Court Watch

Stuller sued Steak N Shake in a declaratory action and, subsequently, filed a motion for a preliminary injunction to enjoin Steak N Shake from: 1) forcing Stuller to implement the 2010 pricing policy while the case was pending; and 2) taking any adverse action against Stuller for refusing to adopt the pricing policy.

The District Court for the Central District of Illinois found that Stuller satisfied the initial threshold for granting a preliminary injunction. Steak N Shake appealed the decision, asserting that Stuller's harm was “self-inflicted” because Stuller chose not to comply with the mandatory pricing policy. Steak N Shake argued that, had Stuller simply chosen to follow the mandated pricing policy, there would have been no need to revoke the plaintiff's franchise rights. As a result, Stuller's harm was in fact “self-inflicted” and did not qualify as irreparable harm.

The defendant relied on a previous Seventh Circuit ruling, Second City Music, Inc. v. City of Chicago, 333 F.3d 846, 850 (7th Cir. 2003) for this argument. In Second City Music, a used audio and video recordings dealer objected to a city ordinance that required it to obtain a license in order to sell audio and video equipment. In that case, the dealer's refusal to apply for the license was classified as a “self-inflicted” injury because the dealer would have incurred no detriment by merely applying for the license.

On appeal, Steak N Shake relied upon the court's following statement in Second City Music: “Injury caused by failure to secure a readily available license is self-inflicted, and self-inflicted wounds are not irreparable injury. Only the injury inflicted by one's adversary counts for this purpose.” The court of appeals clarified that this statement did not lead to a categorical rule that a self-inflicted injury cannot be irreparable harm and stressed that the finding of irreparable harm depends on the circumstances of the particular case. The court distinguished the Second City Music decision, explaining that Stuller's choice not to implement the Steak N Shake pricing policy was not a true choice at all because the action was required in order for Stuller to viably operate. Accordingly, the decision could not be fairly categorized as a self-inflicted injury.

The court of appeals found that Stuller presented enough evidence to show that the policy would be a significant change to its business model and that it would negatively affect (potentially to a considerable extent) its revenue. Because Stuller established the threshold requirement of showing it would suffer irreparable harm without a preliminary injunction, the court affirmed the district court ruling. While the case does not establish a bright-line rule in favor of either franchisees or franchisors, it does provide additional support for arguments that franchisees are not always required to follow the policies set by the franchisor without regard to their impact on the franchisee's ability to operate.

RICO Claims Against Franchisor Move Forward

In WW, LLC v. The Coffee Beanery, LTD, No. WMN-05-3360, 2012 WL 3728184 (D. Md. Aug. 27, 2012), the U.S. District Court for the District of Maryland denied the defendant franchisor's motion to dismiss two RICO (Racketeer Influenced and Corrupt Organizations Act) claims made by the franchisees. Accordingly, these racketeering counts (seldom seen in franchising and more commonly associated with illegal gambling and the Mafia) can now be tried in front of a Maryland jury against The Coffee Beanery, its owners and two company officers. These charges create the potential for both civil and criminal liability, and the franchisor can face treble damages and attorney fees and costs if it is unsuccessful at trial. Because the plaintiff bears the burden of proof in RICO claims, these racketeering claims give both franchisors and franchisees a lot to consider.

As Judge William M. Nickerson stated in the decision, this case has a “long and tortured history” of litigation. Plaintiffs Deborah Williams and Richard Welshans filed suit against the franchisor and seven individual officers after operating an unsuccessful Coffee Beanery franchise in Annapolis, MD, from 2004 through 2007. The plaintiff franchisees claimed that they never made an annual profit and had cumulative operating losses of nearly $325,000. The plaintiffs alleged that the defendants promoted their “caf' concept” to franchisees as a proven and profitable concept, despite knowing that only one of their caf's had ever been successful. In addition, the plaintiffs alleged that the franchise disclosure documents omitted the unaudited financials and other information relating to a restaurant-type caf', in contrast to the usual coffee shop model, including the expense of additional construction, expensive supplies, and meal preparation equipment. The plaintiffs claimed that the owners and officers of The Coffee Beanery engaged in a pattern of racketeering activity against a number of franchisees as a regular way of doing business.

