Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—S.D. Tex.: Bank did not commit fraud when making loan to purchase franchise, (Mar 12, 2015)

By Dan Selcke, J.D.

The federal bankruptcy court in McAllen, Texas recommended summary judgment for a bank accused of being negligent and making fraudulent misrepresentations in making a loan for the purchase of a restaurant franchise, since the borrower could not show that the bank owed him a duty of care or that he had justifiably relied on any of its representations (In re: Saenz Jr, March 6, 2015, Isgur, M).

Humberto Saenz, Jr. operated a Pizza Patron franchise in Rio Grande City. Pizza Patron Inc. (PPI) was the franchisor for Pizza Patron restaurants. At some point in 2009, Jose Gomez showed interest in buying the Rio Grande franchise. The parties reached a preliminary agreement for Gomez to purchase it for $350,000.00. To finance the transaction, Gomez received a loan of approximately $287,200.00 from Lone Star National Bank, 75% of which was guaranteed by the Small Business Administration (SBA). In order for Gomez to get this loan, Saenz had to provide Lone Star with a list of the restaurant’s inventory, fixtures, and equipment. According to Gomez, Lone Star instructed Saenz to provide the newly purchased value of the equipment and fixtures rather than their fair market value.

Gomez signed a Purchase-Sale Agreement for the franchise and took control of it. In 2011, however, he realized that he could not afford to keep the restaurant open and closed its doors. Gomez filed suit against Saenz, PPI, and Lone Star, alleging negligence and common-law fraud. After Saenz filed for chapter 7 bankruptcy, the lawsuit was removed to bankruptcy court, where Lone Star filed a motion for summary judgment.

Negligence. The court held that Gomez could not establish that Lone Star owed him a duty of care, to say nothing of whether Lone Star breached that duty.

Gomez’s negligence claim was based on Lone Star’s alleged failure to perform its obligations as his lender “with regard to the SBA loan that Gomez ultimately received.” In order to get that loan, Gomez signed numerous documents, including the note, loan agreement, commercial loan agreement, and security agreement. In short, he entered into a contract with Lone Star, thereby agreeing to have their relationship defined by the terms of that contract. In Texas, plaintiffs who wanted to transform a breach of contract claim into a negligence claim needed to show the existence of a special relationship between the parties in order to show that a duty existed. That special relationship could be shown by, for example, facts indicating that the lender had an excessive amount of control over the borrower’s business activities, but no such facts were alleged here.

Fraud. The court also held that Gomez failed to state a prima facie case for common-law fraud. First, Gomez alleged that Lone Star misrepresented facts to the SBA when trying to get the organization to guarantee part of his loan. In submitting his hand-written SBA application, Gomez claimed, Lone Star changed the purpose of the loan from “purchase franchise” to “purchase business.” Had the loan been treated as one for the purchase of a franchise rather than a business, it would have triggered an additional set of requirements under Section (I)(3)(e) of the SBA Authorization.

However, even assuming that Lone Star’s alternation of Gomez’s application resulted in a false representation to the SBA, Gomez could not show that he acted in reliance on the representation, a necessary element of fraud. Because he handed the application to Lone Star before it was submitted to the SBA, he tacitly admitted that any changes occurred without his knowledge. Also, the representation was not material, as none of the additional requirements would have made a difference in how the situation turned out. The only requirement that related to the borrower was one that required the franchisor to allow the borrower to defer payment of franchise fees so the borrower could cure a default, but Gomez always paid his franchise fees without difficulty.

Equipment value. Next, Gomez pointed to the incident where Lone Star asked Saenz to provide it with a list of equipment in the restaurant and to value that equipment at the purchase value, rather than at the fair market value. This request, Gomez alleged, was Lone Star’s attempt to inflate the price of the franchise and thereby support the size of the loan. This argument had no merit, as Gomez testified that the purchase price was “set in stone” long before he approached Lone Star to obtain financing. Lone Star gave Gomez a $287,200.00 loan because he asked for a $287,200.00 loan. In any case, Gomez only saw the itemized list after he had submitted his loan application, so he could not have relied on it when making his decision. Also, Lone Star never represented that the equipment had been valued at anything other than the purchase price, so there was no evidence that their representation had been false.

Due diligence. Finally, Gomez alleged that, contrary to the terms of the SBA application, Lone Star failed to verify the financial information provided by Saenz, yet still claimed that it had performed its due diligence as required by the SBA. Even if Lone Star breached the terms of the SBA Application, “mere breach of contract is not fraud and…may not be evidence of fraud.” Also, Gomez could not identify when or how Lone Star represented that it had performed its required due diligence beyond making a conclusory statement that it had done so. Lastly, Gomez had a responsibility to perform due diligence on Saenz’s financial representations himself. Lone Star was not Gomez’s legal representative and was under no obligation to hold his hand through the investment process. To the extent that Gomez relied on Lone Star to perform due diligence that he should have performed himself, that reliance was not justifiable.

The bankruptcy court recommended that the district court grant Lone Star’s motion for summary judgment.

The case number is: 13-70423

Attorneys: Jose Wilfredo Hernandez (Ortiz Millin LP) for Jose Maria Gomez, and JMG Ventures LLC. Benjamin Ray Guerra (Ben Guerra Law Office PLLC) for Lone Star National Bank.

Companies: JMG Ventures LLC; Lone Star National Bank

Cases: FranchisingDistribution TexasNews