Country Style Donuts: Backgrounder

An option is to take CSRL bankrupt and stiff the landlords. Put CSFS into bankruptcy or creditor protection such as under Companies’ Creditor Agreement Act so as to retain control of the contracts, to hand off to a buyer who purchases them as a ‘white knight’.

Canadian Alliance of Franchise Operators
December 15, 2001

Country Style Donuts: Backgrounder
Les Stewart

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Backgrounder
Country Style Donuts (CSD) is owned by a New York-based investment firm called CAI Capital Partners and company II, L.P. It was purchased from Maple Leaf Foods in 1999.

CSD operates 450 retail outlets across Canada. There are 100 self-serve coffee kiosks and 350 stand-alone or mall-based outlets. These figures come from the Canadian Franchise Association (CFA) membership directory, www.cfa.ca. CSD and Grand & Toy are long time members.

Franchisees’ Default Letters
The best information we have is that there were 15 to 20 closed 6 to 8 weeks ago, 40 in this wave and 40 more to come within 30 days (95 to 100). Minutes of an internal meeting have Pat Gibbons stating that 77 stores are “marginal”. Gibbons states that there will be 150 stores left from 350 (200 closures).

Landlords
Of the closing stores, all have not had their leases paid for Dec 1. There is a group that has formed to pursue their rights.

Country Style Donuts
Patrick Gibbons, is the president since September and has a background in Burger King and Blockbuster. All executives have been fired in the last month or are on notice. It would appear that only two executives know the inside scoop: Gibbons and Bruce Morrison, VP Finance.

Country Style Donuts, 2 East Beaver Creek, Building 1, Richmond Hill, ON, 905-764-7066 tel, 905-764-8426

Corporate Structure
There are at least 2 arms-length corporations that make up Country Style Donuts: Country Style Food Services Inc. (CSFS) and Country Style Realty Limited (CSRL). Bunsmaster, Melody Farms, and the warehouse are divisions.

CSFS
This corporation holds the franchise agreements and is therefore the cash source. Its liabilities are the normal current and outstanding lawsuit judgements.

CSRL
The franchisee pays rent to CSFS. CSRL holds the leases for the properties and pays the landlord with franchisee money collected and transferred by CSFS.

As of Dec 1, CSRL is not making lease payments to the defaulted stores although they are legally responsible for the lease payments to the end of its term, usually 10 years.

As an example, a defaulted store in Angus (a little community 30 km. west of Barrie) had a drive thru built this year that cost the property owner $270,000 ($200,000 for land and $70,000 for construction). As a condition of construction, a new 10-year lease was signed between CSR and the owners (3 brothers).

When one of the brothers called on Dec 2nd to see where the lease payment was, he was told by
CSFD's in-house lawyer to "get a lawyer".

The total liability of breaking 75 to 80, 10-year leases is very substantial.

What is happening
It is common knowledge that CSD has been trying to sell as the new owner, CAI, is unhappy with the financial return.

CSD’s main asset is the 350 franchise agreements that are held by CSFS. CSRL’s lease obligations are its greatest liability. The logical choice is clear.

An option is to take CSRL bankrupt and stiff the landlords. Put CSFS into bankruptcy or creditor protection such as under Companies’ Creditor Agreement Act so as to retain control of the contracts, to hand off to a buyer who purchases them as a ‘white knight’.

By not paying their leases, CSD suspects the landlords will take legal action. If there are 50 to 200 lease defaults, the logical decision may be to bankrupt CSRL.

If a direct competitor had picked which locations they wanted to buy via re-structuring, they would not want the warehouse or Melody Farms. Both of these corporations appear to have been made dormant by Gibbons’ management team. Bunsmaster will probably be let go independent because CSD does not have the head lease on the majority of them.

If they are being groomed for re-sale via re-structuring or bankruptcy, the 100 exiting franchisees lose $20 million in capital, are unemployed personally while laying off 1,000 staff. The landlords would lose conservatively, $5 million.

The biggest investors, the franchisees who survive, have $50 million invested and no seat at the table with trustees. The best defence would be to organize into an independent franchisee association and that would be done unless there were forces resisting that collective action.

The Wishart Act specifically prohibits any person from interfering with the formation and operation of independent franchisee associations.

Implications
What is the use of taking legal action against even the most predatory franchisor when it re-organizes itself to evade its legal responsibility? Since litigation takes 3 to 4 years this provides ample time for a corporation to go bankrupt or misuse CCAA to slip off the hook.

The Arthur Wishart Act (Franchise Disclosure) provides only for private rights of action. Franchisees, such as the Grand & Toy group, may find themselves 3 years hence with a 100 % legal victory against a bankrupt entity.

Franchisors have the right to approve when a franchisee sells their franchise and rightly so. But franchisees have no rights whatsoever to approve the purchaser of their system although that directly affects their return on investment.

Les Stewart
Canadian Alliance of Franchise Operators
http://www.cafo.net
705-737-4635 tel
705-737-4950 fax

December 15, 2001


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