Representative proceedings were commenced by a Pizza Hut franchisee,  Diab Pty Ltd, (Franchisee) on behalf of all (apart from 11) Australian franchises, against the franchisor of the Pizza Hut brand in Australia, YUM! Restaurants Australia Pty Ltd (Pizza Hut) in the Federal Court. 

The proceedings were commenced following an unsuccessful implementation of what Pizza Hut called its “Value Strategy” in July 2014 which involved the reduction of the ranges of its pizzas from four to two and the reductions of its prices in the available ranges to $4.95 (from $9.95) and $8.50 (from $11.95).

The Franchisee argued that the implementation of the Value Strategy had directly and indirectly, due to the decrease in franchise community marketing budget, caused it loss.

The Franchisee alleged that Pizza Hut was obliged to set the market price for each pizza at a point that would enable a franchisee to make, maintain or increase profits. The Franchisee’s argued that Pizza Hut's conduct in setting the Value Strategy amounted to contractual breaches of the franchise agreements, negligence and breaches of the Australian Consumer Law.

It was not contested by the Franchisee that Pizza Hut had the power to dictate what products were to be sold and what the maximum price for those products would be. However, the Franchisee sought to have implied into the Franchise Agreement duties on part of Pizza Hut to ensure that each of those maximum prices would involve a profit for the sale of each product.

The implementation of the Value Strategy came about following a trial carried out in New Zealand and the ACT by Pizza Hut.  The Franchisee heavily criticized the trial carried out by Pizza Hut and alleged that the ACT trial was no more than a “PR exercise”  and the business modelling that was put together following that trial was not comparable due to the amount of advertising dollars spent by Pizza Hut to generate the profits seen in the trial.

Pizza Hut argued that the purpose of the implementation of the Value Strategy was to see a recovery in the previous year's decline in transactions and an increase in profitability overall for the system. However, Pizza Hut believed that the results of the implementation were greatly affected by Domino’s learning of the Value Strategy prior to implementation which resulted in Pizza Hut losing its “first mover advantage”.

While it was accepted by the Court that the object of the Franchise Agreement was to enable the franchisees to have a profitable operation, such an object did not specifically require that the maximum price, as fixed for each product, had to be profitable for each franchisee.  The Court noted that a marketing strategy may be a loss leader in the aim to have that customer return and spend more money having appreciated the quality of the product.

The Court also said that, Pizza Hut was not able to ensure that the strategy would result in a profit for each franchisee as Pizza Hut did not have the break down of sales information for each franchisee, but the Value Strategy would be permissible if Pizza Hut genuinely believed that the implementation of the strategy would see an increase in profit for the franchisees generally.

The Court did not imply the obligations sought by the Franchisee into the Franchise Agreement as the Court found the terms proposed to be implied were inconsistent with the express conditions of the Franchise Agreement. Namely, that the Franchisees did not have a claim against Pizza Hut if a promotion was not successful.  The Court said that the implication of terms to mandate that any marketing strategy would result in a profit for the sale of each product would involve the rewriting of the bargain between Pizza Hut and the Franchisee as set out in the Franchise Agreement. 

The Franchisee argued that a duty of care was owed to it by Pizza Hut to the Franchisee in exercising its contractual powers but it was noted that where a contract provided that one party may do something in its uncontrolled discretion, the law should be slow to remake their bargin by imposing a duty of care, the effect of which would be to fetter that discretion. Nevertheless, the Court considered whether Pizza Hut had acted negligently.

The Court found that a the Value Strategy was implemented on Pizza Hut's belief that it would help to reverse declining profits and result in increased profits for the Franchisees. The Franchisee failed to establish that Pizza Hit had acted dishonestly, in bad faith or with reckless disregard for the Franchisees. It followed that Pizza Hut was not found to have acted negligently.

The Court commented that what may have been a poor business judgment, with the benefit of hindsight, did not equate to a lack of fidelity to the bargain or unconscionable behavior on the part of Pizza Hut.

On those findings the Court dismissed the Franchising claims against Pizza Hut.The Franchisee’s was ordered to pay the Franchisor’s costs of the action.

It is to both franchisors and franchisees mutual benefit that strategies implemented are profitable. However, in business, sometimes strategies implemented are not a success due to a variety of factors. The failure of a strategy does not by itself give rise to a cause of action against a franchisor. Prior to commencing proceedings advice should be sought to assess the prospects on any such action and recause to others means of dispute resolution considered.