Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—E.D. Mich.: Professional negligence claim against franchise attorney continues to sizzle, (Jul 30, 2024)

By Martin A. Steinberg, J.D.

Attorney accused of adding evergreen royalties provision in franchise agreement against client’s wishes.

In a legal malpractice case, the federal court in Detroit, Michigan granted summary judgment in Defendants’ favor on the negligent misrepresentation claim but denied summary judgment as to a professional negligence claim. Black Rock Steak House Franchising (Black Rock) sued Harold L. Kestenbaum, P.C. and Harold L. Kestenbaum (Kestenbaum) claiming that Kestenbaum committed legal malpractice by not following its instruction to not insert an “Evergreen Royalties” provision in its area representative agreements (ARAs). Black Rock’s experts determined that by including this provision, Black Rock paid over $652,000 in additional royalties and estimated future royalty payments will exceed $1.7 million. The court approved a report and recommendations and overruled each of Defendants’ objections to the report. The court dismissed Black Rock’s negligent misrepresentation claim because it was duplicative of its legal malpractice claim (Sizzling Black Rock Steak House Franchising, Inc. v. Harold L. Kestenbaum, PC, No. 2:21-cv-11621-SFC-CI (E.D. Mich. July 17, 2024)).

In the franchise industry, royalties which continue to be owed to an area representative based on continuing revenue from restaurants opened during the term of an ARA, after that ARA is terminated, are commonly known as “Evergreen Royalties.” Black Rock did not want any ARAs Kestenbaum prepared for it to possibly be interpreted as requiring the payment of Evergreen Royalties, hence the need for such a specific provision.

Black Rock is a Michigan corporation that owns, operates, and franchises restaurants and licenses its restaurant concept to area representatives for use in establishing restaurants in specific geographic areas pursuant to area representative agreements.

In 2013, Black Rock won first place in a contest called “America’s Next Top Restaurant Franchise” (the Contest). The prize included free “initial legal services” from Kestenbaum, who, at the time, ran a firm called Harold L. Kestenbaum, P.C. (HLK P.C.) based in Melville, New York. Kestenbaum’s legal practice focuses on franchise law, and he is licensed to practice in New York and New Jersey. He understood that, after he provided initial legal services at no cost to the Contest winner, that the company would hire him on a monthly retainer.

In 2014, Kestenbaum began providing free legal services to Black Rock, preparing its franchise disclosure document and other initial documents over a four to six week period. During this initial time period, Kestenbaum worked with the Contest sponsor, Paul Samson, the president of Franchise Edge based in Florida, and had no direct contact with Black Rock or its principals. Black Rock subsequently retained Kestenbaum as its legal counsel for all franchise matters, with a monthly retainer of $1,500 for legal services plus reimbursement of any costs Kestenbaum incurred on Black Rock’s behalf. This monthly retainer increased to $2,000 per month beginning in August 2018.

Between 2015 and 2020, Kestenbaum prepared four ARAs for Black Rock, the fourth one arising after Kestenbaum’s merger with another law firm, Spadea Lignana LLC (Spadea), which has offices in New York and Pennsylvania. Black Rock asserted that it made clear to Kestenbaum that it wanted no ARAs prepared for it to include so-called Evergreen Royalties language. Nevertheless, when in late 2020 Black Rock wished to terminate the second ARA prepared by Kestenbaum, other attorneys at Spadea confirmed that the Second ARA required payment of Evergreen Royalties amounting to $20,000 per month over a 10-year period.

In May 2021, Black Rock ended its client relationship with Kestenbaum, HLK PC, and Spadea. Black Rock alleged that it is paying approximately $20,000 per month in Evergreen Royalties to representative BRM LLC, as required by the terms of the Second ARA, and that it anticipates that it will continue to pay that amount for at least 10 years.

On June 10, 2021, Black Rock filed this legal malpractice action against Kestenbaum, HLK PC, and Spadea in the Oakland County Circuit Court. The complaint alleged that Defendants negligently prepared the Second, Third and Fourth ARAs to include a provision for Evergreen Royalties in direct contravention to Black Rock’s instruction. Black Rock asserted three counts for: (1) professional negligence by all defendants; (2) negligent misrepresentation against all defendants; and (3) negligent supervision against Spadea. Defendants removed this action to this court on July 14, 2021, based on diversity jurisdiction.

On July 21, 2021, Defendants filed a motion to dismiss for lack of personal jurisdiction pursuant to Fed. R. Civ. P. 12(b)(2). On December 17, 2021, the court entered an Opinion and Order granting in part and denying in part Defendants’ motion to dismiss. The court dismissed Spadea for lack of specific personal jurisdiction, but denied the motion as to Kestenbaum and HLK PC by holding that the court has specific personal jurisdiction over them. As a result of this ruling, only the first two counts remained against Kestenbaum and HLK PC.

Defendants moved for summary judgment on September 29, 2023. On April 2, 2024, the Magistrate Judge issued a Report and Recommendation (R&R) recommending that (1) Defendants’ motion for summary judgment be granted in part and denied in part; (2) Michigan law be applied to all claims, including the applicable statute of limitations for Black Rock’s legal malpractice claim; (3) Black Rock’s legal malpractice claim not be barred by limitations; (4) genuine issues of material fact bearing on the merits of that claim exist, precluding summary judgment; and (5) Black Rock’s negligent misrepresentation claim is duplicative of its legal malpractice claim and thus should be dismissed. Defendants filed timely objections to the Magistrate Judge’s R&R, to the extent it recommends denying Defendants’ motion for summary judgment.

Defendants’ objections. Defendants filed six objections to the Magistrate Judge’s R&R.

