Virk Pty Ltd (In Liquidation) v Yum! Restaurants Australia Pty Ltd

[2018] HCATrans 88

[2018] HCATrans 088

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
  Sydney  No S315 of 2017

B e t w e e n -

VIRK PTY LTD (IN LIQUIDATION) ACN 132 822 514

Applicant

and

YUM! RESTAURANTS AUSTRALIA PTY LTD ACN 000 674 993

Respondent

Application for special leave to appeal

KIEFEL CJ
BELL J
GAGELER J

TRANSCRIPT OF PROCEEDINGS

AT SYDNEY ON FRIDAY, 18 MAY 2018, AT 9.00 AM

Copyright in the High Court of Australia

MR A.J. MYERS, QC:   May it please the Court, I appear with MR T.D. CASTLE for the applicant.  (instructed by Levitt Robinson Solicitors)

MR N.C. HUTLEY, SC:   If your Honours please, I appear with my learned friends, MR K.L. ANDRONOS, SC and MR S.A. KEIZER, for the respondent.  (instructed by Webb Henderson)

KIEFEL CJ:   Yes, Mr Myers.

MR MYERS:   The application concerns a contractual power which was exercised honestly but not reasonably.  The franchising industry is built upon contractual relationships in which the franchisor controls the conduct of the franchisee’s business through the exercise of contractual powers.  In this matter, the power concerned the maximum price at which certain pizza products would be sold by Yum’s, approximately 200 Pizza Hut franchisees. 

The Yum model indicated that the introduction of a $4.95 value strategy, as it was called, would be profitable for its franchisees if the market leader, Dominos, did not react with TV advertising of pizzas at $4.95 so as to remove from Yum’s franchisees the first mover advantage of introducing $4.95 pizzas.

The Yum value strategy revealed that the reduction of price on about 50 per cent of the pizza products sold by its franchisees to $4.95 would be profitable if there was a 34.5 per cent increase in transactions.  Yum, through a Mr Houston, its Chief Executive, concluded that Dominos would not react immediately because he, Mr Houston, did not believe Dominos had reacted in an ACT test of the value strategy.  Mr Houston was completely wrong about that fact, whether there had been a reaction, that is a response, by Dominos in the ACT test, but he was honestly so. 

Thus, Yum’s value strategy lacked a reasonable basis for the revenue assumption upon which it was based.  We accept, in this Court, that the cost assumptions of the Yum model were correct and the only issue is the validity for reasonableness of the revenue assumption.  That is the single crucial issue.

KIEFEL CJ:   These proceedings below, though, Mr Myers, have proceeded upon an assumption on the part of both parties that good faith and fair dealing is the term – or an obligation to be implied in contracts.  I know that that is consistent with the approach of some intermediate appellate courts but it is not something that this Court has decided.  The Royal Botanic Gardens v Domain Trust Case, it was pointed out that if a matter proceeds upon this assumption before the court it is not appropriate for this Court to determine it.  I think we might be in the same territory.

MR MYERS:   Your Honour, my client before the judge at first instance and before the Full Court proceeded on the basis that there was to be implied two terms, as I understand it - the secondary term I will leave aside - but one was that the exercise of powers was to be in good faith and reasonable.  It was a two‑pronged implication of the term – or it was an implication of the two‑pronged term and that is what the Full Court proceeded – the basis upon which the Full Court proceeded.

KIEFEL CJ:   But the point is that proceeding upon an assumption that there is even that – those duties to be implied in a contract puts this Court in a position where it has no arguments put before the courts below about whether such a term should be implied and we have nothing from the Full Court where the challenge is maintained.

MR MYERS:   Well, below, in the Full Court, the contentions – I was not there, I say that at once ‑ from reading the decision that was put was that there were two – I have put it as a two‑pronged test, one of good faith and the other of reasonableness.

BELL J:   I think at application book 295, paragraph 156, one has an account of the basis upon which the matter was conducted below, both parties accepting an obligation of good faith and, as it were, the composite obligation, I think, of good faith and reasonableness you were contending for the implied term of objective reasonableness.

MR MYERS:   Yes, and that is what - we were putting below what turned out to be - I will call it the “Braganza test”, that reasonableness is found in the quality of the outcome and at page 344 ‑ ‑ ‑

KIEFEL CJ:   Something of a retrospective approach to reasonableness.

