A recent decision handed down on 5 February 2016 by the Federal Court of Australia provides an interesting example of how the duty to act in good faith applies in practice.

In Diab Pty Ltd v YUM! Restaurants Australia Pty Ltd[1]franchisees of Pizza Hut stores across Australia failed in their claims against the franchisor for breaches of contract, negligence and unconscionable conduct in relation to a franchise-wide pizza price reduction strategy.

The defendant, as franchisor of the Australian Pizza Hut franchise, introduced a price reduction strategy across all stores that reduced the maximum price of the Pizza Hut pizza ranges from AUD9.95 to AUD4.95 and AUD11.95 to AUD8.50, respectively (Pricing Strategy).

The plaintiff, as the representative of the Pizza Hut franchisees, argued the franchisees had suffered economic loss due to the Pricing Strategy and claimed that by introducing the Pricing Strategy, the defendant had:

  1. breached an implied contractual obligation to set maximum prices that would enable a franchisee's business to be profitable
  2. breached its duty of care by implementing a promotional campaign that caused economic loss to the franchisees
  3. breached an implied term to act in good faith, and
  4. acted unconscionably by using its powers under the agreement exclusively for its own interests.

The Federal Court found that the defendant had an implied obligation to act in good faith in conducting promotional activities. However, the plaintiff was unsuccessful for the following reasons:

  • While the object of the Franchise Agreement was to provide the franchisees with the opportunity to operate a profitable business, this did not extend to a requirement to ensure that maximum prices on all products returned a profit to the franchisee. Profits could be made on ancillary goods sold and the object of the Pricing Strategy was to increase market share and customer retention.
  • The franchisor was not privy to the sales information of individual franchisees and the profitability of each store hinged upon a multitude of factors.
  • The Franchise Agreement contained a provision expressly excluding liability for unsuccessful promotional campaigns.
  • The defendant had conducted trial programs, prepared a financial model and consulted with franchisees and its executives in relation to the Pricing Strategy.
  • The failure of the Pricing Strategy was predominantly attributed to the defendant's major competitor pre-empting the Pricing Strategy and adjusting its prices accordingly.

The Court held that, in implementing the Pricing Strategy the defendant had not acted unreasonably, unfairly, dishonestly or negligently. It could not be shown that the defendant had not believed that the Pricing Strategy would benefit the future profitability of the national Pizza Hut brand.

It is important to note that the decision in this case depended greatly on the factual circumstances discussed above. Franchisors should be wary of their obligations to act in good faith and to reasonably consider the interests of the franchisees.