Could Your Business Be Ruined by a Bright Idea of Your Franchisor?

In 2014 a national pizza restaurant chain (consisting of a franchisor and many franchisees) was experiencing declining sales and was looking for new ways to expand its business. It trialled a new "value strategy" in the ACT where pizza prices were permanently reduced by as much as 40%. This was done to increase sales and profitability in the long run. This trial produced promising results, and was rolled out to all the other franchisees nationwide.

Numerous franchisees saw their businesses collapse and many others incurred substantial losses as the pizzas were sold at a loss. Franchisees could not lift their prices as their franchise agreements stated that the franchisor has the power to set the maximum prices. As losses mounted, a group of 190 franchisees took the franchisor to Court to recover their losses. They argued that the franchisor had been negligent in its design of the value strategy.

The Court found that the franchisor had not been negligent, as the franchisor had researched the price cutting strategy by trialling it in the ACT before the national rollout. Furthermore, when looking at the franchise agreement, the Court found that it included conditions which made it clear that profit was not guaranteed to the franchisees. It also found that the franchise agreement gave the franchisor the exclusive power to change pricing and products from time to time.

As the value strategy was created to generate increasing profits in the long run, it was found the franchisor did act properly and was not negligent even though it had driven a number of its own franchisees broke.

Entering into a franchise agreement can be a risky undertaking. You should always seek to determine the rights and obligations of each party before entering into one. Understanding the inner workings of the agreement before it is signed is crucial to minimising the risks of lengthy disputes or costly losses.