Mark Clifford & Ors v Eagle Boys Dial-A-Pizza Australia Pty Ltd

CASES CITED : . HEARING DATES: 09/27/1999; 09/28/1999; 09/29/1999; 09/30/1999; 10/01/1999; 10/05/1999; 10/06/1999; 10/07/1999; 10/08/1999; 10/11/1999; 10/12/1999; 10/13/1999; 03/07/2000; 03/08/2000; 03/09/2000; 03/10/2000; 03/15/2000; 03/16/2000 DATE OF JUDGMENT: 04/14/2000

APPLICANT Mr J E Keesing of Counsel SOLICITORS Gells

LEGAL REPRESENTATIVES: DEFENDANT Mr R M Goot AM of Counsel SOLICITORS Stokes & Panettiere to 08/12/99 then: Nicol Robinson Halletts

INDUSTRIAL RELATIONS COMMISSION OF NEW SOUTH WALES IN COURT SESSION

Matter No IRC2014 of 1998 MARK CLIFFORD & ORS v EAGLE BOYS DIAL-A-PIZZA AUSTRALIA PTY LTD Application under s106 of the Industrial Relations Act 1996

INTRODUCTION 1 These proceedings arise out of an amended application for relief under s106 of the Industrial Relations Act 1996 ("the Act") brought by five applicants against the respondent Eagle Boys-Dial-A-Pizza Australia Pty Ltd. The first and second applicants Mark and Jannette Clifford are husband and wife. They are the sole shareholders and are directors of the third applicant Raniso Pty Ltd. ("Raniso") The third applicant entered into a franchise arrangement with the respondent to operate an Eagle Boys Dial-a-Pizza business at Springwood in the Blue Mountains region. The first and second applicants were also shareholders and directors of the fourth applicant Elksmooth Pty Ltd ("Elksmooth") and the fifth applicant Timothy Dixon was a shareholder of Elksmooth. Elksmooth operated an Eagle Boys-Dial-A-Pizza business in Katoomba pursuant to a franchise arrangement with the respondent. 2 Messrs Gells Solicitors initiated proceedings on behalf of the five applicants. However they subsequently filed a notice of ceasing to act for the fifth applicant who did not participate in the substantive hearing of this application. 3 In essence, the applicants sought findings of unfairness against the respondent with respect to the franchise arrangements, consequential orders either avoiding them or varying them and monetary compensation.

FACTUAL BACKGROUND 4 For about three years before May 1994 the first applicant operated two pizza stores in the Blue Mountains area, one in Springwood and the other at Winmalee. He sold the Winmalee store in June 1993 and moved to better premises in Springwood where that business prospered. He came to the conclusion that his business would benefit from joining a franchise operation because of the benefits in joint marketing and promotion, in group purchasing and because he thought that the take away pizza industry seemed to be moving away from independent proprietors towards franchised chains. He attended a franchise exhibition seminar in late 1993 or early 1994 where Eagle Boys Pizzas was an exhibitor. He made contact with the respondent organisation and commenced negotiations to become a franchisee. 5 Representatives of the respondent had a number of discussions with the first applicant concerning the advantages of becoming a franchisee and after considering alternative franchise operations such as Pizza Haven and Arnolds Pizza and Ribs he selected the respondent organisation. He had been given certain information by representatives of the respondent both orally and in writing covering income projections, joint buying power and the low cost of goods, marketing and the respondent's systems. 6 The third applicant entered into a franchise arrangement with the respondent with respect to the Springwood store in May 1994. The arrangement was the subject of a set of documentation, the relevant details of which I shall refer to later. 7 Initially the first, second and third applicants enjoyed a good relationship with the respondent. The trading figures of the Springwood store increased and the first applicant was pleased with its profitability. 8 Mr Clifford believed that there was an opportunity to open another store in the Blue Mountains area and discussed this with the Managing Director of the respondent Mr Tom Potter. In addition the first applicant looked at opportunities in Bowral, Batemans Bay and Kiama. 9 The fifth applicant was a customer of the Springwood store. They commenced discussions in 1994 which culminated in agreement to apply for a franchise with the respondent for a store at Katoomba. They incorporated the fourth applicant of which they were both directors and shareholders. The fourth applicant entered into a franchise arrangement with the respondent and commenced trading at Katoomba on 28 May 1995. 10 An initial franchise fee of $24,000 was paid and the fourth applicant incurred set up costs of approximately $67,000. Despite training undertaken by the fifth applicant as provided for by the respondent, the first applicant was unhappy with the fifth applicant's performance. Although the Katoomba store operated profitably upon opening, its trading performance deteriorated, as did the relationship between the first and fifth applicants. The fifth applicant left the store in December 1995 and the first applicant then continued to operate it alone. 11 Mr Clifford said that his relationship with the respondent deteriorated in the latter half of 1995. He put this down to some pressure being exerted on him by the respondent's Managing Director Mr Potter to take his brother in as a partner in a franchise operation. Whether or not this is true is, in my opinion, irrelevant for the determination of these proceedings. In any event tension developed between the parties in a number of areas, covering particularly the respondent's advertising and marketing activities, the prices set by the respondent for products produced by its franchisees, financial material provided by the respondent to the applicants, and the cost of ingredients and other goods which the applicants were required to purchase through arrangements established by the respondent. 12 The tone of correspondence and other communications between the applicants (and in particular the first applicant) and the respondent deteriorated during the course of 1996 and became acrimonious in 1997. In March 1997 the first applicant retained a solicitor. 13 Eventually, in July 1998 the applicants debadged both the Springwood and Katoomba stores. The applicants continued to trade as independent traders up until about February 1999 and then became franchisees of the Pinkies' Pizza Ribs on the Run organisation.