The case was remanded to the district court by the Fourth Circuit Court of Appeals after the parties' Michigan arbitration results were vacated by the Sixth Circuit Court of Appeals. Coffee Beanery first tried to dismiss the RICO claims as untimely, asserting that the plaintiffs included the RICO claims in their amended complaint after RICO's four-year statute of limitations expired. Although the original complaint did not contain any RICO claims, it did contain claims of fraud with substantially similar factual allegations. The court explained, quoting from an earlier RICO case, Feinberg v. Katz, Civ. No. 99-45, 2002 WL 1751135, at *11 (S.D.N.Y. July 26, 2002), that the amended complaint relates back “even when the acts of fraud are not fully developed, and no hint of a future RICO claim is given.” Further, the court noted that more evidence is required for RICO claims than for fraud claims, and thus a complaint amended to include RICO claims may relate back despite containing additional allegations.

Here, the franchisees' amended complaint contained “completely new factual allegations,” including new alleged misrepresentations made to other nonparty franchisees. Although these allegations were not present in the original complaint, they alleged the same misrepresentations and failure to disclose the same type of information as advanced in the earlier complaint. The court held that these new RICO claims shared the same “nucleus of operative fact” and were substantially similar to the original complaint's fraud claims, and thus related back to the original, timely complaint.

The court next analyzed the RICO allegations themselves, denying the defendants' motion to dismiss the ' 1962(c) claims but granting their motion to dismiss the ' 1962(d) claims. Section 1962(c) claims require four elements: 1) conduct; 2) of an enterprise; 3) through a pattern; 4) of racketeering activity.

Concerning the third element, the defendants unsuccessfully questioned whether the pattern requirement had been met. To establish such a pattern, a plaintiff must establish the relationship between at least two predicate acts and that the acts pose a threat of continued activity. Here, the plaintiffs alleged that Coffee Beanery and the various defendants continued to promote the caf' concept and sent out fraudulent UFOCs, even though they were aware that the concept was unsuccessful. The plaintiffs argued that the predicate acts of mail and wire fraud occurred “an uncounted number of times against the same type of victim in a nearly identical manner,” thus satisfying the relationship requirement. As to the continuity-of-activity requirement, the court found that the plaintiffs established an open-ended pattern that is ongoing because Coffee Beanery continues to distribute the allegedly fraudulent communications.

As for the fourth element, racketeering activity, the court found that the plaintiffs satisfied the pleading requirement concerning the predicate acts of racketeering. In RICO mail fraud suits against multiple defendants, plaintiffs need only adequately plead the circumstances of the fraud. The plaintiffs' pleadings included details of the alleged scheme's outline, goal, time frame and target audience; the contents of the allegedly fraudulent communications sent using the mail or wires; and the roles of the individual defendants and their continued communications despite alleged knowledge of the franchise system's lack of success. On this fourth element of racketeering activity, the court found that the plaintiffs “have certainly provided sufficient detail to put Defendants on notice of the fraud pled against them.”

After refusing to dismiss the ' 1962(c) claims, the court granted the defendants' motion to dismiss the two ' 1962(d) claims as barred by the intracorporate conspiracy doctrine. When acting within the scope of their employment, corporate agents cannot conspire with each other or with the corporation itself, because all of their authorized acts are attributable to the corporation. Here, the plaintiffs did not allege that the individual defendants had independent personal stakes or acted without authorization, which are the Fourth Circuit's two exceptions to this doctrine. Because the plaintiffs alleged that the individual defendants were in positions such as president and chairman, the court inferred that “[p]resumably ' their authority is largely without limitation.” Thus, the court held that the alleged activities were authorized corporate acts, and the ' 1962(d) claims were barred by the intracorporate conspiracy doctrine.

