On 24 June 2014, Justice Jagot of the Federal Court declined to grant 80 Pizza Hut franchisees an interlocutory injunction restraining the franchisor from implementing a marketing strategy that would set maximum prices and reduce the range of products available.[i]

This decision is of significant interest to both franchisors and franchisees as it provides an insight (at least at an interlocutory stage) into the Court’s view on  whether a franchisor has acted in good faith and not unconscionably in implementing whole-of-business strategies.

OVERVIEW OF THE PROCEEDINGS

The proceedings involved an application for an interlocutory injunction by 80 Pizza Hut franchisees seeking to restrain the respondent franchisor, YUM! Restaurants Australia Pty Ltd (Yum) from implementing a sales strategy referred to in the statement of claim as the “Reduced Price Strategy” (the Strategy). 

The two components of the Strategy which were relevant to this proceeding consisted of: restricting the number of pizza products available to be sold by franchisees and specifying maximum prices for the pizzas sold by franchisees ($4.95 for the “Classic” pizzas and $8.50 for the “Favourites” pizzas, not including delivery).

The interlocutory injunction was sought by the franchisees on two primary bases:

  • Yum owed each of the applicants the following implied duties – a duty to cooperate in achieving the objects of the franchise agreement; a duty to act reasonably and/or honestly in the performance of duties and exercise of any rights, powers or discretions under the franchise agreement; and a duty to act in good faith.
  • Implementing the Strategy involved unconscionable conduct in contravention of section 21 of the Australian Consumer Law (ACL).

THE COURT’S CONSIDERATION OF THE FRANCHISEES’ APPLICATION

In considering whether to grant the interlocutory injunction sought by the applicants, the Court applied the usual test: whether the applicants had made out a prima facie case and whether the balance of convenience favoured the granting of the injunction[ii] (the latter question also including a consideration of whether damages would be an adequate remedy for the applicants).[iii]

Yum did not contest the existence of the implied duties asserted by the applicants (at least in this interlocutory proceeding) and therefore the Court’s assessment of the franchisee’s case focussed on the question of whether Yum had breached those duties or section 21 of the ACL.

Duty to cooperate

The Court agreed with Yum’s submissions that the duty of cooperation is a duty concerned with the advancement of the interests of the business as a whole. Moreover, the Court found that this duty did not extend to requiring the franchisor to grant the franchisees a right of veto over a pricing strategy. Particularly in circumstances where the Pizza Hut Franchise Agreement stated that franchisees “will not permit any Approved Products to be sold at the Outlet at any price exceeding the maximum retail prices advised by Franchisor to Franchisee from time to time”.

Duty to act reasonably and honestly

The Court decided that the process that was adopted by Yum in formulating and implementing the Strategy demonstrated a high level of care.  It was not one which was conceived capriciously or arbitrarily. The Court found that the Strategy was developed based on overseas experience in dealing with similar issues, market testing in WA and the ACT, modelling and two days of consideration by senior management. Yum was able to present documentary evidence that demonstrated that the Strategy had been developed in light of careful considerations with respect to the franchise business as whole. The Court was therefore of the view that Yum had acted reasonably.

Duty of good faith

The Court found that Yum had acted in good faith in developing and implementing the Strategy, with the intention of advancing the interests of all parties and not merely its own interests at the expense of its franchisees and that implementing the Strategy was intended to benefit the business as a whole.

Importantly, Yum had engaged with the franchisees a number of months prior to the implementation of the Strategy. Yum held meetings with franchisees around the country and presented to them on the perceived need for change in the brand’s business strategy and the testing and analysis that had been undertaken. At these presentations the franchisees were also given general details of the Strategy (the Court appeared comfortable with the high level disclosure of the Strategy and observed that confidentiality was a legitimate concern given the commercial sensitivity of the Strategy).

Unconscionable conduct

The Court noted that there was “no evidence whatsoever to suggest that Yum believed it was acting solely in its own financial interest 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 franchise businesses”.[iv] Rather, the Court observed that the evidence disclosed that Yum believed, and continues to believe, that it is acting in the financial interests of all parties and with a proper view to maintaining the profitability of the franchisee’s businesses as a whole. On the evidence presented to date, the Court was of the view that there was no basis for the allegation that Yum had acted unconscionably.

REFUSAL TO GRANT INTERLOCUTORY INJUNCTION

Justice Jagot expressed the view that the applicants’ case was an extremely weak one. In addition, from a balance of convenience perspective, he placed significant weight on the view that damages would be calculable and would be an adequate remedy for the applicants if they were successful at trial.

The Court expressed the view that the injunction sought by the applicants would (if granted) prevent Yum from competing effectively on price, with significant potential adverse impacts on the franchise network as a whole.

The Court also gave regard to the fact that there were around 130 other franchisees who were not party to the proceedings who (on Yum’s evidence) would be adversely impacted by not being able to introduce the Strategy if the injunction was granted.

For these reasons Justice Jagot refused to grant the interlocutory injunction.

THE COURT’S COMMERCIAL APROACH

Operating in the background of this dispute is the ongoing “pizza war” between industry stalwarts, Dominos and Pizza Hut, each battling over who can offer the cheapest slice of pizza. Yum’s launch of the Strategy was a bid by Yum to keep up with its closest competitor. Furthermore, Yum’s market director, Kurtis Smith, informed the Court that the Strategy was a response to “concern about a downward trend in financial performance and the steady loss of customers in the Pizza Hut business in Australia over the last 10 years”.

Justice Jagot took a highly commercial approach to assessing whether the interlocutory injunction should be granted. Despite evidence submitted on behalf of the franchisees that the Strategy could result in both the inability of the owner-managers of the franchises to earn a living and ultimately result in the failure of the franchise business, as well as the potential to damage the franchise’s brand and financial position, the Court declined to grant the orders sought. Justice Jagot took into account the evidence of Yum to the effect that Yum would act rationally in responding to how the Strategy worked in practice.

ROUND 2?

Although no date has been set for the trial of this matter, the parties are scheduled to attend a Directions Hearing on 15 July 2014.