Late last year, Diab Pty Ltd, a franchisee of Pizza Hut, and several other franchisees, brought a class action claim against their franchisor, Yum! Restaurants Australia Pty Ltd, claiming they had breached the franchise agreement by requiring them to enter into a new ‘Value Strategy.’ This article discusses this case and provides recommendations for franchisors in light of the court’s decision.

So What Happened? 

Yum! announced its Value Strategy in June 2014 and required franchisees to reduce the ranges of pizza offered to customers, from four to two, leaving only ‘Classics’ and ‘Favourites’. It also required that the price of ‘Classics’ pizzas would be reduced from $9.95 to $4.95, and for ‘Favourites’ from $11.95 to $8.50.

Diab owned and operated 6 Pizza Hut outlets in south-western Sydney and was having great success in the region before the Value Strategy was implemented. Their claim effectively relates to the idea that Yum! was obliged to set profitable prices for the franchisees and that in any event, they were subject to implied duties in the franchise agreement. 

Namely, an obligation to cooperate with franchisees to achieve the objectives of the franchise agreement, and an obligation to comply with the standards of conduct that are reasonable when considering the interests of the franchisor and the franchisees under the contract. Diab also claimed that Yum!’s actions amounted to negligence and unconscionable conduct under the Australian Consumer Law.

Yum! had decided to implement this Value Strategy after conducting trials in New Zealand and the ACT. They alleged that the tests had resulted in a significant increase in sales revenue for those outlets. Yum! contends that the Value Strategy was part of an integrated marketing campaign that was designed to go along with a change in menu design and a simplified pricing method. It was aiming to be the first to market the ‘$4.95 pizza all day every day’. The results of the trials in the ACT showed there would likely be a 48% sales improvement for most franchisees. Diab, on the other hand, claims the implementation resulted in a significant decline in sales and profitability for its 6 locations.

Part of this disappointment in the Value Strategy has to do with the actions of Dominos. They launched their own ‘$4.95 pizza all day every day’ before Yum! could do so and was then forced to go ahead with it a week later. Dominos’ actions severely impacted on the success of the marketing campaign Yum! was able to conduct, since Dominos had already beat them to it. This resulted in poor results of the Strategy and clearly left the franchisees in dismay.

The Court’s Decision

When considering the facts around Yum! implementing the Value Strategy, the Court had to consider whether they had breached their obligations under the Agreement, or had committed negligence, or breached the Australian Consumer Law.

In the end, the Court held that the object of the franchise agreements was to allow Diab and the other franchisees to have the opportunity to run a profitable business. There was no requirement for Yum! to ensure that all franchisees would be profitable, also noting that a clause in the agreement specifically allowed Yum! to determine pricing strategies and they did not guarantee any strategies or campaigns would be profitable.

The Court also held that Yum! had in fact considered that implementing the Value Strategy would be the best way forward for the franchise system to remain profitable in the future. They had consulted the franchisees before the implementation and had made the decision to move forward with the strategy reasonably and in good faith considering all of the facts.

Finally, in regards to the arguments about negligence and unconscionable conduct, the Court held that both of these claims did not stand up. Yum! did not owe the franchisees a duty of care in respect of providing services to them under the agreement or to avoid causing economic loss and they did not act in bad faith or with disregard of the franchisees.

Consequences for Franchisors

As a result of this decision, franchisors can rest easy knowing that they are not required to ensure that all of their franchisees make a profit as a result of a new strategy or campaign. It is important to ensure the franchise agreement is drafted in such a way to limit the franchisor’s liability as much as possible in this regard while still maintaining the requirements to act reasonably and in good faith.

It is important that franchisors trial and test any new strategies to ensure they are feasible before implementation and to satisfy their obligations under the Agreement, and the Franchising Code of Conduct. It is also worthwhile to consult with franchisees throughout the process to ensure there is open communication and the franchisor will be aware of how the strategy will affect the franchisees. Questions? Get in touch with our franchise lawyers on 1300 544 755.

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