Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION NEWS: 7-Eleven alleges RICO conspiracy by former franchisees to divert cash and inventory from five stores, (Jun 25, 2013)

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

7-Eleven, Inc. has filed a complaint in the federal district court in Brooklyn, New York, alleging that a franchisee of five 7-Eleven stores and a number of related individuals committed a range of statutory, common law, and contractual violations through schemes to divert cash and inventory from the stores (7-Eleven, Inc. v. Khan, June 21, 2013). 7-Eleven asserts claims for violation of the RICO Act, conspiracy to violate the RICO Act, common law fraud, breach of contract, a declaratory judgment, trademark infringement, a mandatory injunction, and recovery of chattels.

Tariq A. Khan operated five 7-Eleven franchise stores located in Nassau County, New York—four franchised to him and one franchised jointly to him and his wife, Senita Khan. In its complaint, 7-Eleven alleged that it properly terminated the franchise agreements after discovering “illicit, wide-ranging schemes” conducted by the Khans and various other individual “lieutenants,” also defendants, to divert cash from the stores and to operate a “business within a business in each of the stores,” which was not reported to 7-Eleven.

According to 7-Eleven, the participants in the schemes manipulated the point-of-sale register to underreport merchandise sales, depriving 7-Eleven of its portion of the profits on those sales. Tariq allegedly transferred merchandise between the franchise stores and independent stores also owned by Tariq to manipulate inventory levels and to understate Tariq and Senita’s reported income.

A 7-Eleven operational review of one of the franchise stores, and a subsequent investigation of all of the stores, revealed a range of “operational discrepancies.” According to the investigation, Tariq’s stores “experienced inventory shortages in excess of $2.43 million in the aggregate” from October 8, 2009 through February 15, 2013, in amounts “multifold the average inventory shortages” experienced by other stores in the same market area. Some of the merchandise “was observed to have been transferred by defendants in a vehicle owned by Tariq to a Gulf Express” also owned by Tariq.

The defendants allegedly reported only part of cash purchases from certain vendors, sold certain merchandise at prices higher than those reported to 7-Eleven, engaged in excessive write-offs of fresh food products to mask inventory shortages, made unreported sales by either bypassing the register or by misrecording transactions, sold merchandise not reported to 7-Eleven, and overstated the cost of goods sold by submitting invoices for certain expenses as inventory purchases. 7-Eleven supported these allegations with statistical evidence of the use of the cancel age verification key, which can be “used to reflect an aborted sale of an age-restricted product,” that demonstrated that the use of the key at the Khans’ stores greatly exceeded the use of the key at other stores in the same market. Moreover, 7-Eleven described the results of “secret shops” conducted at the stores, in which illicit transactions were observed.

Tariq and Senita also allegedly engaged in illicit labor practices, including reporting labor costs “substantially less than the Market average, and less than the number of employees necessary to reasonably handle the volume of reported business.” The labor costs were also “inflated by the presence on the payroll of persons, primarily family members, who do not work at the Stores.” The Khans also employed workers who worked hours in excess of those reported to 7-Eleven, and with names that did not match the Social Security numbers provided for them, according to the complaint.

7-Eleven asserts that the defendants’ conduct constituted violations of the RICO Act and conspiracy to violate the RICO Act. 7-Eleven alleges enterprises consisting of various combinations of the stores and the individual defendants. It claims that cash reports submitted by or on behalf of Tariq, as well as other interstate communications, constituted predicate acts of wire fraud in violation of federal law and the making of false entries in the business records of an enterprise in violation of Section 175.05 of the Penal law of the State of New York. 7-Eleven also claims that the defendants committed common law fraud by intentionally submitting false reports of merchandise sales and inventory purchases to 7-Eleven.

In addition, 7-Eleven asserts that Tariq and Senita breached their contract with 7-Eleven by failing to comply with provisions requiring them to “[c]ause all sales of inventory to be properly recorded at the time of sale”; “[u]se electronic equipment provided by 7-Eleven to scan the sale of all products capable of being scanned”; “furnish to 7-Eleven actual sales data”; “furnish to 7-Eleven daily reports of receipts”; deposit sales proceeds, discounts or allowances in a bank account designated by 7-Eleven; “furnish to 7-Eleven daily summaries of purchases”; “[f]urnish to 7-Eleven copies of invoices for purchases”; “[t]imely submit the Cash Report to 7-Eleven”; “furnish to 7-Eleven weekly time and wage authorizations for the Stores’ employees”; notify 7-Eleven of all discounts, allowances, or premiums received; “[p]rovide 7-Eleven with truthful, accurate, and complete information” regarding compliance with applicable laws and 7-Eleven policies; “[p]ay all sales, payroll and income taxes”; “[m]aintain a high ethical standard”; not commit acts that would adversely affect 7-Eleven; and “devote their best efforts to the business of the Stores.”

Since Tariq and Senita contended that the notice of termination was improper, 7-Eleven seeks a declaratory judgment that it validly and effectively terminated the franchise agreements. As Tariq and Senita have continued to operate the stores using the 7-Eleven name and trademarks, 7-Eleven asserts a claim of trademark infringement under the Lanham Act. 7-Eleven also seeks a mandatory injunction against the Khans requiring them to quit and deliver possession of the stores to 7-Eleven, and recovery of inventory and any proceeds at the stores.

7-Eleven requests treble compensatory damages for the RICO violations, compensatory damages for the common law fraud and breach of contract claims, and a judgment that its termination of the franchise agreements was valid and therefore 7-Eleven is entitled to possession of the stores and their equipment and inventory. With respect to the trademark infringement claim, 7-Eleven seeks an injunction restraining the Khans from use of the trademarks and requiring them to deliver to 7-Eleven “all indicia of 7-Eleven’s trademarks and trade secrets in Tariq’s possession or under his control,” as well as profits from use of the trademarks, treble damages, punitive damages, and attorneys’ fees.

The case is No. 2:13-cv-03538-ADS-ARL.

Attorneys: Stephen Sussman (Duane Morris LLP) for 7-Eleven, Inc.

Companies: 7-Eleven, Inc.

News: FranchisingDistribution RICO NewYorkNews