THE ACCOUNTANTS' EVIDENCE 14 Each side qualified expert accounting evidence. Evidence was given on behalf of the applicant by Francis John Kelly and on behalf of the respondent by Damian Francis Street. Both were sworn and gave their evidence concurrently. 15 A large measure of agreement had already been reached between the accountants but there remained in issue a number of discrete areas, which needed to be determined in the event they became relevant to the final disposition of these proceedings. 16 The first concerned the treatment which should be accorded to a management fee which was paid by the fourth applicant to the third applicant with respect to the operation of the Katoomba store for the provision of certain services rendered by Mr Clifford. Mr Street advocated that those moneys should be regarded as being part of the income of the Springwood store while Mr Kelly took a contrary view. It was necessary to determine this particular issue for the purpose of considering the calculation of the earnings before depreciation, tax and interest for the store. In order to endeavour to apply a uniform approach to both stores I determined to ignore the amount that the third applicant received from the fourth applicant by way of the provision of the first applicant's services even though the first applicant made a contribution by way of personal exertion to the activities of both stores. 17 The next issue concerned the treatment which should be accorded to interest earned by the business from the banking of the takings. Mr Kelly asserted that interest should be excluded from the earnings of each of the businesses because the businesses principally were related to the manufacture and sale of pizzas. He therefore regarded interest as being extraneous. Mr Street on the other hand regarded the interest as an incidental part of the operation of the business. I ruled that the interest earned on normal cash flow funds should be treated as a normal part of the business and therefore included within the relevant calculations to determine earnings before depreciation, interest and taxation. 18 The third issue related to the treatment which should be afforded to earnings of the second applicant who performed a variety of tasks but who appears to have been paid a fixed amount for the work performed by her. Mr Kelly was of the view that in assessing the performance of the business one should allow only for the wages of one owner/operator and that notional wages paid to a family member should be treated as such. Mr Street considered this an artificial approach, particularly when looking at the earning capacity of a business. In the sense that the accounting exercise was designed to ascertain the trend of the businesses over a particular period I rejected the approach of Mr Kelly and adopted the contrary approach as advocated by Mr Street. 19 The final issue related to whether decreases in the selling price of pizza products would have an impact on the gross profit margin of the businesses and whether this was measurable. It was assumed that there had been a slight downward trend in the gross profit margin of each of the businesses over the relevant period. Mr Kelly formed the view that a decrease in sale prices would require the operators of the business to work harder or perhaps reduce the quality of the product by reason of the quantity of the ingredients in order to maintain the same gross profit margin. Working "harder" would result in increased turnover. I should add that the figures produced by the parties relating to each business did not indicate any particular pattern with respect to each price reduction. Mr Kelly conceded that he did not have sufficient underlying data to quantify the impact of price reductions on gross profit margins. Mr Street disagreed with the approach of Mr Kelly. He calculated gross profit margin by taking sales less the direct cost of those sales excluding wages. However he conceded that there were "about sixteen factors" which could affect gross profit margin only one of which was price. Other factors included the amount of mark-up, changes in the purchase price of ingredients and other goods etc. In order to determine the matter with precision it would be necessary to know the number of units of product sold and probably the mix of those units in terms of the type of product. Mr Street said there was no correlation between the price of goods or reduction in their price and the gross profit margin and Mr Kelly was, as I have said, unable to quantify any correlation between the two. On this basis I determined that there was insufficient evidence upon which I could conclude that there was any quantifiable correlation between the price at which the goods were sold and the gross profit margin.

THE APPLICANTS' CASE 20 Ultimately the claims made by the applicants against the respondent focussed on three areas. These were:

1. The franchise agreements and documentation were overall unfair when all of the terms and conditions were taken into account.
2. The pricing regime imposed by the respondent on the applicants for the sale of product rendered the franchising agreements unfair.
3. The amount of moneys expended by the respondent and the nature of the amounts so spent by way of advertising within the areas in which the applicants' businesses operated were so inadequate by reference to the levies paid by the applicants to an overall advertising fund as to render the agreements unfair. 21 I shall deal with each of these claims in turn.

