Australia: Duty of franchisor to franchisee in setting a maximum price for products under a franchise agreement

Last Updated: 11 April 2018
Article by Mathew Deighton and Joey McKenzie

IN BRIEF - APPEAL DISMISSED IN PIZZA HUT FRANCHISEES CASE

In a recent decision of the Full Federal Court in Virk Pty Ltd (in liq) v YUM! Restaurants Australia Pty Ltd [2017] FCAFC 190, the Court held that a franchisor was not in breach of implied contractual duties of good faith and reasonableness and did not act unconscionably in setting maximum prices for products under a franchise agreement.

The Court considered that, although there were implied terms of good faith and reasonableness in the franchise agreement, it was not necessary for these terms to be considered independently and the franchisor was not obliged to act reasonably in an objective sense.

The Court also determined that there was no foundation for an alleged duty of care upon which franchisees could substantiate a claim of negligence.

PIZZA HUT FRANCHISEES BRING CLAIM AGAINST YUM ALLEGING BREACH OF CONTRACTUAL DUTIES, NEGLIGENCE AND UNCONSCIONABLE CONDUCT

In June 2014, Yum! Restaurants Australia Pty Ltd (Yum) decided to implement a business strategy (value strategy) for its Pizza Hut franchise, which included setting new maximum prices on pizza. The value strategy was met with resistance from franchisees, who believed they would not be able to survive financially if the value strategy was implemented.

Through a representative, the franchisees brought a claim alleging breach of contractual duties, negligence and unconscionable conduct. The case, at first instance, failed. On appeal, a new representative of the franchisees clarified the claim contended at first instance and argued that:

  • a tort-like test of reasonableness should be implied into the International Franchise Agreements between Yum and the franchisees
  • Yum failed to act reasonably in adopting the value strategy and setting the maximum prices
  • the primary judge erred in concluding that Yum was not liable in negligence, and
  • the primary judge erred in concluding that Yum was not liable for unconscionable conduct

CONTRACTUAL DUTY AND THE NOTION OF REASONABLENESS

The Court found that under the franchise agreements there were implied duties of good faith and reasonableness. However, the Court rejected the appellant's submission that, when examining this obligation, "the notion of reasonableness is to be viewed distinctly from the obligation of good faith" (at [164]). Rather, the obligation is to be considered "in a composite and interrelated sense" and the primary component of the obligation is good faith (at [164]).

Further, the Court stated that "reasonableness is not to be approached in a case such as this as akin to a tortious duty to exercise due care and skill or to produce a reasonable outcome." The Court then clarified that, in the application of this implied term, reasonableness is determined by reference to the quality of the conduct (Ibid.).

Taking into account that Yum's primary objective was the success of the Pizza Hut franchise against a direct competitor, and the processes Yum undertook in creating, trialling and implementing the value strategy, the Court found that the conduct of Yum in implementing the strategy was not unreasonable.

NEGLIGENCE - DID YUM OWE PIZZA HUT FRANCHISEES A DUTY OF CARE?

The franchisees also alleged that Yum owed a duty of care in exercising its discretionary power under the franchise agreement to set maximum prices of products, and that when setting maximum prices Yum had a duty to ensure that the franchisees could make, maintain or increase profits.

The Court agreed with the primary judge's finding that there was no foundation for the alleged duty of care, as "the alleged duty of care is consistent with the contractual relationship between Yum and the Franchisees" (at [287]). The franchisees contracted with Yum for the right to participate in Yum's system, not for the provision of services by Yum to them. As there was no existing duty of care, the Court found that it was therefore unnecessary to consider the question of breach.

3 TAKEAWAYS FOR FRANCHISORS AND FRANCHISEES

  1. This decision highlights the distinction between the definition of reasonableness under tort law and under contract law, and also affirms the implied terms requiring good faith and reasonableness when executing a contract are a composite obligation that must be assessed by reference to the quality of the conduct.
  2. The decision also indicates that franchise agreements do not automatically give rise to a duty of care on the part of the franchisor, especially where the contractual relationship under the franchise agreement is inconsistent with the imposition of care.
  3. Finally, the decision demonstrates that the implementation of a business strategy by a franchisor which presents risk to its franchisees is not, in itself an unconscionable action, particularly in circumstances where the franchisees are warned of the risk, the business strategy is well-planned and well-executed, and external factors such as the competitive market environment makes the associated risk necessary to ensure the overall success of the franchise.
Mathew Deighton Joey McKenzie Jasmine Zamprogno
Franchising
Colin Biggers & Paisley

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