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Pizza Inn Soap Opera

Pizza Inn is ~400-unit buffet, delivery, carryout, sometimes-drive thru pizza chain in the soutwestern United States with a drama filled past few years that would make some soap opera’s jealous. In 2002, the then-CEO Rogers of Pizza Inn borrowed about $2 million from the company to buy company stock. The stock sank and Rogers couldn’t pay back the company’s cash loan. Rogers was fired as CEO and Pizza Inn wrote off the debt and moved Parker, then President, to CEO. Shortly thereafter, ex-CEO Rogers sold his 27% stake in Pizza Inn to a private investment firm escaping with a tidy profit. With the private investment firm holding a controlling interest, the current executives sought to protect their jobs by writing employment agreements with Pizza Inn. The employment agreements provide that if the four executives left for “good reason” or were removed from their posts, they would receive payouts totaling $7.4 million (Parker would have pocketed $5.4 million, Olgreen $630,000, Clark $605,000 and Preator $597,000), more than twice Pizza Inn’s 2003 profit of $3.1 million, which would have surely bankrupted the company. Eventually the private investment firm got their wish and the shareholders elected new candidates to the board of directors. Parker, the CEO with the parachute employment agreement, resigned and claimed this trigger the parachute and the company owed $5.4 million (he sold 98,000 shares a few days before). He eventually won a settlement of $2.8 million. Pizza Inn even sued its former legal counsel for its role in advising the company on the huge severance packages (the lawyers were supposed to work for the best interest of the company, not the executives). In the meantime, revenues of the franchisor fell due to lower franchisee sales which resulted in the franchisor suffering less royalties and less revenue from the …

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Franchisors Not Liable for Negligent Franchisees

The employee of a franchsee wrestles with a customer over a hot coffee pot.  The coffee spills on the customer burning him.  Is the franchisor liable (the franchisee obviously is liable)?  No, not in New York.  The franchisee is obviously liable, but not the franchisor. 7-Eleven argued in court that there is no evidence of negligence on its part and that the existence of a franchisee/franchisor relationship is insufficient to impose vicarious liability on 7-Eleven for the acts of an individual employed by an independent franchisee. In Nickola v. 7-Eleven, 03-13494, Doyle explained that in determining whether a franchisor may be held vicariously liable for the acts of its franchisee, the most important factor to consider is the degree of control the franchisor maintains over the daily operations of the franchisee. Here, the judge found, 7-Eleven exercised no control over the activities that led to Nickola’s injury. “Thus, in the absence of a principal/agent relationship, or proof that the franchisor exercised a high degree of control over the franchisee, there is no basis for holding the franchisor responsible for the franchisee’s misconduct,” Doyle said.

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We the People, continued

Dollar Financial is getting about $3.25 million back from the founders of We The People (Ira and Linda Distenfield). Dollar Financial alleges that the sellers of We The People deliberately concealed certain franchise sales breached representations and warranties with respect to a number of undisclosed liabilities and other matters arising from the acquisition. Readers may remember this not-so-flattering review, “We The People, or We The Screwed?” on FranchisePundit.com last year. As an aside, the founders of We The People are now a soon-to-be 20 unit franchisee and (equity owner?) broker of the PR Store, which is a fine concept.

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Connecticut Law: Renewal of Franchise Relationships

This article briefly discusses government regulations surrounding the renewal of franchise relationships: The CFA, C.G.S. §§42-133f-g, relates solely to the termination, cancellation or failure to renew a “franchise” relationship, and requires that such action by the “franchisor” be taken only with good cause, normally upon 60 days’ written notice. Lesser notice may be provided in certain unusual circumstances. Good cause includes, but is not limited to, “the franchisee’s refusal or failure to comply substantially with any material and reasonable obligation of the franchise agreement. … ” C.G.S. §42-133f(a). A franchisee which is improperly terminated, cancelled or non-renewed may sue for injunctive relief, damages and attorney fees, C.G.S. §42-133g(a). All franchises entered into or renewed after Oct. 1, 1973 must be for a minimum of three years. The parties cannot contract away rights under the CFA by a choice of law provision. R & B Assoc. of Conn. V. Deltona, Business Franchise Guide (CCH) ¶7,525 (D. Conn. 1980). Nearly all state franchise laws (whether “registration and disclosure” or “relationship” statutes) provide that a franchise exists when: (a) a franchisee is granted the right to engage in the business of selling or distributing (sometimes also “offering”) goods or services under a marketing plan or system prescribed in substantial part by a franchisor; (b) the operation of the franchisee’s business pursuant to that plan or system is substantially associated with the franchisor’s trademark, service mark, trade name, logo, advertising or other commercial symbol; and (c) the franchisee is required to pay, directly or indirectly, an amount of money to become associated with the franchisor, commonly referred to as a franchise fee.

