Millions are at stake in Pizza Pizza dispute

Up to $8.5 million paid out of Pizza Pizza trust accounts has been questioned in a forensic accounting report commissioned by angry franchise owners who suspect mismanagement of their money…Franchisees involved in the legal action have in most cases invested their life savings and mortgaged their homes. They think of little else than making pizzas and battling their company. Families are strained to the breaking point. So are finances.

The Toronto Star
September 25, 1993

Millions are at stake in Pizza Pizza dispute
Kevin Donovan

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Up to $8.5 million paid out of Pizza Pizza trust accounts has been questioned in a forensic accounting report commissioned by angry franchise owners who suspect mismanagement of their money.

Forensic specialists Lindquist Avey Macdonald Baskerville also found evidence of Pizza Pizza changing computer inventory records over the years in such a way that Pizza Pizza took money from franchisees for sales they may never have made.

In this, the latest development in a long-running dispute, Lindquist investigators question Pizza Pizza’s use of franchisee trust funds to pay executives, give free pizza handouts, hold lavish parties for head office staff and franchisees, earn bank interest, develop computer systems for sale to competitors and send franchisees on supposedly “free” trips to Acapulco and Puerto Rico.

Many of the 250 Pizza Pizza franchisees in Ontario have been battling their company’s management for months over money they pay for food supplies, rent, advertising and other charges. They complain of threats and harassment, of working brutally long hours and having little to show for it at the end of the week.

The Pizza Pizza dispute is taking place in a regulatory vacuum, a sort of Wild West of the business world where the side with the toughest lawyers and strongest contracts usually wins. Other franchising companies are watching the battle with keen interest, knowing that decisions made over Pizza Pizza could set a precedent in the industry.

Lindquist, an internationally respected accounting firm, gained access to Pizza Pizza’s books this summer as part of a mediated agreement in the bitter confrontation between the well-known fast food giant and 50 of his franchisees.

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Lindquist reviewed the last five years of transactions and suggested the company pay some of an estimated $8,584,016 back to the franchisees. The Lindquist report also suggests further investigation is needed of other transactions, which franchisees believe could involve millions of dollars more.

But Lindquist’s report states they need more information – some of which Pizza Pizza has refused to hand over – to determine how much of that money is owing to the franchisees.

In its response to the Lindquist report, Pizza Pizza has strongly denied it owes any money to its franchisees and states that all of its business dealings are proper.

“The Lindquist investigation did not find any misappropriation or fraud,” Pizza Pizza states in a response that dismisses, point by point, the Lindquist investigation.

It will be up to a mediator or a court over the next few months to decide how much money – if any – is owed franchisees in the 250-store chain.

It was Tuesday, June 29, 1993 – a moment long awaited by the 50 franchisees of Pizza Pizza who hired Lindquist as the next step in a fight against the company famous for its pizza and quick delivery.

The forensic accountants had probed money laundering, cigarette smuggling and crooked lawyers, and had hunted the missing millions believed salted away by former Romanian dictator Nicolae Ceausescu.

This time they’d be dealing with cheese and pepperoni.

They had gained entry to the company’s Jarvis St. headquarters to see the books.

There is tremendous passion on both sides of this dispute, which began over money but has become very, very personal.

Management style draws ire of franchisees
Associates of founder and president Michael Overs have told The Star he is angered at what he considers an ungrateful group of businesspeople. He sees the franchisees as complainers who should work harder if they are unhappy.

His right-hand man, Lorn Austin, appears to be virtually running the company these days, but has drawn the ire of franchisees because of his abrasive management style and because he helps control financial matters, despite coming to Pizza Pizza in 1989 direct from a prison term for committing a massive fraud in Florida.

Just last week, Austin sent letters ordering most of the franchisees involved in the dispute to vacate their stores by next Tuesday. The franchisees had withheld their weekly payments in protest of the company trying to “terminate” five Hamilton stores also involved in the dispute. But the retired judge mediating the dispute rescinded the terminations pending further discussions in the mediated agreement that has, however temporarily, removed this conflict from the courts.