MR MYERS:   No, not retrospective, but I am saying it has turned out that way.  This is, in effect, what we put.  This is at 343, paragraph 15:

The discussion of principle in Australia is similar to that which has occurred overseas.  In Braganza . . . “Reasonableness is an external, objective standard applied to the outcome of a person’s thoughts or intentions . . .” -

It was said by the Supreme Court in the United Kingdom that that statement was correct.

GAGELER J:   How is it different from the tort‑like test of reasonableness that you say it is not?

MR MYERS:   Just to make sure I understand your Honour’s question, is your Honour saying how is it different from what I would describe as the administrative law‑type ‑ ‑ ‑

GAGELER J:   For a duty of care.  What is different about this?  I take it to be a term implied by law.

MR MYERS:   Yes.

GAGELER J:   So how is it different from a duty of care owed to the other contracting party?

MR MYERS:   Can I answer the first part of the question first?  I think the notion that an obligation to act reasonably requires a certain process to be undertaken which is reasonable and that includes only taking into consideration relevant facts, for example, and not taking into consideration irrelevant facts.  Well, it is possible, I suppose, that one could be entirely reasonable in one’s process and yet come to the wrong result.  I think it unlikely, so, although it is a different formulation it is likely that the outcome will be the same. 

How is it different from an obligation of reasonableness in tort?  That, I think, resides in how one approaches the question of is it reasonable in its outcome.  Someone, say a medical practitioner, might do everything reasonably in accordance with established practice and so on in undertaking a medical procedure but still the outcome could be disastrous. 

Now, in this case, we would say that if it were concluded that something should be done which did not give the franchisee a reasonable opportunity to make a profit - or franchisees in total, I accept that distinction - then, notwithstanding the nature of the process that had been undertaken by the franchisor in exercising contractual power, the contractual power would not have been properly exercised. 

KIEFEL CJ:   I think Justice Bennett understood the argument to be one akin to strict liability, so he seems to have thought it had a tortious content. 

MR MYERS:   Well, it is not strict liability in the sense - Justice Bennett made a distinction between two cases.  One was the case where the decision gives the reasonable opportunity to profit from the exercise of the franchise and the other is where the outcome is the derivation of a reasonable profit.  It is not strict liability in that latter sense and I think that was a distinction that was made by her Honour at first instance. 

That is really apparent, from memory, in the declaration or whatever it was – the appendix A to the order which, I think, is on page 172 of the court book.  Maybe one – well, one can go to it or not but what I am saying to the Court is that that was the distinction that her Honour made.  We are not arguing for strict liability in that second sense of ensuring that there is profitability but that there is a reasonable opportunity for profitability. 

We say that that should be so in the case of a franchise arrangement where the franchisor, through the exercise of a multitude of contractual powers but particularly the power, in this case, to set the maximum price at which approved products can be sold, has tremendous power over the way in which the franchisee’s business is conducted and it is not enough for a person in business, a franchisor, to be reasonable in the approach that they take to making a decision.  They have to make the correct decision. 

Incompetence should not be an excuse.  If a person has applied the correct procedures and comes up with a result that is unreasonable one is really forced to say in the ordinary case that there must be some level of incompetence there and the franchisees, who are in a very vulnerable position, should not only expect adherence to reasonable procedures but a reasonable outcome which would be the result of a competent exercise of the power.

GAGELER J:   Now, if this is a term implied by law, is it a term implied into any commercial contract or are we into only a class of commercial contracts and, if so, which class?

MR MYERS:   Your Honour, we are here dealing with this particular class of contract in a sense.  Obviously, it is a single franchise agreement but whether it is to be implied in particular contracts would depend upon the nature of those contracts in substance or that would be the most important consideration.

KIEFEL CJ:   But that would mean that you would be having regard to the intention of the parties rather than it being implied as a matter of law.

MR MYERS:   One would look at the characteristics of the contract to assist in determining the relationship between the contracting parties.  It is not an examination of subjective intention in any sense.

KIEFEL CJ:   No, imputed intention.

MR MYERS:   It depends – but it is imputed from – one reaches a conclusion about intention, whatever adjectival description it has, if it be intention by examining the characteristics of the contract. 

