Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D. N.J.: Franchise law claims against Steak N Shake fail, (Jul 8, 2015)

By Michael Menzhuber, J.D., LL.M.

A Steak N Shake franchisee’s allegations that its franchisor violated the New York Franchise Sales Act and the New Jersey Franchise Practices Act failed to state a claim for which relief might be granted, according to the federal district court in Newark, New Jersey (Cornerstone Investment Partners, LLC. v. Steak N Shake Enterprises, Inc., July 6, 2015, Wigenton, S.).

Background. In 2012, Cornerstone Investment Partners, LLC explored the opportunity to purchase and operate a Steak N Shake franchise. Stake N Shake, a burger and milkshake franchisor, traditionally offered franchises for “Classic” restaurants. Shortly before the franchisor began negotiations to grant Cornerstone a franchise, it opened its first “Signature” restaurant. The “Signature” restaurant differed from the “Classic” restaurant in that it was smaller and offered a more limited menu.

After withdrawing its initial approval for Cornerstone to build a “Classic” restaurant, it entered into a franchise agreement granting a franchise to Cornerstone for a “Signature” restaurant located in Paramus, New Jersey. Steak N Shake refused to provide cost estimates to Cornerstone for the “Signature” model. Instead, it provided cost estimates using data from its “Classic” restaurants.

After opening its “Signature” restaurant, Cornerstone began to experience significant operating losses, stemming from unexpectedly high costs. To accommodate for these costs, it requested changes in the standard of performance mandated by the franchise agreement.

Cornerstone later filed a complaint against Steak N Shake, alleging: (1) a violation of the New York Franchise Sales Act; (2) a violation of the New Jersey Franchise Practice Act; (3) fraud; (4) misrepresentation; (5) breach of contract; (6) a violation of the Racketeer Influenced and Corrupt Organizations Act (RICO); (7) a violation of the New Jersey Consumer Fraud Act; and (8) punitive damages. Steak N Shake asserted that the claims were time-barred due to the limitations period contained in the franchise agreement.

New York Franchise Sales Act. The New York Franchise Sales Act requires the disclosure of necessary information for a franchise agreement. The franchisor contended that it was not required to register in New York pursuant to an exemption based on net worth. The court noted that this exemption applies “if the department finds that such action is not inconsistent with the public interest or the protection of prospective franchisee.”

The court further noted that Cornerstone’s claims relied on allegations of misleading oral statements and determined that these allegations were vaguely pleaded in the complaint and contradicted by the language of the franchise agreement. Consequently, it dismissed this count.

New Jersey Franchise Practices Act. Pursuant to the New Jersey Franchise Practices Act, a franchisor may not impose “unreasonable standards of performance.” Cornerstone contented that Steak N Shake imposed “unreasonable standards” as a result of its uniform pricing strategy and unproven business format. The court disagreed. It found that Cornerstone did not set forth facts to support its “unreasonable standards” claims. Instead, it had difficulty meeting the franchisor’s standard due to higher occupancy costs.

Fraud and misrepresentation. The court determined that Cornerstone did not set forth facts sufficient to support claims for fraud and misrepresentation. The court found that: (1) it entered into the franchise agreement knowing that the “Signature” restaurant and flagship had operated for only a short time; (2) there was no requirement in the franchise agreement requiring the franchisor to provide the information identified by Cornerstone; and (3) Cornerstone did not alleged that Steak N Shake failed to disclose anything that it was required to disclose under the financial disclosure document (FDD).

Breach of contract. Although Cornerstone alleged a breach of contract due to a violation of the covenant of good faith and fair dealing, the court found that it did not plead a specific provision of the FDD that was breached. The court found that Cornerstone’s claim that it was misled by oral misrepresentations by Steak N Shake representatives was contradicted by the FDD.

The franchisor argued that the Cornerstone’s breach of contract claim was unsupported by Indiana law, which it asserted was the relevant law due to a forum selection clause in the franchise agreement and which limited covenants of good faith and fair to contracts other than franchise agreements. The court determined that, regardless of whether the covenant applied, Cornerstone did not adequately plead a violation of such covenant.

The case is No. 2:14-cv-06581-SDW-SCM

Attorneys: Stephen Frank Pellino (Basile, Birchwale & Pellino LLP) for Cornerstone Investment Partners, LLC, and Cornerstone Investment Partners I, LLC. Alexander Xavier Saunders (Peckar and Abramson PC) for Steak n Shake Enterprises, Inc.

Companies: Cornerstone Investment Partners, LLC; Cornerstone Investment Partners I, LLC; Steak n Shake Enterprises, Inc.

Cases: FranchisingDistribution StateUnfairTradePractices NewJerseyNews