Facts

In June 2014 eighty Pizza Hut franchisees applied for an injunction to stop their franchisor YUM! Restaurants Australia Pty Ltd (Yum) from implementing a new marketing strategy across the Pizza Hut network called the “Reduced Price Strategy”.

The Reduced Price Strategy would have limited the number of menu items to be sold in Pizza Hut outlets and specified the maximum prices for those items (which as the name of the strategy implies were to be discounted from usual prices).

Yum believed that this strategy would increase sales but the 80 franchisees believed it would have a detrimental – even catastrophic – impact upon the profitability of their individual businesses.

The franchisees’ case

The franchisees provided financial modelling by an expert witness to establish their prediction that the strategy would lead to the failure of franchised businesses.

The franchisees claimed that Yum owed implied duties to them to act reasonably and in good faith and to co-operate with the franchisees and it was going to breach these duties with the Reduced Price Strategy.

They also said that Yum was guilty of unconscionable conduct (section 21 Australian Consumer Law).

The Yum case

Yum’s case was that something urgently needed to be done to the Pizza Hut business in Australia which had been steadily losing customers for the last 10 years. Yum had used similar strategies in the United States and New Zealand and claimed these were successful. Yum decided to test 2 different pricing models - one in WA and one in Canberra. The WA trial did not succeed and was abandoned but the ACT trial conducted from February to April 2014 was considered a success as sales, transactions and profits increased for the trial stores.

Yum believed the results would be even stronger if the trial was expanded to a national strategy because of the impact of national marketing. Additionally Yum conducted financial modelling on a store by store basis to determine the impact on franchisees.  The matter was given serious discussion among Yum’s senior executives including the risks of the strategy on “outlier businesses” in particular and the level of increased sales these would need to maintain profitability. Ultimately Yum decided it was a strategy in the best interests of the Pizza Hut system.

Yum also considered that if no action was taken, brand performance would worsen and the risks to Yum and the franchisees of not implementing the strategy outweighed the risks of implementing it. Yum also submitted that the success of the strategy would be evaluated overtime and like any business decision changes could be made as necessary.

On the basis of the evidence submitted by Yum as to the effort it has put into developing and trialling the “Reduced Price Strategy”, the Court rejected the franchisee’s basic accusation which was that Yum was acting solely in its own financial interests to increase its royalty revenue, at the expense of, and without any proper or reasonable regard for the interests of, the franchisees in maintaining the profitability and asset values of their franchised businesses.

In fact the evidence showed that Yum believed, and continues to believe, that it is acting in the financial interests of all parties to the franchise agreement and with a proper view to maintaining the profitability of the franchisees’ businesses as a whole.

As to whether Yum had failed to co-operate in good faith with the franchisees, the Court said any such duty did not give the franchisees a “right of veto over a pricing strategy” where the franchise agreement expressly provides that franchisees must not sell products in excess of the maximum retail prices advised by the franchisor.

The care which Yum took in developing the strategy shows it was not one which was invented capriciously or arbitrarily and demonstrated that Yum was acting in good faith with the intention of advancing the interests of all parties. Further franchisees were involved in the process of developing the strategy although it was agreed, not in any detail.

The franchisees submitted the basis of Yum’s modelling was unreasonable and wrong because it did not factor in a reasonable return on investment for the franchisees. Yum’s response was that even if the modelling turns out to be wrong it does not mean Yum has breached the implied duty of good faith or is guilty of unconscionable conduct.

The court agreed and said the question is whether Yum has failed to act reasonably and honestly in the performance of its duties or failed to act in good faith, not whether it has adopted a financial model with which the franchisees disagree.

The court considered that the 80 franchisees had a weak case and the balance of convenience (which is what is assessed in an application for an injunction) did not favour the granting of their injunction. Relevant to the court’s decision to reject the injunction and allow Yum to implement its Reduced Price Strategy were the following factors:

  1. The evidence that there has been a continuing deterioration in the overall profitability and brand recognition of the Pizza Hut business, suggesting that something at least needed be done.
  2. There were about 130 other franchisees who are not parties to the proceedings and who, on Yum’s evidence, would be adversely impacted by Yum not being able to introduce the Reduced Price Strategy,. The impact on these third parties was an important consideration.
  3. Even if the strategy would have a material detrimental impact on the applicant franchisees, the extent of this would depend on how long the strategy operated and the court accepted Yum’s submission that it would act rationally in responding to how the strategy works in practice.
  4. That damages (financial compensation) would be an adequate remedy for any franchisee who suffers loss as a result of the introduction of the Reduced Price Strategy if it is established at trial that the strategy was implemented in breach of any obligation of Yum under the franchise agreement or the unconscionable conduct provisions of the ACL.
  5. An order restraining Yum from implementing the Reduced Price Strategy would be inherently impractical and inconvenient and the effect of an injunction in this form would be to prevent Yum, as a market participant, from competing effectively on price with significant potential adverse impacts.

Update:

Since the injunction hearing above, a class action has been reportedly filed by Diab Pty Ltd, a company owned by Sydney Pizza Hut franchisee Danny Diab, against Yum in the Federal Court on August 12.

The franchisees are seeking damages from Yum to cover the profits they say they have lost since the Reduced Price Strategy was introduced on July 1.

A directions hearing has apparently been set for October 3 and the court has given the franchisee group members until October 28 to opt out of the action.