Changing product sales strategies: The constraints on franchisors

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1 - MCW In Focus Franchsing Update Changing product sales strategies: The constraints on franchisors Alicia Hill - Corporate Recovery and Dispute Resolution Brisbane - T E ahill@mcw.com.au Jordan Rovers - CORPORATE RECOVERY and DISPUTE RESOLUTION - T E jrovers@mcw.com.au October 16, 2014 In A & A (Sydney) Pty Ltd v YUM! Restaurants Australia Pty Ltd [2014] FCA 678, the Federal Court of Australia was asked to determine whether or not to restrain YUM! Restaurants Australia Pty Ltd (YUM!), the Australian Pizza Hut franchisor, from implementing a sales strategy known as the Reduced Price Strategy (RPS). The Facts With approximately 300 Pizza Hut outlets nationally, poor financial performance and loss of customers over a 10 year period, senior executives of YUM! decided to implement the RPS, a strategy which had been successful in both the United States and New Zealand. YUM! had tested the RPS in both WA and ACT, with WA being unsuccessful and ACT successful. The key elements of the RPS were: restriction of the number of pizza products available for sale by franchisees; and imposition of maximum prices for those products. Following the WA and ACT trials, YUM! formed the view through market research and internal modelling that the RPS would address key concerns of the business including increased brand relevance through increased sales and consumption and increased franchisees profitability. As a result of disclosure of the plan to implement the RPS nationally, 80 franchisees filed an urgent application for an injunction restraining YUM! from launching the RPS. Page 1 of 5

2 The basis of the application for the injunction was two-fold: YUM! would breach the following duties implied by the franchise agreement if they were permitted to implement the RPS: duty to cooperate with franchisees in achieving the objects of the franchise agreement (Duty of Cooperation); duty to act reasonably and/or honestly in performance of their duties and exercise of any rights, powers or discretions under the franchise agreements; and duty to act in good faith towards the franchisees under and in relation to the franchise agreement and the exercise of any rights, powers or discretions including the duty to have regard for the franchisees legitimate interests in enjoyment of the fruits of the franchise agreements and not to render those interests nugatory; and Implementing the RPS would be unconscionable conduct for the purpose of section 21 of the Australian Consumer Law (ACL). Section 21 of the ACL provides that a person must not, in trade or commerce, in connection with supply of goods or services to a person or the acquisition of goods or services from a person, engage in conduct that is, in all the circumstances, unconscionable. Evidence was presented by the franchisees to demonstrate that it was likely implementation of the RPS would substantially reduce the profits franchisees are able to derive from operation of their business, which would cause loss and damage, and in the most extreme cases, loss of the franchisees business. It was estimated the monetary loss would be in the order of $10 million. Considerations for the Court The Court found it needed to answer the following questions to decide whether to injunct the implementation of the RPS: have the franchisees made out a prima facie case; and does the balance of convenience favour the franchisees or YUM!. Prima facie case Page 2 of 5 Copyright McInnes Wilson Lawyers

3 The franchisees had to show that they have a sufficient likelihood of successfully arguing that implementation of the RPS amounts to breach of the franchise agreement and/or section 21 of the ACL, to justify the Court maintaining the status quo and preventing the implementation of the RPS. The crux of the franchisees argument appeared to the Court to be that YUM! had not acted in good faith as it had not consulted with the franchisees in respect of the modelling undertaken. While the Court agreed that the modelling was not objectively reasonable as YUM! had not taken account of the rate of return to franchisees on their capital investment, it was an express term of the franchise agreement that the 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. The Court found that the franchisees had not produced evidence to suggest YUM! was acting solely in its own financial interests. In contrast, the evidence presented by YUM! demonstrated that it believed and continued to believe, it was acting in the financial interests of all franchisees with a view to maintaining profitability of the franchisees businesses as a whole. The Court found that the RPS was not invented capriciously or arbitrarily by YUM! as it was based on overseas experience, market research in WA and ACT, internal modeling and two days of deliberation by senior executives. The Court found that if there was a question to be tried it was a weak one. Balance of convenience The Court then considered whether the inconvenience or injury to the franchisees if the injunction were not granted outweighed the injury to YUM! if the injunction were granted. The Court also took the interests of third parties and the general public into consideration. In determining which party the balance of convenience favoured, the Court assessed whether damages is an adequate remedy. Damages will be an adequate remedy if the franchisees would, in all material respects, be in as good a position if they were confined to damages as they would be if the injunction was granted. In finding that the balance of convenience favoured YUM!, the Court stated the following factors Page 3 of 5

4 as critical to its determination: existence of evidence that there had been a continuing deterioration in the overall profitability and brand recognition, meant something needed to be done; approximately 130 other franchisees were not parties to the proceedings and would be adversely impacted by YUM! not being able to introduce the RPS; the extent of the detrimental impact of the RPS was dependent on how long the strategy operated and YUM! had submitted they would review the strategy s performance; damages would be an adequate remedy for any franchisee who suffers loss as a result of the introduction of the RPS if it is established at trial that the RPS was implemented in breach of the franchise agreement or the ACL; and an order restraining YUM! from implementing the RPS would be inherently impractical and inconvenient and would prevent YUM!, as a market participant, from competing effectively on price with significant potential adverse impacts steps already taken by YUM! in anticipation of implementation of the RPS including the making all media bookings, both mail drops and television advertisements. The Court noted that YUM! would still be required to incur the costs of this advertisement if they were required to cancel the bookings at this late stage. Decision As the franchisees had a weak prima facie case and YUM! had successfully demonstrated the balance of convenience tipped in their favour, the Court refused the franchisees application for an injunction, meaning YUM! could implement the RPS. In summary This case demonstrates how the Courts are likely to approach an application asking them to grant an injunction and the factors it will consider. Courts will be hesitant to grant an injunction except where the applicant can demonstrate that the damage likely to be suffered significantly outweighs the damage to the party to be restrained. While franchisees can take peace of mind knowing the Court will grant relief where a franchisor is attempting to implement policies/strategies detrimental to them, the franchisor must be acting other than in good faith. The overall impact, level of care and testing undertaken in developing the strategy are critical considerations. Therefore, franchisors should take care to consider the terms of all franchise agreements when Page 4 of 5

5 taking steps to implement new or alter existing marketing strategies. The franchisors must be able to demonstrate to a Court, if necessary, that they are acting in good faith and in what they believe is the best interests of the franchisees and the franchise system. Contact the article author for more info Alicia Hill Corporate Recovery and Dispute Resolution Brisbane T E ahill@mcw.com.au Jordan Rovers CORPORATE RECOVERY and DISPUTE RESOLUTION T E jrovers@mcw.com.au Page 5 of 5