In this case, the Full Federal Court considered the scope and operation of an implied term of good faith and reasonableness in restricting the exercise of a franchisor’s discretion to set prices.  It concluded that a requirement of reasonableness was not separate to an obligation of good faith and required a focus on behaviour in exercising the discretion rather than the outcome of the behaviour.

A number of Pizza Hut franchisees (Franchisees) claimed that the Pizza Hut franchisor YUM! Restaurants (YUM) had breached its implied obligations of good faith and reasonableness when it exercised its contractual power to set the price of pizzas down from $9.95 to $4.95 for pick up and delivery.   

The trial judge agreed that YUM’s discretionary power to fix maximum prices was subject to an implied obligation that it be exercised honestly and reasonably and with reasonable cause.  However, on the facts, the trial judge found that YUM had not acted “dishonestly", or in bad faith or with reckless disregard” for the Franchisees. 

The Franchisees did not dispute the findings that YUM had acted honestly but argued that the maximum prices set and the methodology applied in constructing those prices, when considered objectively, were each unreasonable. In other words, the Franchisees argued that good faith and reasonableness were distinct concepts and the finding of lack of dishonesty did not dispose of the matter.

In upholding the trial judge’s conclusions finding that there was no implied obligation for YUM to ensure profitability for the Franchisees, the Full Federal Court explained:

  • the implied obligation of good faith and reasonableness is to be considered in a “composite and interrelated" sense.  Consideration of the reasonableness of a party’s conduct is directed to the primary component of the obligation, namely good faith;
  • reasonableness is not to be approached in terms of producing a reasonable outcome.  Rather, it goes to the quality of the conduct (in this case, the exercise of the price setting power) to determine whether it was "capricious, dishonest, unconscionable, arbitrary or product of a motive which was antithetical to the object of the contractual power".  Conduct with any of these qualities could never be said to be in good faith; and
  • conversely, where there is a finding of good faith (or a finding that there was an absence of bad faith) in connection with the exercise of a contractual power, then the exercise of the power must also have been reasonable.