Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D.N.J.: Summary judgment denied on Dunkin’ Donuts’ claims of tax, immigration, and identity theft violations by franchisees, (Oct 10, 2013)

By Tobias J. Gillett, J.D., LL.M.

The federal district court in Newark refused to grant summary judgment on Dunkin’ Donuts’ claims that its franchisees had committed tax, immigration, employment, and identity theft violations—entitling Dunkin’ to terminate the franchises (Dunkin’ Donuts Franchised Restaurants LLC v. JF-Totowa Donuts, Inc., October 9, 2013, Walls, W.). The court further denied summary judgment on the franchisees’ wrongful termination counterclaims.

Between April 2002 and February 2009, Dunkin’ Donuts entered into a series of franchise agreements with corporate entities of which Ashwin Prajapati and Gregory Lulko were officers, members, and/or shareholders. The agreements provided that use of the franchise premises for any illegal or unauthorized purposes would constitute an incurable default causing irreparable harm and willful trademark infringement; that conviction of a crime or offense that Dunkin’ believed was injurious to its systems, trademarks, or goodwill would be a default; and that the franchisees had to maintain full, complete, and accurate records in accordance with generally accepted accounting principles and in a form to be prescribed by Dunkin’.

On May 28, 2009, Dunkin’ sent the franchisees a letter terminating the agreements effective 60 days from receipt. The purported grounds for termination were violations of applicable tax and labor laws, violation of the federal Identity Theft and Assumption Deterrence Act and applicable state law, and violation of immigration and employment laws. Dunkin’ then filed suit against the franchisees, seeking a declaratory judgment that the franchisees’ conduct violated the agreements and constituted grounds for termination, and asserting claims for trademark infringement, unfair competition, and trade dress infringement. The franchisees filed counterclaims, and both parties moved for summary judgment.

Franchisees’ motion for summary judgment. The court denied the franchisees’ motion for summary judgment. The court dispensed with the argument that Dunkin’ had failed to provide documentary support for its allegations, finding that, “after three years of litigation,” Dunkin’s claims were “supported by numerous references to record evidence, including deposition transcripts, documentary evidence, and expert reports.”

Dunkin’ also did not violate the New Jersey Franchise Practices Act (NJFPA). Dunkin’s termination of the franchisees complied with the NJFPA’s 60-day notice requirement because Dunkin’s notice specifically stated that the termination was effective 60 days from receipt of the notice. The fact that Dunkin’ filed suit within that 60 day period did not violate the NJFPA because the NJFPA did not prohibit a franchisor from commencing legal action during the pendency of a 60-day notice period, and the filing of a lawsuit did not act as a termination of the franchise agreements. The notice also complied with the requirement that the franchisor give “written notice setting forth all the reasons for such termination.” The issue of whether Dunkin’ had good cause for the termination was one for the trial fact finder.

Franchisor’s Motion for Summary Judgment

The court also denied Dunkin’s motion for summary judgment, finding that genuine issues of material fact remained regarding each of the allegations Dunkin’ made in support of its claims.

Tax violations. Dunkin’ contended that the franchisees violated the federal tax laws (1) by hiding income paid to Prajapati under the management fee expense category of the franchise companies, (2) by burying loan repayments in the management fee category, and (3) by failing to maintain accurate books and records.

With respect to the first allegation, Dunkin’ claimed that that the ledgers for several franchises showed payments made to Prajapati through the management fee category, and that none of the payments had been properly included in a Form 1099 or in Prajapati’s personal income tax returns. It was unclear what materials Prajapati’s accountant reviewed in preparing the franchisees’ tax returns, or what he recategorized from the records he was provided. Moreover, certain documents relied on by Dunkin’ were not year-end ledgers or statements, and therefore they could not accurately represent what documents were used to prepare the tax returns. Further, the accountant’s testimony that he did not know of the management fees was contradicted by the testimony of the bookkeeper for the franchises. Therefore, the issue of whether the franchisees “willfully” prepared false tax returns could not be decided on the present record.

Dunkin’ also failed to show that no genuine issue of material fact remained as to the second allegation. The allegation was based on activities occurring in 2004 and 2005, and Dunkin’ had not provided a copy of the franchise agreement that governed that franchisee during that time period, nor did the record demonstrate who owned and controlled the franchise during that period.

Finally, genuine issues of material fact remained regarding the franchisees’ alleged failure to maintain accurate books and records. Dunkin’ relied on the same facts and information for this claim as it did for the other claims, and genuine issues of material fact existed for this claim for the same reasons as for the other claims. Moreover, Dunkin’ had not provided any evidence that the franchisees had destroyed any records or withheld them from Dunkin’, and the franchisees also pointed to records maintained in Dunkin’s Point of Sale System and the accounting program QuickBooks, as well as to multiple audits conducted by Dunkin’ and the Internal Revenue Service that cleared the franchisees as complying with record keeping requirements.

Immigration violations. Similarly, genuine issues of material fact remained regarding Dunkin’s claim that the franchisees had failed to fill out and maintain I-9 Employment Eligibility Verification Forms for their employees, as required by the Immigration Reform and Control Act of 1986. Although Dunkin’ claimed that the franchisees had only produced 51 I-9 forms for the 190 employees that they had hired from January 1, 2007 to September 17, 2009, the franchisees claimed that Dunkin’ had requested and never returned many required records during previous audits. Moreover, Prajapati had provided a printout from the federal E-Verify program indicating his compliance with I-9 and employment inquiries, and his participation in the E-Verify program entitled the franchisees to a rebuttable presumption that they complied with the law.

Identity theft. Finally, the franchisees raised genuine issues of material fact regarding Dunkin’s claim that they committed identity theft by misappropriating social security numbers and other identifying information of two former employees and another individual and using that information to verify the employment of other individuals who were unlikely to be authorized to work in the United States. Dunkin’ relied on deposition testimony from the three individuals, but Prajapati vehemently disputed those allegations, and referred to deposition testimony from third parties explicitly contradicting some of the testimony relied on by Dunkin’.

Counterclaims. Finally, the court denied Dunkin’ summary judgment on the franchisees’ counterclaims for (1) a declaration that their franchises, leases, and development agreement had not been terminated; (2) a declaration that they had not committed trademark infringement or unfair competition by continuing to use Dunkin’s trademarks and trade dress after the purported termination; (3) an injunction against termination of the franchises, leases, and development agreement, as well as damages, costs, and attorneys’ fees; and (4) a declaration that Dunkin’s conduct breached the implied covenant of good faith and fair dealing.

The first three counterclaims involved adjudicating the same issues in Dunkin’s claims, and therefore summary judgment was not appropriate for the same reasons. Moreover, Dunkin’ had failed to carry its burden of showing that no issues of material fact remained regarding the claim that Dunkin’ had acted in a manner that had “the effect of destroying or injuring” the franchisees’ right “to receive the fruits of the contract.”

The case is No. 2:09-cv-02636 (WHW).

Attorneys: Melissa A. Provost (Saiber LLC) for Dunkin Donuts Franchised Restaurants. Alan R. Ackerman for JF-Totowa Donuts, Inc.

Companies: Dunkin Donuts Franchised Restaurants; JF-Totowa Donuts, Inc.

Cases: FranchisingDistribution NewJerseyNews