Franchisees involved in the legal action have in most cases invested their life savings and mortgaged their homes. They think of little else than making pizzas and battling their company. Families are strained to the breaking point. So are finances.

The forensic investigators had their work cut out for them. They had 25 days to probe “key issues” in a mass of payments and transactions of at least $295 million over five years.

To understand what to look for, the investigators took a crash course on Pizza Pizza from their clients, the franchisees.

Perhaps the most important aspect of the Pizza Pizza dispute relates to what they call the “pools”.

Every week, Pizza Pizza franchisees deposit their cash receipts in their own bank account, which is open to Pizza Pizza under their franchise agreement. One day a week, every week, Pizza Pizza removes money to pay for food delivery, royalties owing the company, and other charges including payments to these “pools”.

Weekly contributions to pools are based on percentages of sales. There is a pool for rent payments, advertising, delivery, and for the special one-number system used to send orders to individual stores.

The franchisees consider these monies “trust funds” belonging to them, to be administered by Pizza Pizza staff and used only to pay for the proper items.

In their lawsuit, franchisees allege these trust funds have been mismanaged and their money misspent.

So the forensic accountants rolled up their sleeves and went to work.

The first discovery came as a complete shock to franchisees. There were no pools kept over the past five years, not in the physical sense.

Instead of separate bank accounts and separate ledgers that franchisees always believed existed to control the trust monies, Pizza Pizza maintained one giant, general ledger. Various accounting codes were used to differentiate one charge from another.

Lindquist, in its report, told Pizza Pizza that each pool is “a separate entity which collects and expends certain funds of the franchisee” and should be treated that way using separate bank accounts and ledgers.

Pizza Pizza’s response states that they are currently setting up a separate accounting system for the advertising pool and did so earlier this year for the telephone system. But they say the separate accounting will prove more costly.

Forensic investigators also found evidence of something franchisees had long suspected whey they turned their spotlight on weekly sales reports of a sample of 16 stores.

In the case of eight stores, they found a pattern of Pizza Pizza “unilaterally” changing numbers on the company computer system to raise store inventories to a fictional level. This meant that Pizza Pizza was withdrawing money from franchisee bank accounts based on the sale of products that were never sold.

In the worst case, they found 64 changes over 79 weeks, 62 of them inflating sales, only two of the changes decreasing sales. The storeowner in question has previously told The Star that $9,219 was wrongly taken from his bank account during that period.

Franchisees suspected of under-reporting sales
Lindquist was denied permission to interview the Pizza Pizza staff who apparently made the changes. They quote president Michael Overs, who hovered around the accountants during most of their investigation, as saying this was “not company policy.” Lindquist quotes Lorn Austin as saying this practice has been reduced or stopped as of this year.

In Pizza Pizza’s response, they say they suspected franchisees were under-reporting sales and increased them to where their business experience told them was the proper level.

Pizza Pizza also contends it notified franchisees of these changes at all times, and they state that in any event they would “reverse themselves” the next week “because of the nature of the mathematical model” Pizza Pizza uses to make its calculations.

In its conclusion on this matter, the Lindquist report states: “sufficient instances of inventory numbers being changed” were found to justify an investigation of all stores over the past five years. But this has not yet been done.

As the 25-day probe wore on last summer, the Lindquist investigators began to isolate numerous examples of Pizza Pizza using, in Lindquist’s opinion, an as yet unknown portion of trust account monies to their benefit.

That means that, by using the trust account monies to pay for parties, salaries or computer development, Pizza Pizza did not have to take the money out of its profits.

In each case that follows, Lindquist has noted the full amount of the categories of expenditure disputed. Lindquist makes it clear that in many cases, they lack sufficient information to determine how much money, if any, Pizza Pizza owes its storeowners. That will ultimately fall to a medator or a judge to decide.

Here are some of the points raised in the report:

  • $281,506 paid by the advertising pool for trips by franchisees to Pizza Pizza conventions in Puerto Rico and Acapulco in 1988. Lindquist notes that Pizza Pizza told certain franchisees they could earn “free” trips paid by the company if they reached certain sales targets. But Lindquist’s investigation found these “free” trips were paid for the franchisees themselves through contributions to the advertising pool.

