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Good faith, reasonableness and $5 pizzas

Virk Pty Ltd (in liq) v YUM! Restaurants Australia Pty Ltd [2017] FCAFC 190

GOOD FAITH AND REASONABLENESS is an implied obligation built of two components. However, according to the Full Court of the Federal Court, these components are not entirely independent considerations, and to a large extent inform one another.

In the well-known class action case, YUM! Restaurants, the franchisor of the Pizza Hut franchise in Australia, adopted a business strategy as part of which it exercised its discretionary power under its franchise agreement with each franchisee to set the maximum price for pizzas. The strategy reduced the number of ranges of pizza from four to two, and significantly reduced prices across the two remaining ranges.

The move was opposed by a large number of franchisees, concerned that their financial survival would be made more difficult by lower prices – a concern that was ultimately justified as the strategy failed to reverse a trend of diminishing profits.

Source: Pexels

At first instance, Justice Bennett found that YUM! had acted honestly despite the consequences of the strategy, having considered the results of similar price changes in other markets, tested the strategy on a small scale in the ACT and modelled potential outcomes prior to exercising its contractual power.

On appeal it was argued that her Honour’s finding of honesty and an absence of bad faith did not dispose of the matter, and that her Honour erred in applying a subjective rather than objective standard of reasonableness when considering the implied duty of good faith and reasonableness that attached to the exercise of the price setting power. Neither argument succeeded.

The Full Court made clear that the obligation of good faith and reasonableness ‘is to be considered in a composite and interrelated sense’ (at [164]). In this context, ‘reasonableness’ was not to be approached separately as importing a tort-like obligation of due care and skill (see [164], [192]). Rather, it described the quality of the decision-making conduct – assessing whether it was ‘capricious, dishonest, unconscionable, arbitrary or the produce of a motive which was antithetical to the object of the contractual power’ (at [164]).

The decision means that where an obligation of good faith and reasonableness is implied into a franchise agreement, it does not import a requirement that business decisions made under the agreement be reasonable in a distinct objective sense. The decision of the Full Court suggests that if the exercise of a contractual power is deemed to be in good faith, it will at the same time be necessarily reasonable, and vice-versa.

Ultimately, a win for franchisors but not for franchisees.

To read the full judgement, follow this link – http://www.judgments.fedcourt.gov.au/judgments/Judgments/fca/full/2017/2017fcafc0190

Catchwords:

  • Franchise agreement
  • Good faith and reasonableness
  • Reasonable
  • Implied obligation
  • YUM!
  • Pizza Hut