Legal Insights

Chicken Wars: Nando's franchisees strike back

• 05 April 2017 • 9 min read

A key case on the obligation of good faith and the prohibition of unconscionable conduct interconnecting with franchising and franchise agreements

Last year’s Pizza Hut decision finally provided some guidance as to how – in the context of a roll out of a new national marketing and pricing strategy – the obligation of good faith and the prohibition of unconscionable conduct interconnect with franchising and franchise agreements. Fortunately for franchisors, the decision was very much in their favour, putting considerable emphasis on the parties’ express powers and obligations under their agreements and the impact that the agreements have on limiting the application of good faith and unconscionability. A new matter before the Supreme Court of Victoria, involving fast food franchisees and their objections to the roll out of a store refurbishment and re-branding strategy, will further develop the law in this area, providing guidance and greater certainty to the sector.

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Background

Three Nando’s franchisees (Franchisees) are claiming against Nando’s Australia Pty Ltd (Franchisor) seeking damages, injunctions and declarations of invalidity, following the Franchisor demands to refurbish their restaurant premises. Following the Franchisees’ refusal to refurbish their restaurants, the Franchisor terminated the franchise agreements as a result. However, the Franchisees have claimed that the restaurant refurbishments were too expensive and that the Franchisor’s termination on the basis of their failure to refurbish was invalid. Their claims rest on allegations by the Franchisees that the Franchisor breached the Franchise Agreements, failed to act in good faith and engaged in unconscionable conduct.

Under the Franchise Agreements, the Franchisor is entitled to require (in the Franchisor’s reasonable discretion) that the Franchisee refurbish their respective restaurants at their own cost. The Franchise Agreements between the Franchisor and three Franchisees were either due to expire or were continuing (though with obligations to upgrade the restaurants in their licenses to occupy the restaurant premises). Each Franchise Agreement also requires that the Franchisee maintain ‘the high standards required by Nando’s… including the maintenance and appearance of the Premises’ and use ‘only such décor, equipment, fixtures, fittings and furnishing as are approved by Nando’s and attend to the design and layout of the Premises as directed by Nando’s’.

In 2015, the Franchisor embarked on a programme to upgrade all of the restaurants and sites in their system to meet what they saw as changing conditions and customer needs in the fast food sector. From the Franchisor’s point of view, the refurbishments were intended to be part of a strategy to deliver consistent standards and branding across the network, maintain existing customers and to attract new customers. It is common ground that the restaurants in question have not been refurbished in several years. The refurbishments required Franchisees to undertake and pay for upgrades to their restaurants to different standards depending on the restaurant. The estimated refurbishment prices for the Franchisee’s restaurants ranged from $207,248.36 (at the Narre Warren restaurant) to $549,992.19 (at the Braeside restaurant).

The Franchisees refused to undertake and pay for the upgrades on the basis that they were too expensive and had not been negotiated with the Franchisees prior to implementation. Eventually, following (at least according to the Franchisor) meetings and discussions, the Franchisor issued breach notices requiring the Franchisees to agree to the works. The Franchisees did not comply with those notices and the Franchisor then issued termination notices and attempted to re-enter and take possession of each of the restaurants. The Franchisees sought and obtained injunctions against the Franchisor restraining it from acting on the termination notices and permitting the Franchisees to continue to operate their restaurants while the Court determined the underlying dispute.

Contentions

The Franchisees allege that:
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the Franchisor:
- failed to negotiate with the Franchisees as to the cost of the restaurant refurbishments
- failed to remind the Franchisee to exercise its option to renew its lease in writing
- trespassed on the Franchisee property by taking possession following termination of the Franchise Agreement
by acting in this manner, the Franchisor had engaged in unconscionable conduct and breached the implied duty of good faith.

Relevant legal principles

The case has some similarities with a decision of the Federal Court in February 2016, involving Pizza Hut and several of its franchisees. In Diab Pty Ltd v YUM! Restaurants Australia Pty Ltd (known as the Pizza Hut decision), the franchisees contended that, in imposing a new pricing regime (involving franchisees selling pizzas at a cut price of $4.95 connected with a new marketing strategy), the franchisor had breached an alleged implied obligation to ‘guarantee’ that the franchisees make a profit and, further, were acting in bad faith and unconscionably. Click here for our detailed article analysing this case.

