Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—N.D. Cal.: Franchisor allowed to foreclose on former franchisees’ pledged collateral, (May 21, 2014)

By Linda O’Brien, J.D., LL.M.

Fast food franchisor Jack in the Box was allowed to proceed with a private foreclosure sale of collateral used to secure financing by its former franchisees in a breach of contract action brought by the franchisor against the former franchisees, the federal district court in San Jose has decided. Thus, the franchisor’s motion to modify a turnover order was granted (Jack in the Box, Inc. v. Mehta, May 19, 2014, Davila, E.).

Deepak and Kiran Mehta, and their companies, were franchisees of Jack in the Box, Inc. (JIB). In 2012, the franchisees executed a promissory note and security agreement with GE Capital Bank (GECB) that granted GECB a security interest in the interior fixtures and furnishings used to operate their Jack in the Box restaurants. As part of the financing arrangement, JIB consented to GECB obtaining a security interest in the collateral and agreed to subordinate its security interest to that of GECB.

In 2013, JIB terminated its franchise and lease agreements with the Mehtas for failure to make timely payments due under the franchise agreements. JIB filed suit against the Mehtas, alleging breach of contract and violations of the Lanham Act and California’s Unfair Competition Law, and took over operations of their restaurants in lieu of a receivership pursuant to a turnover order. The turnover order also enjoined all creditors from seeking to enforce any claim, right, or interest against the defendants relating to the property or interfering with JIB in the conduct of the business. GECB moved to intervene and JIB moved to modify the turnover order to allow a private foreclosure sale between it and GECB.

The court found that the asset agreement between JIB and GECB was a commercially reasonable disposition of the financing collateral. Under Section 9610 of the California Commercial Code (Code), after a default by the obligor, a secured party may dispose of any collateral following any commercially reasonable process. JIB sought approval of an asset purchase agreement with GECB which would result in a private foreclosure sale between the two entities. Under the agreement, JIB would purchase from GECB all of the collateral in which GECB had a security interest pursuant to the financial arrangement with the Mehtas. JIB argued that the agreement was commercially reasonable because (1) the agreement was negotiated at arms-length; (2) the sale price was reasonable for collateral which was used in a going concern and accounted for depreciation; and (3) the agreement included terms consistent with the notice requirements of the Code and provided for the transfer of the defendants’ ownership rights to JIB.

The defendants’ arguments that JIB lacked standing to negotiate a sale of the collateral and its foreclosure sale was premature before trial were rejected. The court noted that the defendants defaulted on the financing agreement with GECB and it may exercise its right to dispose of the collateral. Moreover, the defendants’ title in the collateral would pass to JIB as a result of the sale and appeared to be technicality at the current stage of the litigation since the defendants lost control over the collateral’s disposition. Finally, the financing arrangement between the Mehtas and GECB was not an issue in the suit and a trial would have no effect on the defendants’ breach of that arrangement. Thus, it was appropriate to modify the turnover order to allow the sale of the collateral to proceed, the court concluded.

The case is No. 5:13-cv-04444 EJD.

Attorneys: Robert Scott McWhorter (Nossaman LLP) for Jack in the Box, Inc. Kelli Michelle Kennaday (Kennaday, Leavitt & Daponde PC) and Megan Alicia Lewis (Wilke Fleury Hoffelt Gould and Birney, LLP) for Deepak Mehta, Mehta Enterprises, Inc., and Deepak Enterprises Inc.

Companies: Jack in the Box, Inc.; Mehta Enterprises, Inc.; Deepak Enterprises, Inc.

Cases: FranchisingDistribution CaliforniaNews