1. Overall Unfairness 22 In summary the applicants complained that the franchise agreements including all of the supporting documentation were unfair in that they were excessively complex and long, the number of fees charged by and payable to the respondent and the quantum of those fees were excessive, the respondent as franchisor was able to control the price at which the applicants sold their product, the goodwill of the businesses was transferred to the respondent so that the applicants had no benefit and there were restrictions imposed on the activities of the applicants after the termination of the franchise agreements. 23 At the commencement of the hearing the respondent through its counsel Mr Goot indicated without making any concession as to unfairness that the respondent would not rely upon or seek to enforce for any purpose or for any circumstances some of the provisions of the franchise agreements particularly those which impacted consequent upon the termination of the agreements and which would have affected the ability of the applicants to continue to trade in the businesses. 24 The applicants relied for this part of the case on an expression of opinion of David Acheson given in an affidavit filed in the proceedings. Mr Acheson was the Queensland President and National Director of Public Affairs of the Franchise Counsel of Australia and had had a great deal of experience in franchising arrangements. It was his assessment in particular that the agreements were unfair in a number of ways but particularly by reference to the number, nature and quantum of fees payable by the applicants to the respondent. The respondent relied on opinions of two experts in franchise arrangements who also swore affidavits which were tendered in the proceedings. One was Robert James McComb, a franchising consultant and the other Associate Professor Andrew Terry of the School of Business Law and Taxation, Faculty of Commerce and Economics at the University of New South Wales. Both Mr McComb and Associate Professor Terry had been involved with the respondent's business and had met Mr Potter, its Managing Director. However I am not persuaded that such an involvement as disclosed in their affidavits would per se detract from any reliance on the opinions expressed in their affidavits. Both Mr McComb and Associate Professor Terry disagreed extensively with the opinions expressed by Mr Acheson. By arrangement made between the parties the evidence of each of these three experts was to be accepted on the face of the affidavit material without regard to any oral evidence and without detailed submissions having been made by counsel about them. 25 Mr Acheson criticised the large number of fees which the respondent was entitled to charge under the franchise agreements some of which he said were highly unusual. He listed the fees as follows:

Initial Franchise Fee $20,000 Initial Advertising Fee - 4% for first 3 months, unusual Construction Consultancy Fee - $4,000, unusual Training Fee - unusual, but stipulated as nil for Springwood Franchise Service Fee - 6% and 8% Advertising Contribution - 6% Local advertising - 1% Network Service Fee - 1% - unusual Software Licence Fee - Eagle Boys may specify - unusual Mark Service Fee - $333 per annum rising by 10% pa - very unusual Supplier Goodwill Fee - $500 per annum - extremely unusual Renewal Fee - $5,000 - most franchises do not charge a renewal fee Disposal Fee - 3½% of Disposal Price plus a variable fixed sum - unusual

Mr Acheson also commented: All percentages noted above are of gross sales other than the Disposal Fee. These 12 or 13 fees are many more than normal. Most franchise systems would have only 2 or 3 fees - initial franchise fee, ongoing service fee and probably an advertising contribution. 26 The opinions expressed by Mr McComb and Associate Professor Terry were to the contrary. Although some of the fees may have been unusual they were not in the aggregate exceptional compared to their understanding of the fee structure utilised by other franchisors. 27 Having read the affidavit material to which these three witnesses have deposed, I am not persuaded that any finding of unfairness can attach generally to the nature, extent and quantum of the fees payable by the applicants to the respondent or to the other matters relied upon by the applicants in this regard. 28 There was tendered into evidence survey reports of Lorelle Frazer lecturer in Administration Management at the Department of Government, Economics and Logistics, University of Southern Queensland conducted into contractual arrangements in Australian franchise agreements and franchise fees. Whilst the information set out in both documents is of interest, I am unable to derive any information from either which would allow me to draw any conclusions about whether any relevant unfairness attaches to these franchise agreements by reference either to the contents of the agreements or the quantum of fees charged. The information contained is by necessity of too general a nature and covers such a divergent area that no safe conclusions can be drawn with respect to the particular agreements which are the subject of these proceedings. 29 Another matter adverted to by the applicants in connection with the franchise agreements was the provisions of clause 32.8 which are in the following terms: The Franchisee acknowledges that - (a) the goodwill of each Eagle Boys Outlet is the property of Eagle Boys and will inure for the benefit of Eagle Boys; and (b) if after the determination of this Agreement, the Franchisee was only prohibited from competing against other Eagle Boys Outlets within the area allocated by Eagle Boys to each Eagle Boys Outlet, then the Franchisee could, after the determination of this Agreement, establish a business that competed with another Eagle Boys Outlet, just outside the area of the relevant Eagle Boys Outlet, and effectively affect or misappropriate a significant proportion of the goodwill of the relevant Eagle Boys Outlet, and therefore Eagle Boys is justified in prescribing in clause 32.3 a restraint area that is or may be greater than the area allocated by Eagle Boys to any one or more or each of the Eagle Boys Outlets throughout Australia; and (c) each of the restraints in clause 32.3 is both fair and reasonable and that the Franchisee has received sufficient and valuable consideration for the restraints in clause 32.3 by Eagle Boys entering into this Agreement. 30 The provisions of clause 32.8 need to be considered in conjunction with Pt 33 and Pt 27. Pt 33 allows the franchisee to dispose of the franchise business upon complying with certain conditions which do not appear to me to be relevantly unfair. In addition Pt 27 sets out the effect of termination of the franchise agreements with specific contemplation that the franchisee may remain in possession of the pizza outlet provided all materials which would distinguish it as an Eagle Boys operation are removed. 31 Notwithstanding the fact that clause 32.8 prima facie declares that the goodwill of each outlet is the property of the respondent, the provisions to which I have referred do not appear to be consistent with this clause in terms of creating any particular unfairness. The situation might have been otherwise in circumstances applying to the Springwood outlet which had been operated by the applicants for some time prior to becoming an Eagle Boys outlet. If the goodwill of that outlet had been, in some way not made clear by the franchise agreement, assigned to the respondent in circumstances where the applicants would have lost the benefit of the goodwill, particularly on termination, then this would require serious consideration in terms of any unfairness. However, the remaining and prima facie inconsistent provisions of the agreement militate against a finding of unfairness in this respect. 32 These particular provisions of the agreement and the other parts of the agreement to which I have referred were not the subject of detailed submissions by Mr Keesing of counsel who appeared for the applicants and accordingly I do not propose to take this matter further. 33 Having regard to the submissions made by the parties with respect to this issue and having regard to the material upon which the applicants' claim in this area was based, I am not persuaded that any unfairness attaches to the agreements in the manner alleged by the applicants.