Apart from the RICO claims, the court granted and denied the defendants' additional motions. First, the court determined that the defendants' supplemental motion to dismiss for lack of personal jurisdiction was untimely and thus waived. The court also took judicial notice of defendant Kevin Shaw's misdemeanor conviction for theft of traffic cones at a construction site, which plaintiffs had previously categorized as a felony. The court instead left this “perceived misunderstanding” for the parties to dispute at trial. The court also dismissed the plaintiffs' detrimental reliance claim because the claim failed to allege facts that amounted to the required clear and definite promise element.

Additionally, the court denied the defendants' motion to dismiss the Maryland Franchise Act claims, holding that the plaintiffs pleaded the alleged misstatements and fraudulent omissions with enough particularity to satisfy Rule 9(b). The Act's joint and several liability provisions allowed the plaintiffs to proceed without alleging particular statements made by each individual defendant. Finally, the court dismissed the intentional and negligent misrepresentation claims against two individual defendants. Here, the plaintiffs had not provided enough detail regarding the alleged misrepresentations made to them, and the only alleged statements by these two individuals were made to nonparty franchisees.

This decision, and the court's recognition of the viability of possible RICO claims against franchisees, has the potential to be quite influential for future franchise disputes.

Lauren Sullins Ralls is an associate in the Atlanta office of Kilpatrick Townsend & Stockton LLP. She can be contacted at 404-532-6967 or [email protected].

Restaurant Pricing Litigation Clarifies Definition of a 'Self-Inflicted' Injury for Franchisees

In a recent decision, the Seventh Circuit affirmed an Illinois federal court's ruling that a long-standing Steak N Shake franchisee did not have to comply with the franchisor's policy on setting the prices for menu items, finding that forcing the franchisee to implement the pricing policy would constitute irreparable harm.

In Stuller, Inc. v. Steak N Shake Enterprises, Inc., No. 10-CV-3303 (C.D. Ill. 2011), a franchisee of five Steak N Shake restaurants across Illinois, Stuller, Inc. (“Stuller”), sued when Steak N Shake threatened to terminate its franchise contracts if it did not adopt the new policy of uniform prices and promotions. Stuller, which had operated Steak N Shake franchises since 1939 through its predecessors, argued that this policy was contrary to the long-standing custom and business practice between Steak N Shake and its franchisees that allowed franchisees to set their own prices for menu items, maintain custom menus, and elect whether to follow certain promotions. Stuller presented evidence that the policy would be a significant change to its business model and that it would negatively affect its revenue. Indeed, Stuller argued that it previously had lost nearly $540,000 after implementing a corporate pricing strategy in 2007, and thus refused to adopt the new policy. Stuller alleged that, after refusing to follow the new policy, it was threatened with termination of its franchise rights unless the policy was implemented.

Stuller sued Steak N Shake in a declaratory action and, subsequently, filed a motion for a preliminary injunction to enjoin Steak N Shake from: 1) forcing Stuller to implement the 2010 pricing policy while the case was pending; and 2) taking any adverse action against Stuller for refusing to adopt the pricing policy.

The District Court for the Central District of Illinois found that Stuller satisfied the initial threshold for granting a preliminary injunction. Steak N Shake appealed the decision, asserting that Stuller's harm was “self-inflicted” because Stuller chose not to comply with the mandatory pricing policy. Steak N Shake argued that, had Stuller simply chosen to follow the mandated pricing policy, there would have been no need to revoke the plaintiff's franchise rights. As a result, Stuller's harm was in fact “self-inflicted” and did not qualify as irreparable harm.

The defendant relied on a previous Seventh Circuit ruling, Second City Music, Inc. v. City of Chicago , 333 F.3d 846, 850 (7th Cir. 2003) for this argument. In Second City Music, a used audio and video recordings dealer objected to a city ordinance that required it to obtain a license in order to sell audio and video equipment. In that case, the dealer's refusal to apply for the license was classified as a “self-inflicted” injury because the dealer would have incurred no detriment by merely applying for the license.