BELL J:   Examining the characteristics of this contract, one finds in clause 6.2 the recognition that the franchisee will not have any claim against Yum in relation to the level of success of any promotion and then one goes to the franchisee’s representation at application book 232 in subparagraph (c) in which the franchisee acknowledges that the establishment and operation of the business is attended by significant financial risks.  In the context of this agreement, where is the room for the implication?

MR MYERS:   My answer is that one looks at page 234 of the court book at paragraph C1.  The case is not concerned with 6.2 which is dealing with promotions and so forth:

MAXIMUM RETAIL PRICE

Franchisee 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.

We apprehend it is that power that is being exercised, although, in relation to other powers, there are some words that suggest that there shall not be a claim or action against the franchisor, that is 6.2, but they are limited to 6.2.

BELL J:   To promotions, amongst other things.

MR MYERS:   Yes, but this is setting the price of approved products generally and that is what happened ‑ ‑ ‑

BELL J:   That is, strategy was not a promotion.

MR MYERS:   No, it was not a promotion, it was a strategy.  This was something that was going to apply to the whole of the country for an indefinite period of time.  It was not a promotion like, for example, the test in the ACT.  Now, that would be a different kettle of fish, I concede. 

BELL J:   So, Mr Myers, factually, your case comes down to this, that notwithstanding the power conferred on Yum to fix maximum prices under the agreement, in making its decision in this case it failed to take into account one objective fact and that objective fact related to the response by Dominos to the ACT test run of the value strategy.  Notwithstanding the evidence that there were a variety of considerations that fed into the formulation of the value strategy, the failure of Mr Houston to take account of that one fact denied the exercise of the contractual power conferred on Yum.

MR MYERS:   Yes, because that was the critical fact for determining whether there would be a 34.5 per cent increase in transactions and a 35.4 per cent in transactions under the Yum model the strategy became break‑even for franchisees in general.  That meant that unless that was done – I am sorry, unless that was correct that there would be a 34.5 per cent uplift in transactions, the effect of this direction about fixing maximum price would have denied the franchisees a reasonable opportunity to make a profit. 

BELL J:   Notwithstanding unchallenged evidence, not only as to Mr Houston’s honesty but in relation to the quite elaborate consideration that had been given to the value strategy and to the view that some action had to be taken because Yum and the franchisees were losing market share, notwithstanding all of that, the failure to take into account that one objective fact, you say invites, because of the implied term, then the power of the court to, as you put it, review the consequences of the honest decision that proved to be wrong.

MR MYERS:   Yes, we do say that because we accept the soundness of the other assumptions in the strategy.  It was just one assumption, of course, but the critical assumption without which this could not be profitable.  That is the significance of it.  Of course, there were lots of other assumptions, all sorts of things about how much would be spent on advertising, what sort of get up would occur and so on and so on and so on.  But it is that fact which was critical.

BELL J:   I am raising with you perhaps the notion of the court reviewing for reasonableness the exercise of the contractual power, taking reasonableness in the objective sense for which you contend.  It has large consequences in terms of commercial life, one would think.

MR MYERS:   Taking this case, only in this regard that if the court does not undertake the task of determining whether that assumption, that single assumption is made out, then the franchisee is left exposed to any decision that is made or the consequences of any decision that is made about price and it is that single assumption that is significant.  The court’s review of the assumption does not involve making judgment decisions about what is necessary to make a business profitable, it just involves making a decision about the existence or not of a particular fact which is essential for the profitability of the business.

KIEFEL CJ:   Thank you, Mr Myers.  We need not trouble you, Mr Hutley.

We consider that on the cases pleaded the applicant has insufficient prospects of success on appeal to warrant the grant of special leave. 

There is an additional reason why special leave should not be granted.  In the courts below, the parties have assumed the existence of an implied duty of good faith and reasonableness.  This may be consistent with the approach of some intermediate appellate courts but this Court has not decided that question.  In Royal Botanic Gardens and Domain Trust v South Sydney City Council (2002) 240 CLR 45 at 63 [40] the parties had likewise accepted the existence of such an obligation. The Court said that whilst the issues respecting the existence and scope of the “good faith” doctrine are important, it was an inappropriate occasion to consider them. Because of the assumption upon which this litigation has proceeded, an appeal in this matter would be an inappropriate vehicle for the consideration of those questions. Special leave is refused with costs.

The Court will adjourn to reconstitute.

AT 9.23 AM THE MATTER WAS CONCLUDED