2. The Respondent's Pricing Regime 34 Clause 11.12 of the franchising agreements allowed the respondent to set the price at which products would be sold from each outlet. The respondent maintained a pricing policy with respect to all of its outlets which, presumably, enabled it to create consistent advertising material. 35 At first the respondent maintained a five tier pricing policy enabling five different levels of prices to be set by franchisees throughout the operation. This was presumably to allow franchisees to take into account the particular circumstances which applied to their particular area of operation. 36 There is some evidence, at least early in the relationship between the applicants and the respondent that the respondent was cognisant of the particular circumstances applying to the Springwood operation. By memorandum dated 21 July 1994 the Marketing Department of the respondent advised Mr Clifford to increase the price of his products sold at Springwood because "in essence you are operating in a market with limited competition." 37 By 31 March 1995 Mr Clifford wrote to the respondent with respect to both the Springwood and Katoomba operations asking that it not reduce the sale price for products because this would have a significant impact on income from both stores. There was a discussion between Mr Simmonds of the respondent and Mr Clifford on 6 April 1995 which led to an agreed position as to pricing. 38 A memorandum to all of the respondent's franchisees from Mr Potter dated 4 April 1996 asserted that low priced deals with a limited run were "out there to pull in customers, bring them in the door (both with delivery and take-aways) and also give you and your staff the ability to up-sell to create more profits from the increased transactions." 39 In 24 June 1996 Mr Clifford wrote to Mr Potter complaining that sales in both stores had not increased and in fact had fallen in Katoomba following a recent promotion which had reduced prices. Following correspondence between the parties Mr Clifford asserted that following a reduction in prices "sales would have had to increase by around 25 percent to maintain my previous profit level." He asked that certain promotional price reductions be stopped. There followed further correspondence between the parties with Mr Clifford continuing to complain about many aspects of promotions adopted nationally by the respondent and a response from the respondent to the effect that the applicants' stores were part of a national operation and the applicants were expected to join in all promotions. 40 On 26 February 1997 Mr Clifford wrote to the respondent under the heading "Price Decrease" stating that there was now a dispute between the Katoomba and Springwood stores and the respondent in terms of price reductions at each store. By letter dated 4 March 1997 the respondent replied stating that there had been a steady decline in sales over the past 12 months at both stores and that Mr Clifford had failed to ascertain why this was occurring and had been unable to arrest the decline despite his unwillingness to participate in promotions. The letter said in part: "We believe your decline is in part due to current pricing structures offered by Eagle Boys which conflict with your consumers' current needs. They are viewing Sydney-based television and reading paraphernalia from areas around the Blue Mountains which clearly display pricing levels under what they have to pay in Springwood and Katoomba from "your" Eagle Boys stores. We have experienced this scenario previously with other non competitive Eagle Boys stores. A decision to reduce pricing in these towns stimulated immediate rises in turn-over, new customer inquiries and total orders received." There was complaint made about the continued representations and presumably alleged intransigent attitude expressed by Mr Clifford. The letter concluded that: "If I can be of any assistance in coordinating a mediation process, I would be more than happy to oblige." 41 By 27 May 1997 Mr Clifford was obviously concerned about the level of sales in Katoomba. In a facsimile transmission to Mr Potter that day he complained of lower sales at Katoomba and suggested that higher prices should be used to regain profits. He pointed to the fact that there was high unemployment and low income in Katoomba with a slowing tourist trade. He said that all car yards in Katoomba had closed in the last six months and (presumably) ten other businesses so that the overall economy in Katoomba was deteriorating. 42 Mr Potter responded by letter dated 29 May 1997 and it was obvious that there was a deterioration in the personal relationship between Mr Clifford and Mr Potter. Mr Potter pointed out that in tough economic conditions there was no point in increasing prices. He said, in part,: "Mark, this letter in essence is to inform you that the pricing structure at Katoomba and Springwood will not change. If you believe your pricing structure should go back up I suggest you do the following ….inform us in writing that this is the case and provide us with hard, solid evidence from any marketing or advertising consulting firm who can prove it and suggest it would be best for your business ….that being the case, I am happy to release you from your Franchise Agreement for both Katoomba and Springwood." There followed further correspondence between Messrs Potter and Clifford including a letter from Mr Potter dated 21 June 1997 in which he said in part: "I stand by my advice to you that if you can supply solid evidence from a qualified marketing or advertising company that if your pricing returned to its previous structure, that your sales and profits in Springwood and Katoomba would improve, we would release you from your Franchise Agreement. This offer still currently stands." 