No guarantee of short term profit

In determining the case, the Federal Court ruled that the Franchise Agreements did not contain a ‘guarantee as to profit and that, at best, it could be said that the object of the Pizza Hut Franchise Agreements was to enable the franchisees reasonably to have the opportunity to run a profitable operation. In assessing the new pricing regime and marketing strategy, the Court ruled that:

the franchisor believed, rightly or wrongly, but reasonably, that Pizza Hut had no choice but to implement the cut price strategy due to market forces
even though the franchisor was not obliged to consult with the franchisees in the implementation of the cut price strategy, it did so
the franchise agreement did not require that franchisees be entitled to turn a profit on every single product
the franchisor made a decision in good faith by balancing all the evidence at its disposal, which it believed would promote the future profitability of its franchisees.

Conduct not unconscionable

The Pizza Hut franchisees also claimed that the decision to cut prices was unconscionable. That claim was not made out, as unconscionable conduct requires more than mere unreasonableness, extending into the realm of serious dishonesty and intentional exploitation of a disability. The franchisees’ key allegation that the decision to cut prices was made for the purpose of benefitting the franchisor’s US parent company was not made out. Further, even if that allegation had been made out, the decision was, in any event, reasonable.

The extent of the good faith obligation

While the definition is not settled, a failure to act in good faith has been made out in circumstances where a party has acted dishonestly, unreasonably, maliciously, capriciously or for an improper purpose. A duty of good faith does not, however, require that a party subrogate its own interests to those of a counterpart. Given the evidence as to why Pizza Hut embarked on this new strategy, Pizza Hut did not breach its' duty of good faith to its franchisees.

Our analysis

The case as currently pleaded by the Franchisees is very weak, but that’s not to say that there isn’t a good claim in there somewhere. The key allegations on the current pleadings (i.e. failure to negotiate; failure to remind the Franchisees to exercise the option and trespass) have no contractual basis under the Franchise Agreements and little hope (without more) of succeeding on the basis of bad faith or unconscionable conduct. The Franchisees would be better placed advancing arguments based on the Pizza Hut decision and attacking the marketing strategy and the reasonableness of the restaurant refurbishments.

Right to require refurbishments

It’s very clear that the Franchisor has the ability to require that the Franchisees carry out refurbishments, fettered only by the requirement of reasonableness. However, the Franchisees don’t appear to have taken issue with the reasonableness of the refurbishments. The obvious line of attack would be that the costs of the refurbishments were too high, for example, in comparison to the Franchisee’s profits or the ability of the Franchisees to pay for the refurbishments given the length of time remaining on their Franchise Agreements. Alternatively, the Franchisees could possibly argue that the Franchisor did not have a reasonable basis for requiring the upgrades, which might rest (for example) on a lack of market research, failure to consult franchisees or a lack of analysis of the upside, as compared to the costs across the network. None of these arguments have presently been raised, nor is it clear whether the facts would support these claims.

Unconscionable conduct

This current allegation of unconscionable conduct is entirely lacking in any particulars or even any analysis and application of the various factors listed in the Australian Consumer Law. Effectively, the Franchisees merely assert that the Franchisor’s conduct in terminating the Franchise Agreements was unconscionable. The types of allegations that Franchisees might make in these types of situations are that:

the Franchisees were in a weaker position to the Franchisor having regard to the strengths of their relative bargaining positions
the refurbishments were not reasonably necessary for the advancement of the Franchisor’s legitimate interests
the Franchisor exerted undue influence or used unfair tactics in its dealings with the Franchisee
the Franchisor’s treatment of the Franchisees was inconsistent with its treatment of other Franchisees in a similar situation
a failure by the Franchisor to disclose to the Franchisees its plans regarding the restaurant refurbishments and the related marketing strategy.

Whether the Franchisor’s conduct in requiring expensive refurbishments was unconscionable is a more nuanced consideration, and will require examination of the relationship between the parties. If the Franchisor was to have required the refurbishments with no notice, with no room for negotiation and at great expense to the Franchisees, the Franchisees’ argument in favour of unconscionable conduct would be stronger. It appears, however, from the franchisor’s defence, that it made significant efforts to notify the Franchisees of upcoming refurbishments, and that meetings were held and discussions took place between the parties. The content and adequacy of these negotiations and the extent to which the refurbishments would have been financially burdensome on the Franchisees may ultimately be in dispute between the parties, but don't currently appear to be a matter of contention.

Obligation of good faith

Without an allegation by the Franchisees that Franchisor engaged in conduct that was dishonest, capricious, malicious or for some improper purpose, this part of the claim will likely fail. No such allegation has been made at the current time.

Conclusion

On the current case, the Franchisees will have a difficult time establishing that the Franchisor acted unconscionably or in bad faith. Despite this, the case is worth watching as it should continue to develop the law in this area and help define the outer reaches of those obligations and their impact on detailed and sophisticated franchising arrangements. We will provide further updates of the case, as the matter progresses through to trial.