Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—N.D. Ala.: Restaurant franchisees’ breach of contract claims against franchisor may proceed, (Mar 10, 2015)

By Linda O’Brien, J.D., LL.M.

Former Mexican restaurant franchisees that sustained consistent losses and ultimately closed their business operations alleged sufficient facts to pursue breach of contract and fraudulent suppressions claims against the franchisor, the federal district court in Birmingham, Alabama has decided (Fern Street Investments, LLC v. K&F Restaurant Partners, LLC, March 9, 2015, Haikala, M.).

K&F Restaurant Partners is a franchisor of Izzo’s Illegal Burrito casual dining restaurants. In November 2010 and June 2012, Fern Street Investments (FSI) and Fern Street Chace Landing (FSC) entered into franchise agreements with K&F for two Izzo’s franchises in the Birmingham metropolitan area. K&F provided franchise disclosure documents to FSI and FSC, which disclosed relevant financial and corporate information regarding the franchise.

The two franchises consistently sustained losses and, in 2013, FSI and FSC closed the restaurants. Subsequently, FSI and FSC filed suit against K&F, asserting claims, in part, for breach of contract and fraudulent suppression and/or misrepresentation. The plaintiffs alleged that K&F withheld pertinent financial information and failed to perform certain obligations on which the successful operation of the restaurants depended. K&F moved to dismiss the complaint for failure to state a claim.

Breach of contract. The court determined that the plaintiffs’ allegations were adequate to survive a motion to dismiss. FSI and FSC alleged that K&F breached the franchise disclosure document and franchise agreements by (1) failing to provide demographic information for either restaurant location; (2) requiring the purchase of overpriced equipment, signage, supplies, and products; (3) using an inexperienced marketing firm that was incapable of providing a proper marketing plan; (4) failing to apply the advertising fee in plaintiffs’ market area; (5) requiring the use of a point of sales (POS) system that improperly calculated state sales tax; and (6) failing to provide adequate and effective training to franchisee personnel.

In the complaint, the plaintiffs also alleged that they entered into valid, enforceable franchise agreements with K&F, they performed their obligations under those agreements, K&F breached those agreements, and the franchisees were harmed and suffered damages. K&F’s argument that the damages allegations were insufficient was rejected. The court noted that the plaintiffs’ allegations — that they were damaged because they invested significant amounts of personal capital and sustained losses until both franchises were forced to cease operations — were adequate to put K&F on notice of the nature of the damages that FSI and FSC sought.

Fraudulent suppression. To state a claim for fraudulent suppression, a plaintiff must allege that the defendant had a duty to disclose material facts, the defendant concealed or failed to disclose those facts, the concealment or failure to disclose induced the plaintiff to act, and the defendant’s action resulted in harm to the plaintiff, the court explained. FSI and FSC alleged that K&F owed them a duty to disclose that (1) their flawed POS system collected insufficient state sales taxes; (2) their franchise business model was unworkable; and (3) their purchasing and inventory controls, accounting methods, promotional techniques, and personnel training were lacking. The failure to disclose induced them to enter into the franchise agreements and caused them to sustain damages.

K&F ‘s argument that the plaintiffs failed to identify the specific parts of the franchise disclosure documents that K&F purportedly misrepresented was rejected. The court found that the franchise disclosure document was attached to the complaint as an exhibit and the defendant should have no difficulty locating the relevant provisions of the document that refer to the plaintiffs’ allegations. Furthermore, the plaintiffs alleged sufficient facts for a court to determine whether K&F owed them a duty to disclose and to maintain their fraudulent suppression and misrepresentation claims, the court concluded.

The case is No. 2:13-cv-01935-MHH.

Attorneys: Michael J. Douglas (Friedman Dazzio Zulanas & Bowling PC) for Fern Street Investments LLC, and Fern Street Chace Landing LLC. Christina M. Saunders (Lloyd Gray Whitehead & Monroe) for K&F Restaurant Partners LLC.

Companies: Fern Street Investments LLC; Fern Street Chace Landing LLC; K&F Restaurant Partners LLC

Cases: FranchisingDistribution AlabamaNews