43 In a letter of 23 June 1997 Mr Potter said that Mr Clifford's store although in a relatively isolated area "…. is not immune from market forces. Your business is not only competing in the pizza market, but in the fast food market in general and has to fight for its share of its customers' expendable income for the purchase of fast food. Your area is exposed to a number of fast food competitors and is accessed by Sydney television stations which carry a proliferation of competitors' advertisements in the pizza industry and the fast food industry. This creates an expectation in the minds of your customers as to what is a "fair price" for your product. By pricing your product at a level above what your customer perceives to be "fair" you are greatly damaging your goodwill in your franchise territory." 44 Mr Potter referred to a dispute resolution procedure contained within the franchise agreement and suggested that Mr Clifford take advantage of that procedure. 45 Mr Clifford replied in part by letter dated 15 July 1997 when he said that a dispute notification had been faxed to the respondent's office on 26 February 1997. 46 By letter dated 3 November 1997 Mr Clifford notified the respondent of a dispute which he required to be submitted to mediation. However, that dispute concerned the amount of advertising expended by the respondent in the applicants' areas of operation and did not refer to the respondent's pricing structure. 47 During the course of further correspondence Mr Potter wrote to Mr Clifford on 11 November 1997 offering to pay for a professional consultant "to come to your market place and provide …. advice …. ." In that same letter Mr Potter again recommended a mediation process and asked that Mr Clifford's lawyers put forward a list of points for mediation. He concluded: "Please note, that we are prepared to come to Sydney for this process, as well as pay for the market research, which I have continuously offered in the past." 48 Mr Clifford continued to assert the correctness of his position. A facsimile transmission from him to the respondent's management dated 22 January 1998 said: "Pizza Hut in Sydney advertised two large pizzas from $16.95. No-one else is advertising prices on TV in Sydney. I am located in an area where the only store apart from mine that promotes deals, sells two large at $18.95. Please explain why you would sell two large at $14.95." 49 On 12 February 1998 Mr Potter wrote to Mr Clifford about the Springwood store stating that he wished to "go through the process required to enable a market research company to come into the area and do a broad range of research on pricing structures and the availability of pricing, which can be charged in the Springwood area." Mr Potter sought agreement from Mr Clifford which he said had been obtained verbally to provide his time to market researchers, supply sales and transactions trends for the last two years and peruse market research questionnaires. Mr Clifford conveyed his approval by facsimile of 17 February 1998. 50 As it transpires the market survey was never conducted, nor was this dispute submitted to mediation in accordance with the provisions of the franchise agreements. I am unable to determine why these matters were not pursued by the parties. 51 The evidence discloses that the philosophical and fundamental difference of approach to the pricing strategy which was imposed by the respondent on the applicants commenced from about late 1995 when the applicants experienced a down-turn in profitability. However there were other factors which may have impacted upon the profitability of the stores. I have already referred to the state of the local economy in Katoomba about which Mr Clifford complained to Mr Potter. In Springwood the operation was faced with competition in early 1996 with the opening up of Ronnies Pizza and some Chinese restaurants nearby as well as other pizza shops within the region. 52 Furthermore, the applicants were unable to prove that the variations in the price of product imposed by the respondent on the two operations had any particular adverse impact on profitability. So much was conceded, appropriately, by Mr Keesing during the course of submissions. Part of the difficulty lies in balancing the advantages which Mr Clifford saw in becoming part of a national franchise operation against the disadvantage in what he saw as the imposition of a pricing policy which need not necessarily reflect precise trading circumstances in each of the Springwood and Katoomba areas. 53 There is no evidence beyond the assertions of Mr Clifford that the pricing policy adopted by the respondent caused any particular quantifiable harm to the two businesses operated by the applicants. The evidence of the accounting experts to which I have previously referred could not quantify any loss suffered by the applicants in this area. There were obvious philosophical differences of approach between the applicants and the respondent. However I am unable, on the state of the evidence, to conclude which of these approaches was correct; perhaps at times both approaches may have been inappropriate for the particular circumstances of each business. But this is a matter of speculation and an unsatisfactory basis upon which to found a finding of unfairness. 54 Having regard to the philosophical approach of both sides, with particular regard to the content of the communications between them and to their joint inability to pursue mediation, I am unable to conclude that any relevant unfairness exists by reason of the respondent's pricing regime and strategy as it affected the applicants' operations either in the terms of the relevant agreements or in terms of the conduct of the respondent. In reaching this conclusion I have also had regard to the evidence given by the accounting experts to which I have previously referred.