On appeal, Steak N Shake relied upon the court's following statement in Second City Music: “Injury caused by failure to secure a readily available license is self-inflicted, and self-inflicted wounds are not irreparable injury. Only the injury inflicted by one's adversary counts for this purpose.” The court of appeals clarified that this statement did not lead to a categorical rule that a self-inflicted injury cannot be irreparable harm and stressed that the finding of irreparable harm depends on the circumstances of the particular case. The court distinguished the Second City Music decision, explaining that Stuller's choice not to implement the Steak N Shake pricing policy was not a true choice at all because the action was required in order for Stuller to viably operate. Accordingly, the decision could not be fairly categorized as a self-inflicted injury.

The court of appeals found that Stuller presented enough evidence to show that the policy would be a significant change to its business model and that it would negatively affect (potentially to a considerable extent) its revenue. Because Stuller established the threshold requirement of showing it would suffer irreparable harm without a preliminary injunction, the court affirmed the district court ruling. While the case does not establish a bright-line rule in favor of either franchisees or franchisors, it does provide additional support for arguments that franchisees are not always required to follow the policies set by the franchisor without regard to their impact on the franchisee's ability to operate.

RICO Claims Against Franchisor Move Forward

In WW, LLC v. The Coffee Beanery, LTD, No. WMN-05-3360, 2012 WL 3728184 (D. Md. Aug. 27, 2012), the U.S. District Court for the District of Maryland denied the defendant franchisor's motion to dismiss two RICO (Racketeer Influenced and Corrupt Organizations Act) claims made by the franchisees. Accordingly, these racketeering counts (seldom seen in franchising and more commonly associated with illegal gambling and the Mafia) can now be tried in front of a Maryland jury against The Coffee Beanery, its owners and two company officers. These charges create the potential for both civil and criminal liability, and the franchisor can face treble damages and attorney fees and costs if it is unsuccessful at trial. Because the plaintiff bears the burden of proof in RICO claims, these racketeering claims give both franchisors and franchisees a lot to consider.

As Judge William M. Nickerson stated in the decision, this case has a “long and tortured history” of litigation. Plaintiffs Deborah Williams and Richard Welshans filed suit against the franchisor and seven individual officers after operating an unsuccessful Coffee Beanery franchise in Annapolis, MD, from 2004 through 2007. The plaintiff franchisees claimed that they never made an annual profit and had cumulative operating losses of nearly $325,000. The plaintiffs alleged that the defendants promoted their “caf' concept” to franchisees as a proven and profitable concept, despite knowing that only one of their caf's had ever been successful. In addition, the plaintiffs alleged that the franchise disclosure documents omitted the unaudited financials and other information relating to a restaurant-type caf', in contrast to the usual coffee shop model, including the expense of additional construction, expensive supplies, and meal preparation equipment. The plaintiffs claimed that the owners and officers of The Coffee Beanery engaged in a pattern of racketeering activity against a number of franchisees as a regular way of doing business.

The case was remanded to the district court by the Fourth Circuit Court of Appeals after the parties' Michigan arbitration results were vacated by the Sixth Circuit Court of Appeals. Coffee Beanery first tried to dismiss the RICO claims as untimely, asserting that the plaintiffs included the RICO claims in their amended complaint after RICO's four-year statute of limitations expired. Although the original complaint did not contain any RICO claims, it did contain claims of fraud with substantially similar factual allegations. The court explained, quoting from an earlier RICO case, Feinberg v. Katz, Civ. No. 99-45, 2002 WL 1751135, at *11 (S.D.N.Y. July 26, 2002), that the amended complaint relates back “even when the acts of fraud are not fully developed, and no hint of a future RICO claim is given.” Further, the court noted that more evidence is required for RICO claims than for fraud claims, and thus a complaint amended to include RICO claims may relate back despite containing additional allegations.

Here, the franchisees' amended complaint contained “completely new factual allegations,” including new alleged misrepresentations made to other nonparty franchisees. Although these allegations were not present in the original complaint, they alleged the same misrepresentations and failure to disclose the same type of information as advanced in the earlier complaint. The court held that these new RICO claims shared the same “nucleus of operative fact” and were substantially similar to the original complaint's fraud claims, and thus related back to the original, timely complaint.

