basis of experience in New Zealand and trials of a reduced price conducted at Pizza Hut outlets in the ACT. The model and its basis was heavily criticised by Diab.

On 19 June 2014 Pizza Hut’s main competitor, Domino’s, notified its franchisees of its decision to pre-empt Yum and launch a price point for its pizzas of $4.95 all day every day. This gave Domino’s ‘first mover advantage’ with this type of strategy. Yum decided it had no choice but to proceed with the Value Strategy.

The proceedings against Yum were brought as a class action commenced by Diab under Part IVA of the Federal Court of Australia Act 1976 (Cth) (Act). The group members were defined as the franchisees who suffered loss as a result of the introduction of the Value Strategy. Following opt-out notices being sent to all potential group members, only 11 members opted out.

The case against Yum was based in contract, negligence and the Australian Consumer Law. In essence it was alleged that:

  1. The IFA should be construed so that Yum was obliged to set profitable prices – being prices that would enable a franchisee to make, maintain or increase its profits and, in implementing the Value Strategy, Yum had breached the IFA.
  2. Yum was negligent in that it had breached:
    1. an implied duty owed to each franchisee to:
      • cooperate with the franchisees to achieve the objects of the IFA; and
      • comply with standards of conduct that are reasonable having regard to the interests of the parties to the IFA.
    2. a duty of care owed to each franchisee in relation to any conduct or decision by Yum in providing services as franchisor and in the exercise of its powers under the IFA; and
  3. Yum had engaged in unconscionable conduct contrary to s21 of the Australian Consumer Law by pursuing a strategy of the objective testing of the simplified pricing model as a learning for other markets so as to enable Yum to enhance its own profits, not those of the franchisees.

Decision

The franchisees were ultimately unsuccessful in each element of their claims against Yum. In a detailed judgment following an 18 day hearing and extensive submissions from both parties, Justice Bennett generally accepted Yum’s submissions and held that:

  • Although there was no dispute that the obligations of cooperation, good faith and fidelity to the bargain must be taken into account in construing the rights under the IFA, Yum did not have an obligation to set a price to ensure that the franchisees would make a profit with respect to a particular promotion;
  • Yum did not owe either an express or implied duty of care to the franchisees of this nature, and to impose such a duty would involve rewriting the bargain between the franchisor and franchisees; and
  • Yum had not engaged in unconscionable conduct in implementing the Value Strategy.

In a judgment of 174 pages, Her Honour concluded that Diab had not established that Yum was in breach of its obligations in relation to implementation of the Value Strategy.

The Court accepted that the object of the IFA was to enable the franchisees to reasonably have the opportunity to run a profitable operation. However, that did not mean that it was an object of the IFA that the maximum price fixed for each pizza in the product line had to be profitable for each franchisee, as profit is measured at the level of the franchise operation as a whole. The IFA made it clear that Yum had control of promotions and the setting of a maximum price and that liability for unsuccessful promotions was excluded. Therefore, the notion that Yum must set a price to ensure the franchisees would make a profit was inconsistent with the IFA and also practically unworkable, as there were many franchisees with different abilities and liabilities of which Yum had no detailed knowledge. In addition, Pizza Hut was suffering a decline in market share.

The Court also found that Diab failed to show that the franchisor had acted dishonestly, in bad faith, or with reckless disregard for the franchisees. Yum had made what it considered to be the best decision from its point of view and for the future profitability of the franchisees. Her Honour noted that although hindsight grants the viewer 20/20 vision of the success or failure of a proposed strategy (for example, Yum believed that it would have a first mover advantage), at the time it was implemented the decision was not unconscionable, nor unreasonable or irrational. Nor did Diab establish that Yum breached the alleged duty of care that it owed the franchisees: Yum was not under a duty to ensure profitability of each franchise, nor under a duty to ensure that profits were maintained or increased.

Implications

Based on the result, Diab was ordered to pay Yum’s costs of the proceeding. On 8 March 2016, the period for filing a notice of appeal in the proceedings was extended to 7 September 2016.

In an era when most class actions are settling before judgment, this is a timely reminder that novel claims may fail if they do proceed to judgment.