3. Advertising expenditure 55 It is first necessary to have regard to some of the provisions of the franchise agreement. 11.23 (Advertising) The Franchisee must expend an amount of money not less than the Local Advertising Amount each Quarter throughout the Term on its own advertising and promotion of the Franchise Business (in addition to any advertising and promotion conducted by Eagle Boys under the Advertising Fund) including, without limitation, in the preparation and publication of its own advertising and promotional materials. If the Franchisee expends less than the Local Advertising Amount on its own advertising and promotion of the Franchise Business each Financial Year then the Franchisee will pay the difference between the sum of the Local Advertising Amount for the four quarters of the relevant Financial Year less the amount actually spent by the Franchisee in advertising and promoting the Franchise Business during the relevant Financial Year into the Advertising Fund. 11.24 The Franchisee may prepare its own advertising and promotional materials provided that the Franchisee must not publish or distribute any advertising or promotional material without first submitting that material to Eagle Boys and obtaining Eagle Boys prior written consent to that publication or distribution. 11.25 The Franchisee must ensure that any advertising and promotional material includes - (a) a statement that the Franchise Business is operated as an independent business under licence from Eagle Boys; and (b) such other information as Eagle Boys may reasonably consider necessary to inform third parties that Eagle Boys does not accept liability for the acts, debts or defaults of the Franchisee. 20.6 Eagle Boys will establish the Advertising Fund. The Advertising Fund will operate to pay the costs of advertising, developing and promoting the Eagle Boys System, Eagle Boys Image, the Products, the Services and Eagle Boys Outlets for the benefit of Eagle Boys and Eagle Boys franchisees including the Franchisee. 20.7 Eagle Boys will, as it deems appropriate and in its absolute and sole discretion, apply monies held in the Advertising Fund for the advertising, development and promotion of the Eagle Boys System, Eagle Boys Image, the Products, the Services and Eagle Boys Outlets PROVIDED ALWAYS THAT Eagle Boys may at its absolute and sole discretion from time to time advance monies to the Advertising Fund which will be refundable to Eagle Boys out of the Advertising Fund in priority to other advertising or promotional debts. 20.8 The Franchisee acknowledges and agrees that - (i) the total contributions to the Advertising Fund need not be expended in the calendar year or Financial Year in which such contributions are received; and (ii) a reserve may be accumulated in the Advertising Fund; and (iii) Eagle Boys is entitled to administer the Advertising Fund as it deems appropriate and is not obliged to expend a proportionate part of the total Advertising Contribution in any area on any particular Eagle Boys Outlet or on behalf of any particular Eagle Boys franchisee. 56 The franchise agreements entered into for both the Springwood and Katoomba stores required the applicants to pay an advertising contribution of 6 percent of gross revenue to the Advertising Fund and to expend 1 percent of gross revenue for local advertising. In addition there was to be paid 1 percent of gross revenue for the Springwood store (later reduced to 0.5 percent) and 0.5 percent of gross revenue for the Katoomba store as a contribution towards the cost of the respondent operating a network telephone number common across its operations to enable the easy purchase by telephone of Eagle Boys products. This is commonly referred to as a "131" telephone number. 57 On 22 December 1994 Mr Potter wrote to all franchisees proposing changes to the use made of the moneys contributed to the advertising fund and a reduction in the contribution to the 131 telephone number from 1 percent to 0.5 percent of gross revenue. That letter said in part: As most of you would be aware, marketing in some Eagle Boys' areas can be more cost effective than in others. In areas where we have minimal competition and maximum penetration we are in a position to achieve massive advertising coverage with television, direct mail and other sources. In some cases this is costing less than the 4.5% of your contribution. Examples of this is in stores such as Young, Cowra, Bathurst, Orange and Dubbo where television advertisements are screened almost weekly, along with effective direct mail and other sources of media. It is now becoming apparent that it is difficult for us to expend the level of funds needed in these areas, therefore almost wasting money to achieve the desired 4.5%. This in turn throws undue stress on both the Eagle Boys' system and our accounting procedures. These funds could be better spent in other areas where it is more costly to advertise and market, yet would have greater potential, eg. areas such as Canberra and Newcastle, where we are in need of greater exposure. This in turn would give higher returns to all Franchisees and, in turn, into the Advertising Fund. This proposal is not robbing Peter to pay Paul but, in essence, sensible franchising as the system continues to grow and all Franchisees reap the benefits. We are in a position to continue to attempt to spend 4.5% of the current 6% directly into each area on an ongoing basis, yet we wish to alter the current practice and in future attempt to spend the 4.5% in your area within the bounds of our marketing strategies and constraints. As Eagle Boys now has 55 stores we believe that this added flexibility, combined with some consideration from yourselves, will lead to an overall reduction in the cost of our current advertising thereby benefiting all Franchisees. 58 Mr Clifford agreed to the above suggestion on behalf of the Springwood store. 59 Advertising for both the Springwood and later the Katoomba operations was principally directed to the distribution of advertising material through letterbox drops in each area. 60 On 5 January 1995 Mr Clifford wrote to Mr Potter stating that Springwood was in a unique position making it hard to spend 4.5 percent in that area and that the same consideration would apply to the Katoomba shop which was then at a proposal stage. He suggested that letterbox drops be complemented by newspaper and radio advertising and nominated the local FM 96.1 radio station which is situated in Penrith, near the foot of the Blue Mountains area. The respondent's advertising agency replied by letter dated 20 January 1995 stating that the cost of radio advertising and the amount of advertising necessary would not justify the use of the radio medium to advertise the applicants' products. The letter said in part: "Most people who would hear your commercials on Sydney radio would not be in a position to order Eagle Boys even if they wanted to. Given this, in the immediate term, we believe your money is better spent by limiting the geographic reach of your advertising activity …." I should add from other evidence given in the proceedings that radio station FM 96.1 has a specific coverage directed in part to the Blue Mountains area and it is obvious that the respondent's advertising agency was not aware of this fundamental fact. 61 By memorandum dated 9 June 1995 addressed to all franchisees Mr Potter reiterated that the respondent was not required to spend 4.5 percent of the 6 percent advertising levy in the franchisee's area "but will endeavour to do so whenever reasonably possible." 62 On 4 November 1995 Mr Clifford wrote to the respondent on behalf of the Springwood operation asking for details of advertising fund expenditure and suggesting the doubling of letterbox drops each month. He also asked whether billboards and newspaper advertising could be included in expenditure in the Springwood area and that posters of the main monthly deals be made available for the Springwood store. 63 Mr Clifford again wrote to the respondent on 23 April 1996 with respect to both stores. He asserted that the letterbox drops were not sufficient to maintain or improve sales and complained about the lack of television or radio advertising. He conceded that there was no local television station but said that there was available radio, newspaper and cinema media. He concluded: "A lot of money is paid by these stores for promotion by Eagle Boys and it would help if further advertising was made available." 64 As at October 1996 Mr Clifford complained that the only advertising which had occurred had been a monthly letterbox distribution, and an advertisement which appeared in a Blue Mountains tourist magazine for three months and an advertising slide at a local cinema for three months. 