Pizza Pizza said its actions were appropriate because the free trips provided an incentive to promote sales.

  • $934,864 worth of complimentary cards providing free pizzas to complaining customers, suppliers, landlords and Pizza Pizza staff, and charged to the advertising pool. Lindquist said they could not determine how many of these cards were given to head office staff and suppliers and therefore used to the benefit of Pizza Pizza.

In its response, Pizza Pizza states that none of its staff ever benefited from these cards and most were handed out to radio stations for promotions.

  • $425,223 paid from the advertising pool to Lorn Austin between 1990 and 1992. The Lindquist report notes that Austin was paid $80,000 from the ad pool in 1990, $175,000 in 1991 and $170,223 in 1992. (Austin declared bankruptcy in late 1991 and remains bankrupt while federal officials review his file.) Based on an interview with Austin, Lindquist says that “at a minimum,” $34,045 of Austin’s salary last year should not have been paid out of the advertising pool because during the time he received that money he was performing functions other than advertising work at Pizza Pizza. Lindquist recommends further discussions between the parties to gain more information concerning Austin’s role in the advertising department.

Pizza Pizza’s response states that all of Austin’s time was properly paid by the advertising pool because: “Lorn Austin worked many overtime hours for no additional pay, and devoted his full time and attention as expected as the manager of the advertising function.”

  • 482,000 of real estate pool money paid to head office executives’ salaries and expenses when they were working on expanding Pizza Pizza’s business. Lindquist says these monies appear to be costs that should be paid by Pizza Pizza since the real estate pool monies are to be spent paying rents or for the salaries of people renegotiating existing leases.

Pizza Pizza responds by saying that expanding Pizza Pizza’ business benefits the stores and so that money was properly spent by the rental pool.

  • At least $267,100 for Christmas parties, a boat cruise and a 20th Anniversary celebration in 1988, all paid for the franchisees’ advertising pool. The Lindquist report notes that franchisee, through their contributions to the pool, paid for their own attendance and, and in most cases, for head office staff, executives, suppliers and other guests. In all cases, the report states that franchisees were unaware they were paying for these parties.

In its response, Pizza Pizza said these functions helped “encourage open communications between franchisee and franchisor.” They also note that these events advertised Pizza Pizza. For example, in the case of the boat cruise, a “banner” was put on the boat.

  • An unknown amount of money paid from the franchisee-funded Order Processing Department Pool to develop the famous “one-number” system. The Lindquist report notes that Pizza Pizza has sold this system to Swiss Chalet, New Orlean’s Pizza in Kitchener, Mr. Gaddy’s in Texas and to a California fast food chain. Since franchisees pay $1 per pizza order into this pool, Lindquist suggests they should be paid back whatever was expended to develop the system for these sales.

Pizza Pizza’s response states that the one-number system needed more development, and adds that any profit Pizza Pizza received went back into the company for the benefit of the franchisees.

$1 per pizza pays for order system

  • Up to an estimated $2,783,650 that may have been lost to the franchisees because they pay Pizza Pizza for supplies from its commissary every week, but Pizza Pizza does not pay its suppliers of the raw goods until from 20 to 80 days after the franchisees make their payments. The Lindquist report makes two points. 1. Pizza Pizza has the use of the franchisees’ money for many days, a potential benefit of $2,783,650 based on a calculation of bank interest rates over an average of 50 days. 2. On the other hand, if Pizza Pizza paid its suppliers promptly, they probably could take advantage of discounts. Lindquist calculates that, at a rate of 1 per cent discount, the potential benefit would be $1,825,000.

In response Pizza Pizza states “there is absolutely no evidence to support the assumption” of savings for prompt payment, and “there is no basis for the assumption” Pizza Pizza benefited from having money at its disposal for 20 to 80 days.

Both the Lindquist report and Pizza Pizza’s response will now go under the microscope of an independent accounting firm retained as part of the current mediation process.


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