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What Constitutes a “wrongful” Termination Of A Franchise Agreement?

Hospitality Net published an insightful article also applicable to non-hospitality franchisees. Below are excerpts: 1. good Faith Or Bad What Constitutes A “wrongful” Termination Of A Hotel Franchise Agreement? However, it should also be noted that if a franchisor has legitimate business reasons to justify termination of the franchise such as the failure to pay franchise fees or royalties, the Court may not care that the termination was also motivated by an improper reason and may uphold the termination based upon the legitimate grounds. 2. Does a Hotel Franchise Agreement Contain an Implied Covenant of Good Faith and Fair Dealing and, If So, What Is It? Generally speaking, it’s the franchisee who attempts to use the implied covenant “creatively” to assert rights which may or may not be expressed in the contract. The franchisor, on the other hand, is likely to claim that the franchisee is using the implied covenant as a “blank check” to create a contractual right which doesn’t exist and to “rewrite” the contract in a manner which is more favorable to the franchisee. 3. After a Notice of Termination is Served, Should the Franchisor Or Franchisee, or Both, Run to Court to Obtain an Injunction? By striking first, and moving for a preliminary injunction to prevent termination of the franchise, the franchisee may be able to focus the Court’s attention on the franchisee’s strongest argument — that without an injunction, the franchisee will lose its business, forfeit its investment and have its franchise canceled.

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More on the Quiznos Class Action in Wisconsin

More biting accusations from 28 Quiznos franchisees in this class action in Wisconsin. Here are some excerpts: Quiznos Sub forces its franchisees to buy food and supplies from the company or its approved vendors at unfair prices and sets retail prices too low for the stores to make a profit, according to a lawsuit filed by 28 operators of Quiznos franchises in Wisconsin…. The lawsuit, which seeks millions of dollars in damages for lost investments, accuses Quiznos of fraud, violations of federal and state antitrust laws, racketeering, breach of contract and violations of Wisconsin’s fair dealership law, attorney Justin Klein said Tuesday… “They tell you who you can buy from and who you can’t buy from,” he said. “The prices are unreasonably high. Quiznos gets rebates from approved vendors.”

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Arbitrations Clauses

Is arbitration preferable to litigation? While it is usually less expensive, this case illustrates how things are rarely simple in litigation or arbitration: BACKGROUND: MailCoups…provided the 30-page preprinted form contract, which contained an arbitration clause that reserved MailCoups’ right to protect its intellectual property in court and provided for arbitration proceedings to be held in Boston at the American Arbitration Association regional office closest to its headquarters. DISPUTE: In September 2000, Nagrampa [franchisee] unilaterally terminated the agreement after two years of operating her MailCoups franchise in Contra Costa County at a loss. She allegedly incurred over $180,000 in personal debt and had to pay more than $400,000 in fees to the franchisor, but did not receive the 41 percent in profits that the company had promised her. Claiming Nagrampa owed it over $80,000 in fees, MailCoups initiated arbitration proceedings in December 2001, initially designating Los Angeles as the hearing location. After her attorney objected to the proceeding and refused to file a response to the arbitration, the AAA case manager notified the parties that the hearing would take place in Boston in accordance with the arbitration clause’s forum selection provision. The arbitration clause in a Mailcoup’s Franchise Agreement allowed the franchisor to pursue intellectual property claims in court while restricting all of the franchisee’s issues to arbitration, and designated Boston as the arbitral forum. CLAIMS: Among her [Mailcoup’s franchisee] various claims was a cause of action challenging the validity and enforceability of the arbitration clause as violating the California Consumer Remedies Act. The clause was substantially one-sided, unconscionable, oppressive, outside her reasonable expectations and contained within an adhesion contract, the franchisee alleged. JUDICIAL DECISION: It was procedurally unconscionable because “Mail Coups had overwhelming bargaining power, drafted the contract, and presented it to Nagrampa on a take-it-or-leave-it basis,” she wrote. …

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Quiznos franchisees file class-action fraud lawsuit