65 Mr Clifford continued to press for increased and enhanced local advertising in the Springwood and Katoomba areas and the respondent continued to resist. 66 It was Mr Potter's evidence in affidavit form that electronic advertising in the Springwood and Katoomba catchment areas was "inappropriate" because of the high price charged by the Sydney media whose catchment area was predominantly metropolitan Sydney of which the Springwood/Katoomba catchment areas formed a small part. He said that he relied on market research which he said was exhibited to his affidavit, although I was unable to find any documentation which I would regard as being capable of characterisation as market research. 67 Media plans produced by the respondent scheduling the details of advertising undertaken in both the Katoomba and Springwood areas shows in essence that the only medium used was the distribution of leaflets either by way of letterbox delivery or delivered in association with a delivery of a local newspaper, the Blue Mountains Gazette. This is apart from a three month period during which advertising was placed in a Katoomba tourist magazine and a three month period during which an advertisement was displayed at a cinema. 68 Mr Keesing prepared documentation which reflected moneys expended by the applicants by way of levies paid to the advertisement fund. For Katoomba during the period May 1995 to July 1998 the amount paid as adfund levy was $103,729.60. The amount spent on local advertising during this period was approximately $70,000. For the period during which the Springwood store was a franchisee of the respondent the sum of $185,409.75 was paid as adfund levy. During this period an amount of approximately $55,000 only was spent by way of local advertising. The expenditure in both cases is, of course, exclusive of any more widespread advertising expenditure incurred by the respondent with respect to the totality of its operations. 69 The applicants' claim was that the manner in which the franchising agreements operated in connection with the payment by the applicants of an advertising levy of 6 percent produced unfairness. Firstly the disparity of the amounts paid by way of advertising levy as against what was directly spent in each of the areas, even allowing for 1.5 percent of the 6 percent being paid on an operations wide basis was ipso facto indicative of unfairness. This was compounded because, as the respondent conceded, there were in reality no other means available to it to effectively expend money by way of advertising in each of the catchment areas. In these circumstances, it was said to be unfair to require the applicants to pay such a large percentage by way of advertising levy. Even that part of the notional 1.5 percent of the 6 percent advertising levy which presumably went to advertising the totality of the operations would have been of a lesser utility to the applicants' operations than would apply to Eagle Boys outlets in areas where other advertising media on a national or more extensive regional basis would be of assistance. 70 By way of example, profit and loss statements for the respondent's advertising account were produced for the financial years ending 30 June 1996, 1997 and 1998. In the 1997 financial year total revenues exceeded $2.3 million. The cost of production for television advertising and television advertising itself exceeded $600,000. The cost of production of advertising material in print form exceeded $560,000 although the distribution of printed material seems to have exceed in cost $610,000. In general terms there appears to have been expended on advertising by way of television about half the amount spent on print media. Mr Potter asserted that the television advertising material would have had no or little benefit for the applicants. 71 The respondent sought to justify the lack of expenditure in the applicants' catchment areas on the basis that there was no other avenue available to it to provide worthwhile advertising for the applicants' operations. 72 I should add that there is no evidence which would enable me to conclude that the applicants suffered any quantifiable financial loss by reason of the failure of the respondent to undertake more intensive advertising in or over any particular media. So much was conceded by Mr Keesing. Accordingly, any loss sustained by the applicants with respect to such unfairness must, in my opinion, be limited by way of compensation to the difference between 4.5 percent of gross revenue paid to the advertising fund and what was actually expended. The resultant amounts calculated by Mr Keesing were $84,023.34 for Springwood and $7,984.92 for Katoomba. Mr Goot did not dispute "the arithmetic concerning the 4.5 percent claim" but did, on behalf of his client dispute the methodology used in connection with the claim. 73 Mr Goot submitted that firstly there was never an obligation to spend 4.5 percent in any particular area. I have previously set out an extract from the provisions of the franchise agreement. I accept Mr Goot's submission that there is no contractual obligation to spend 4.5 percent in the catchment area in which a franchisee operates. But there is an obligation to consider what moneys can reasonably be expended and in what manner. The respondent did not do so. Also, in my opinion, the disparity between what was expended and an amount which represents 4.5 percent of the gross revenue is so great as to itself indicate unfairness. 74 The second submission made by Mr Goot in this area was that the suggestion that 4.5 percent would be expended in a franchisee's catchment area was made before the Katoomba documentation was entered into, and accordingly had no application to the Katoomba operation. I reject this submission because firstly, any omission to refer to this aspect in pre contractual negotiations does not preclude a finding of unfairness on the same basis as applied to the Springwood operation and secondly, both Mr Potter and other members of the respondent's organisation and Mr Clifford were at all relevant times aware of the existence and general thrust of the respondent's proposal in this regard during the period whilst the Katoomba operation was in existence; furthermore, the correspondence between the parties applied relevantly to both Springwood and Katoomba. 75 Finally, Mr Goot pointed to moneys of about $3,600 which were spent "indirectly" during the relevant period. He submitted that the amount of this claim should be discounted by extrapolating a ratio of direct to indirect spending. I reject such a claim because any moneys paid by way of indirect expenditure on advertising would more appropriately come within the 1.5 percent part of the advertising fund levy that was to be spent generally on promoting the respondent's franchisees and operations. 76 The respondent set for itself the aim of attempting to spend 4.5 percent of the 6 percent advertising levy paid to the advertising fund within each franchisee's area (if reasonably possible). There was no contractual obligation to do so; nevertheless it represents in my view a standard which the respondent ought to attempt to have achieved. The respondent was sensitive to the needs of franchisees and the requirement to achieve some form of balance between what was expended nationally and by way of "branding" and what was expended within each local region. 77 In determining whether there was any relevant unfairness as contended for by the applicants I accept the approach adopted by the respondent as to what was an appropriate standard; that is 4.5 percent of the 6 percent adfund levy to be expended locally if reasonably possible. The respondent has asserted that it was not reasonably possible to expend 4.5 percent locally in connection with the applicants' businesses. I do not think it is fair in all the circumstances for the respondent to have required the applicants to pay 4.5 percent of gross revenue to the advertising fund. The discrepancy between 4.5 percent and what was actually expended locally is, in my opinion, so great in relative terms as to support a finding of lack of fairness, that is, unfairness. 78 In reaching this conclusion I also have regard to the totality of the fee structure imposed on the businesses by the respondent, the details of which I have previously set out. Whilst I have not concluded that in the aggregate all of these fees including ongoing fees based on gross sales created any relevant unfairness per se, the payment of 4.5 percent to the advertising fund in circumstances where it was not reasonably possible to expend this amount locally tips the scales in favour of the applicants when looking at the totality of the ongoing fees payable by them to the respondent and what was given in return by the respondent to the two businesses as franchisees. 79 Accordingly I uphold the applicants' submissions under this head.