First, New York law should apply. The court overruled this objection because the Magistrate Judge correctly stated that the choice of law was Michigan. Defendants argued that New York law should apply because this is a legal malpractice action against a New York attorney, and that New York has a substantial interest in determining whether its admitted attorneys properly performed legal services or deviated from the applicable standard of care.

Yet, Defendants did not dispute that there is no conflict between Michigan and New York legal malpractice law. This fact was dispositive because before undertaking a choice-of-law analysis, the court must first determine whether an actual conflict exists between the substantive laws of Michigan and New York. Only if an actual conflict exists must the court proceed to determine which state has a materially greater interest in having its laws applied.

The Magistrate Judge, however, recognized that Michigan and New York statute of limitations law differed for legal malpractice claims, with Michigan providing a two-year limitation for malpractice claims, while New York has a three-year limit. Nevertheless, because Michigan’s common law choice of law rule considers statutes of limitations as procedural it is governed by the law of the forum.

Second, there are no disputed issues of material fact. Though the Magistrate Judge found that the first element of the legal malpractice claim was uncontested, he correctly found that there are genuine issues of material fact as to the second, third and fourth elements of that claim. To establish a legal malpractice claim in Michigan, Plaintiff must demonstrate: (1) the existence of an attorney-client relationship; (2) negligence in the legal representation of the plaintiff; (3) that the negligence was the proximate cause of an injury; and (4) the fact and extent of the injury alleged. Defendants, however, argued that that there was not any genuine issue of material fact as to the third element, namely whether Defendants’ actions were the proximate cause of Black Rock’s claimed injury of having to pay evergreen royalties under the Second ARA.

The court agreed with the Magistrate Judge, considering the evidence in the light most favorable to Black Rock, that issues of material fact remain for the jury to decide with respect to Black Rock’s legal malpractice claim, including (1) how to interpret the relevant article of the Second ARA, (2) whether Defendants advised Black Rock to fully or partially terminate the Second ARA, (3) whether Black Rock could terminate the Second ARA for failure to meet the development schedule and other obligations, (4) whether Defendants’ actions were the proximate cause of Black Rock’s claimed injury.

Third, the first ARA is not relevant to Black Rock’s allegations. The First ARA had an evergreen royalties provision, however, the next subsection stated that the franchisee forfeits rights to royalty fees after termination of the agreement, without condition or modification. The first draft of the Second ARA contained these same two contradictory provisions. These facts supported the existence of a disputed issue of material fact whether Kestenbaum used reasonable care and skill in drafting the Second ARA to satisfy Black Rock’s stated intentions not to include an unbounded evergreen provision in that ARA.

Fourth, it was undisputed that Black Rock was aware of and agreed to evergreen royalties. The court commented that while Defendants would like the court to ignore the deposition testimony and rely only on the evidence Defendants cited, the Magistrate Judge was correct that the evidence, viewed in the light most favorable to Black Rock, created a genuine issue of material fact whether Kestenbaum used reasonable care and skill to draft the Second ARA that satisfied Black Rock’s objectives. To the extent Defendants argued that Black Rock was contributorily or comparatively negligent for presumably not reading the Second ARA, such an argument would not mandate summary judgment.

Fifth, Black Rock’s suit was time barred. Because this case involved a continuous legal relationship between Black Rock and Defendants until at least December 2020, Black Rock timely filed its legal malpractice claim within the statutory limitations period, when it filed suit in July 2021. In enacting Mich. Comp. Laws 600.5838(1), the Michigan legislature adopted the “last treatment” or “continuous professional representation” approach to the accrual of a legal malpractice claim. This rule provides that if a plaintiff is injured as a result of professional services, but continues to receive related services, those continuing services constitute the matters out of which the claim for malpractice arose for limitations purposes.

Sixth, Black Rock’s anticipated future damages were speculative. Defendants objected to the Magistrate Judge’s recommendation that Black Rock’s anticipated future damages were not speculative because “any number of unpredictable events would terminate Plaintiff’s obligations to pay evergreen royalties.” As a general rule, damages are not permitted which are remote and speculative in nature.

Black Rock presented unrebutted expert testimony that Black Rock has paid evergreen royalties totaling $522,649 through April 2, 2023. Black Rock asserted that it has continued to pay additional evergreen royalties each month since then which now totals in excess of $652,383.46. Black Rock also presented unrebutted expert testimony regarding estimated future royalty payments totaling $1,716.449. Because Defendants challenged the amount of any future damages, not the fact of such damages, this challenge was insufficient to act as a prohibition on speculative damages.

Negligent misrepresentation claim. Finally, the court accepted the Magistrate Judge’s determination that Black Rock’s negligent misrepresentation claim is duplicative of its legal malpractice claim and thus should be dismissed.

Conclusion. The court adopted the April R&R; overruled Defendants’ Objections; and granted in part and denied in part Defendants Motion for Summary Judgment: (1) granted as to Plaintiff’s Negligent Misrepresentation claim in Count II and dismissed it with prejudice, and (2) denied summary judgment as to Plaintiff’s Professional Negligence claim in Count I.

The Case is No. 2:21-cv-11621-SFC-CI.

Judge: Cox, S.

Attorneys: Mayer Morganroth (Morganroth & Morganroth, PLLC) for Sizzling Black Rock Steak House Franchising Inc. David C. Anderson (Collins Einhorn Farrell PC) for Harold L. Kestenbaum PC and Harold L. Kestenbaum.

Companies: Sizzling Black Rock Steak House Franchising, Inc.; Harold L. Kestenbaum PC

Cases: FranchisingDistribution MichiganNews GCNNews