The court next analyzed the RICO allegations themselves, denying the defendants' motion to dismiss the ' 1962(c) claims but granting their motion to dismiss the ' 1962(d) claims. Section 1962(c) claims require four elements: 1) conduct; 2) of an enterprise; 3) through a pattern; 4) of racketeering activity.

Concerning the third element, the defendants unsuccessfully questioned whether the pattern requirement had been met. To establish such a pattern, a plaintiff must establish the relationship between at least two predicate acts and that the acts pose a threat of continued activity. Here, the plaintiffs alleged that Coffee Beanery and the various defendants continued to promote the caf' concept and sent out fraudulent UFOCs, even though they were aware that the concept was unsuccessful. The plaintiffs argued that the predicate acts of mail and wire fraud occurred “an uncounted number of times against the same type of victim in a nearly identical manner,” thus satisfying the relationship requirement. As to the continuity-of-activity requirement, the court found that the plaintiffs established an open-ended pattern that is ongoing because Coffee Beanery continues to distribute the allegedly fraudulent communications.

As for the fourth element, racketeering activity, the court found that the plaintiffs satisfied the pleading requirement concerning the predicate acts of racketeering. In RICO mail fraud suits against multiple defendants, plaintiffs need only adequately plead the circumstances of the fraud. The plaintiffs' pleadings included details of the alleged scheme's outline, goal, time frame and target audience; the contents of the allegedly fraudulent communications sent using the mail or wires; and the roles of the individual defendants and their continued communications despite alleged knowledge of the franchise system's lack of success. On this fourth element of racketeering activity, the court found that the plaintiffs “have certainly provided sufficient detail to put Defendants on notice of the fraud pled against them.”

After refusing to dismiss the ' 1962(c) claims, the court granted the defendants' motion to dismiss the two ' 1962(d) claims as barred by the intracorporate conspiracy doctrine. When acting within the scope of their employment, corporate agents cannot conspire with each other or with the corporation itself, because all of their authorized acts are attributable to the corporation. Here, the plaintiffs did not allege that the individual defendants had independent personal stakes or acted without authorization, which are the Fourth Circuit's two exceptions to this doctrine. Because the plaintiffs alleged that the individual defendants were in positions such as president and chairman, the court inferred that “[p]resumably ' their authority is largely without limitation.” Thus, the court held that the alleged activities were authorized corporate acts, and the ' 1962(d) claims were barred by the intracorporate conspiracy doctrine.

Apart from the RICO claims, the court granted and denied the defendants' additional motions. First, the court determined that the defendants' supplemental motion to dismiss for lack of personal jurisdiction was untimely and thus waived. The court also took judicial notice of defendant Kevin Shaw's misdemeanor conviction for theft of traffic cones at a construction site, which plaintiffs had previously categorized as a felony. The court instead left this “perceived misunderstanding” for the parties to dispute at trial. The court also dismissed the plaintiffs' detrimental reliance claim because the claim failed to allege facts that amounted to the required clear and definite promise element.

Additionally, the court denied the defendants' motion to dismiss the Maryland Franchise Act claims, holding that the plaintiffs pleaded the alleged misstatements and fraudulent omissions with enough particularity to satisfy Rule 9(b). The Act's joint and several liability provisions allowed the plaintiffs to proceed without alleging particular statements made by each individual defendant. Finally, the court dismissed the intentional and negligent misrepresentation claims against two individual defendants. Here, the plaintiffs had not provided enough detail regarding the alleged misrepresentations made to them, and the only alleged statements by these two individuals were made to nonparty franchisees.

This decision, and the court's recognition of the viability of possible RICO claims against franchisees, has the potential to be quite influential for future franchise disputes.

Lauren Sullins Ralls is an associate in the Atlanta office of Kilpatrick Townsend & Stockton LLP. She can be contacted at 404-532-6967 or [email protected].