CONSEQUENTIAL ORDERS 80 The applicants have succeeded in establishing unfairness with respect to each of the franchise agreements for the reasons and in the manner which I have previously described, namely the disparity between what was actually expended from the moneys paid by the third and fourth applicants to the respondent by way of levy to the advertising fund and the amount actually expended from the advertising fund by the respondents for direct advertising in each of the catchment areas appropriate to each of those applicants. Notwithstanding that the respondent's proposal was dated 22 December 1994, it follows that the unfairness attaches to the franchise agreements from inception. 81 This raises the question as to whether the franchise agreements should be varied or declared wholly or partly void, and if so from what time. 82 In normal circumstances any such declaration should be appropriate only to the finding of unfairness. However in these proceedings the amended summons sought to attack a number of clauses of the franchise agreements, in particular clauses dealing with restraint of trade after termination, restrictions on competition and disposal of the franchise businesses. During the course of the proceedings concessions were made on behalf of the respondent that it would not seek to enforce any of those provisions and some additional provisions for any purposes. In these circumstances, it would seem more appropriate to declare the respective franchise agreements void from inception, preserving however all rights with respect to moneys paid by any party to any other party thereunder save for an order for payment of compensation which should follow from the finding of unfairness which I have made. 83 Accepting the mathematical calculations undertaken by Mr Keesing, as did the respondent, it follows that the respondent should be ordered to pay compensation to the third applicant of $84,023.34 and to the fourth applicant of $7,984.92. 84 I should add for completeness that these applicants had claimed in the course of the proceedings refund of moneys paid by way of an initial advertising contribution in the sum of $10,000 and $5,000 respectively based on allegations that those moneys had not in fact been expended by the respondent. Whilst there may have been some merit in such a claim, details were not included within the amended summons or subsequent documentation filed as required by the rules and accordingly, the respective applicants have not been permitted to claim these amounts in these proceedings. 85 There seems no reason why interest should not become payable with respect to those amounts which I have concluded that the respondent should pay to each of third and fourth applicants. However these amounts became progressively due as each of the applicants made payments with respect to the advertising fund in amounts which I have found created relevant unfairness. Accordingly, interest should become payable as and from 1 August 1998 being a date after these applicants ceased to be franchisees. 86 In view of the nature of the findings which I have made I intend to reserve costs.

ORDERS 87 Consequent upon the finding of unfairness which I have made I make the following orders:

1. The franchise agreements between the respondent and each of the third and fourth applicants and all ancillary documentation are declared void from their commencement, but so as not to affect the payment of moneys already paid by the third and fourth applicants to the respondent.
2. The respondent to pay to the third applicant the sum of $84,023.34 and to the fourth applicant the sum of $7,984.92 together with interest thereon calculated in accordance with the provisions of the Supreme Court Act from 1 August 1998 to date of payment.
3. Costs are reserved.
4. Liberty to apply with respect to costs.

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