Pizza wars, the $4.95 pizzas they spawned and the allegedly disastrous impact on Pizza Hut franchisees, is about to be put on trial in a case that will put the $170 billion franchise sector on edge.
The appeal lodged in the Federal Court of Australia will be heard next month, and up to 90 per cent of Pizza Hut franchisees are backing the class action by liquidator Bob Jacobs at Auxilium Partners.
Pizza Hut franchisees are hoping to take the company for $80 million.
It comes as the relationship between franchisees and franchisors has come under the spotlight, and legislative reforms are set to be introduced that would make franchisors jointly responsible for workplace abuses if they have significant control or influence on the franchisee.
Not surprisingly, the Franchise Council of Australia is fighting to water down the legislation. It will also be keeping an eye on the latest litigation.
The legal action came about after Jacobs was appointed liquidator to three entities that held Pizza Hut franchisees after Pizza Hut franchisor US giant Yum! allegedly requested its franchisee network slash the cost of pizzas up to 50 per cent in July 2014 in response to Domino’s dropping the price of its pizzas.
A class action ensued in August 2014, alleging unconscionable conduct, losses and business collapses as a direct consequence of orders from Yum! to halve pizza prices.
But the case was lost in 2016 and months later Yum! sold the Pizza Hut business to private equity operator Allegro, which has embarked on a strategy to reinvigorate demand and take on Domino’s.
It has also bought another franchised pizza chain Eagle Boys, which got into strife due to fierce competition and questionable strategies.
There is no doubt pizza is a tough business. The $4 billion industry has faced savage competition in the past few years with low-priced pizzas introduced to the Australian market by the biggest network Domino’s, which was able to take market share from its rivals.
But the strategy is about to hit the headlines again with a decision by Jacobs to appeal the case. Yum! was unavailable for comment.
Jacobs stumped up $50,000 of his own money to file the appeal after failing to get backing from a litigation funder.
Instead he successfully filed an application with the Australian Taxation Office for an indemnity available to Trustees and Liquidators (insolvency practitioners) under The Financial Management and Accountability Act 1997.
Put simply it is a transfer of wealth … When this occurs, franchisees who have families to feed, and financial institutions to pay, resort to any means to stay alive and that may include under paying staff, working inhumane hours whilst receiving little or no compensation themselves to keep the business alive, whilst at the same time the franchisor uses its power under the contract to ensure its substantially enhanced fees are paid.
The three companies – representing eight Pizza Hut stores – Jacobs acts as liquidator for owe the ATO $1.5 million, making it the biggest creditor. In a sworn affidavit, Jacobs says a “reasonable” estimate of the total debt owing to the ATO as a result of the failure of 42 Pizza Hut entities is more than $10 million.
The case will be heard on May 15 with Allan Myers QC representing the franchisees.
At the heart of the appeal is that franchisors exert a significant degree of control over franchisees in the running of their businesses and that it is therefore in everyone’s interest, including staff and the creditors (ATO) and therefore the public as taxpayers who eventually end up paying for the “value strategies” launched by Pizza Hut in 2014.
This has resulted in lost revenue for the ATO, while the franchisor, Yum!, exited and the franchisees are left to pick up the pieces.
Jacobs argues it is up to legislation ( proposed amendments to Fair Work Act are already in play to create new requirements for the franchising sector) and the rule of law to ensure that franchisors’ pick up the cost instead..
There’s a lot at stake, besides a potential damages bill of between $40 million and $80 million.
The franchise sector is estimated to be worth $170 billion and there are a number of big players who operate in it, including McDonalds, 7-Eleven, Caltex, Domino’s and KFC.
If the appeal is a success it will set a precedent for franchisors, particularly that they are culpable if the strategies they set wreak havoc on their franchise network.
Until now, the balance between franchisees and franchisors has been tipped in favour of the franchisor, and some franchisees liken the relationship to indentured slavery.
Some blame rampant underpayment of wages on flawed business models pushed on them by franchisors. There are a string of big franchise businesses that have become embroiled in wage fraud scandals, including Caltex, Domino’s, 7-Eleven, United Petroleum and Pizza Hut.
Former Pizza Hut franchisee Danny Diab, who was the lead litigant in the original claim against Yum!, wrote to the Minister for Revenue and Financial Services Kelly O’Dwyer in 2015 saying “the franchisor and the franchisee relationship is governed by inflexible franchise contracts written by the franchisor and confer significant power over the contract to franchisors which can be exercised arbitrarily”.
The letter, obtained by Fairfax Media, outlines the legal action, how franchisees tried to obtain an injunction to stop Yum! forcing them to sell pizzas at $4.95, and why it ended up in a class action.
“History shows, Yum!’s sophistication and superior legal representation was successful in quashing the injunction application,” it says. “Yum! proceeded with forcing the price drop on all franchisees across the country despite desperate pleas by the franchisees asking Yum to reconsider their decision.”
In the letter Diab says he spent more than $2 million in legal fees and was required to put up a further $1.5 million as security for Yum!’s costs.
He said the decision to set a maximum price so low, if it were successful, would have increased sales revenue significantly.
“Put simply it is a transfer of wealth from one party to the contract to the other being a franchisor, with all the risk being borne by the franchisee.
“When this occurs, franchisees who have families to feed, and financial institutions to pay, resort to any means to stay alive and that may include underpaying staff, working inhumane hours whilst receiving little or no compensation themselves to keep the business alive, whilst at the same time the franchisor uses its power under the contract to ensure its substantially enhanced fees are paid,” he says.
Going up against franchising giants with deep pockets isn’t for the faint hearted. But until the balance of power shifts, there aren’t many alternatives.