Another group of franchisees accuse Quiznos of fraud: A group of Quiznos franchisees have filed a class-action lawsuit against the Denver sandwich chain in U.S. District Court for the Eastern District of Wisconsin. The lawsuit alleges that Denver-based Quiznos has “systematically defrauded its franchisees in a scheme designed to build the brand at the expense of its operators in the field.” The suit contends that the company forces franchisees to buy food and supplies from Quiznos or its affiliates at inflated prices while setting retail prices so low that franchisees can’t profit. The lawsuit also alleges that Quiznos omits or misrepresents key facts about its business operations when selling franchises. Link to another background article. Link to previous Quiznos articles on Franchise Pundit

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Investing in Private Placement Offerings (Part 1)

I’ve spent most of past year working full time for a private equity and asset management firm. I thought I knew a lot about the private investment world before I started (I’ve been part of several business that received venture capital funding), but what I learned has been a tremendous eye-opener, particularly in seeing the naivity of investors. My job involves handling and fixing issues (legal, financial, complaints, compliance, etc) that involve hundreds of investors. I often speak to investors when they have concerns or complaints. I have a lot to say on this topic because I slap my head almost daily at the mistakes, misconceptions, and wholly amateur approach investors make when deciding whether to invest in my company’s real estate related investments and funds. This will be a multi-part series of postings that will be equally relevant to those looking at investing in private placement offerings and those looking to be a franchisee. The no-bologne, no excuse due diligence an investor in a private partnership should go through before locking themselves into an investment is nearly the same a potential franchisee should go through before locking themselves into a franchise. Venture capitalist often repeat that they do not invest in “ideas”, but rather they invest in the “people”. I always hear that them say they’d much rather have a “C” idea ran by an “A” team, than an “A” idea ran by a “C” team. Focusing on the “people”, the franchisors or general partners, is indeed key from what I’ve seen. How well do you really know the people and managers you’ll be investing with? Have you done a background check on the managers? Have you asked for audited financials this deal and other deals? If they aren’t audited by a reputable firm, walk away…don’t believe the …

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Not-so-super Super Suppers

This is one of the better articles I’ve read recently giving readers an “inside look” at the franchising experience – what can go wrong, the competing dynamics and interests in the franchising business model, and financial and legal realities. And that was just the beginning of Ross’s troubles. It seemed like her email account logged a new message almost every day, welcoming another Super Suppers franchisee to her region of the state while she was still struggling to attract new business. With neither the money nor the energy to advertise locally, she again turned to Super Suppers corporate headquarters for help. While I’m sure the new franchises weren’t technically encroaching on her protected territory, it still has significant impact on sales. Even if no more new Texas franchises were sold, she would still see many new locations pop up in the near future. Not to mention the “other guys” — Dream Dinners and Dinners Ready!, among others, were beginning to make multiple appearances around town. Unlike franchises that can thrive in heavily saturated markets (Starbucks, McDonald’s), a meal-assembly center needs a large number of households in any given territory to be successful. According to Bill Byrd, it takes 500-700 households to support a Super Suppers, but he concedes the divvying up of territories is “not an exact science.” Whenever there is a “hot” segment, copycats franchisors are only months behind. Success breeds competition, and the competition can ride your wave and simultaneously learn from your mistakes without experiencing the costs. Potential franchisess must evaluate whether their soon-to-be franchisor will constantly innovate and improve to stay ahead of the competition. For example, a less-experienced franchise owner wouldn’t know that regional and national advertising in a franchise-based business plan is usually rolled out well after a significant number of stores have …

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Remodeling Required

Great advice from Paul Steinberg in the forum: March 20 ’06 issue of NRN cover story states that KFC franchisor-mandated remodels ($250-500K per unit) may force smaller franchisees to sell; www.nrn.com When buying a franchise, remember to ask about any upcoming mandated capital improvements. Particularly in the hospitality industry, many franchisors have a schedule for upgrades/remodels; this is necessary to keep the brand image fresh. What appears to be a “bargain” price from a selling franchisee may cost more than an “expensive” alternative outlet if the higher-priced outlet has the current decor and the cheaper outlet will be needing a facelift.

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Thoughts on Due Diligence & Exclusive Territories

Why does this site often post negative horror stories about franchisees who don’t do enough due diligence or franchisors who appear to take advantage of naive entrepreneurs? Because the “scared straight” method often works, and you’ll be happy you spent a little extra time researching the financial and legal aspects of the business. The franchise salesman and commissioned consultants rarely fully apprise the franchisee of the risks and obligations from entering into a legal contract that could potentially have the franchisee on the hook for hundreds of thousands of dollars. Franchising can be wonderfully prosperous and rewarding endeavor, or it can be an angry and bankrupting experience. The later can usually only be controlled BEFORE you pay the franchise fee and sign the franchise agreement. For example, if your franchise agreement grants the exclusive territory in such a way that another location can be theoretically constructed 2 blocks away, perhaps you are best to walk away if this will obviously overly dilute your customer base to the point of unsustainable sales. Franchisors are notorious for milking profitable locations by stacking franchises as close as legally possible. Why? Because franchisors make more money from each additional $25K franchise fee plus the additional gross revenue, and two stores will always gross more than one. Some poorly organized and managed franchisors get themselves into a virtual Ponzi scheme where the company must keep earning increasingly more franchise fees to support their growing franchisor operations that is not sustainable by royalties alone. If the franchisor won’t carve out a territory big enough for you to make a comfotable profit, you don’t have to ask why, you know why. Here is an extreme example (Caught in a Franchise Fiasco, The Toronto Star, Mar. 14, 2006) of what can happen when the franchisor-franchisee relationship evolves …

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Required Facelifts & Capital Expenditures

From the forum: March 20 ’06 issue of NRN cover story states that KFC franchisor-mandated remodels ($250-500K per unit) may force smaller franchisees to sell; www.nrn.com When buying a franchise, remember to ask about any upcoming mandated capital improvements. Particularly in the hospitality industry, many franchisors have a schedule for upgrades/remodels; this is necessary to keep the brand image fresh. What appears to be a “bargain” price from a selling franchisee may cost more than an “expensive” alternative outlet if the higher-priced outlet has the current decor and the cheaper outlet will be needing a facelift. Hat Tip: Paul Steinberg

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SBA Guaranteed Loan Program Q&A

A banker answers questions about the SBA’s guaranteed loan program @ Franchise Times. Here is a summary: When is a SBA loan a good choice for borrowers? anytime What can I finance with a SBA loan? any legitimate business need How much down is typical? 10%-30% (higher for startups) What do I do first? write a business plan and see your banker What are some basic term guidelines for an SBA 504 and 7a program? 7a: These are general small business loans. The term of the loan tends to mirror the use of funds (how long you can amortize the asset, length of equipment loans are based on the life of the equipment). They’re one through the bank but SBA guarantees a portion of the loan. 504: These are restricted to expenditures that will spark job creation or retention. Generally used for long-term fixed assets and facilities (not working capital). Max net worth of applicant must be under $7.5 million. Can they be used together? Yes. Can you give me an example of a deal that works with both 7(a) and 504? restaurant How does a construction loan work? Short-term loans that typically require interest-only payments during construction and become due upon completion. How is the money I borrow actually disbursed? The bank distributes the money as needed and planned. The contractor will submit a draw request monthly to cover the labor and materials for work completed to date. How long does the draw approval process take? Ideally 3 days How long does it take to obtain a construction loan approval? No timeframe given

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New Quiznos Lawsuits

Quiznos is facing more class-action lawsuits over delays in getting locations approved for its franchisees, and keeping their $25,000 franchise fee. More from the Denver Post article: The case alleges “deceptive business practices” in the company’s franchise sales method and demands that the company stop selling franchises in New Jersey until all existing franchisees get locations or are refunded their franchise fees. In a separate case filed in December in the Ontario Superior Court of Justice, the plaintiffs allege that the company is violating Canadian franchise law by not disclosing to potential franchisees full details and processes for securing locations. Quiznos, of course, denies violating any law. Hat tip: Paul Steinberg Franchisors usually carefully craft the franchise agreements to enable wiggle room in stalling or denying approval of locations. Warning flags include evidence of high franchisee turnover or higher proportion of revenue from non-royalty revenue which can sometimes be gathered and deduced from the UFOC Items 19-21. I know of a major dating franchise where one location in a big city has been sold 3 times over in the past few years, with the most recent franchisee begging the previous franchisee who sold it to him to take it back for FREE because it was draining money. If he closed the business, he would have breached the franchise agreement and would be obliged to pay tens of thousands in fees, charges and damages. Update: March 1, 2006 You can track the Ontario case on Goldman Sloan Nash & Haber’s web site, the Canadian law firm representing the plaintiff. The firm posted the detailed statement of claim (complaint) against Quiznos. Hat tip: Michael Webster

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