Strained Relations, Part 2

By the way, most of the individual franchisees and the association have the same attorney, and that attorney has filed several lawsuits against Shakey's over the last several years. It's a significant part of his practice. We've recently learned they have a litigation fund approaching $200,000, and in my opinion, most of this is simply the law firm attempting to use as much of that $200,000 as they can.

Entrepreneur.com
October 6, 2003

Strained Relations, Part 2
With franchisor and franchisees at odds, can Shakey's survive?
Devlin Smith

Late last year, a group of Shakey's franchisees filed a lawsuit against their parent company, alleging fraud and misrepresentation on the part of the pizza franchisor. Shakey's has taken the position that none of its officials have said anything that was fraudulent or a misrepresentation. While the case is scheduled to go to trial in Los Angeles in February, both sides were scheduled to participate in court-ordered mediation in September.

Last week, we interviewed John McNulty, a Shakey's franchisee and president of the Shakey's Franchised Dealers Association. This week, we interview Mitchell Shapiro, an attorney with the Los Angeles law firm of Jenkens & Gilchrist, outside counsel for Shakey's in this case. With the case impending, Shapiro was unable to comment freely, but agreed to provide a franchisor's perspective to the situation.

What is the current state of litigation with Shakey's franchisees?
The franchisees brought an action late last year - not all the franchisees, but several of them - claiming misrepresentation, fraud and various other law violations. Shakey's has denied all the allegations of the lawsuit, and a trial is presently set for February 2004 in downtown Los Angeles.

As far as the franchisees claiming misrepresentation and fraud, what is Shakey's response?
In general, the franchisees are claiming that various officials of Shakey's over the past several years have made statements which they claim are fraudulent. When you look at those statements, most of them are new executives who have come on and said, "We're going to turn this company around, we're looking forward to increasing sales, we hope to have new products," and things like that. They weren't representations as much as they were predictions of the future. A lot of those predictions didn't turn out, but that doesn't equal misrepresentation or fraud, and Shakey's has taken the position that none of its officials have ever said anything that was fraudulent or a misrepresentation. That, in a nutshell, is the response to that.

There are other allegations. For example, I believe there are allegations that Shakey's had violated a California law that precludes a franchisor from inhibiting the rights of its franchisees to associate. Shakey's doesn't believe there's any evidence of that. In fact, the franchisees associate regularly. They have a dealers' association that meets monthly, and Shakey's has never interfered with that, nor has it interfered with any of the franchisees. We have taken depositions of several franchisees, and not one of them has any evidence of Shakey's ever interfering with their right to associate.

By the way, they also claim their sales are down. In almost all cases, their sales are up, notwithstanding very limited inflation and increased competition in the pizza market. We have their records, and most of their sales have gone up.

Has Shakey's ever been under investigation from the FTC or any organization like that for any of these fraud claims?
Not that I'm aware of. I don't believe they have been, and I'm certainly not aware of it if they have.

Does Shakey's believe it is operating in breach of contract of the UFOC or any other deals with franchisees?
Shakey's is not in breach of any obligations to the franchisees, and it has quite forcefully asserted that position in the current litigation. No court has held that it has breached any obligation.

How does Shakey's feel it is viewed by its franchisees?
It is impossible to know how it is viewed by the franchisees, and of course each franchisee presumably has a different view. In taking depositions of several franchises, we have noted that their views of Shakey's differ greatly from one to the other.

Based on those depositions, do you have any idea how many franchisees are generally pleased with Shakey's?
I don't know that I can tell you how many are generally pleased. I assume the ones who have joined in the litigation are not generally pleased. I have noted that the complaints differ greatly from franchisee to franchisee. Some really don't have any significant complaints and seem to have gone along because their fellow franchisees have filed a lawsuit. Others seem more vehement and have a great deal of complaints.

How does Shakey's see the current state of the relationship between the franchisor, the Franchised Dealers Association and franchisees in general?
Obviously, if there's litigation between the franchisors and the franchisees, the relationship is not optimal. Shakey's would like the litigation to go away, and it would like to have a better relationship with its franchisees. It has sought that by mediation, but the franchisees have done everything in their power to resist mediation. The court ordered mediation in a 90-day period, and we wanted it immediately in that 90-day period. The franchisees have deferred and delayed and frustrated that. It's now taking place only seven days before the end of that 90-day period.

So is it still possible for this case not to go to trial, for the sides to come to a resolution?
It's possible, but I haven't seen any conduct by the franchisees that gives me a great deal of faith that that will happen at the mediation. As I've said, they've delayed and frustrated it. We gave them an opportunity to choose a mediator—we suggested the names of several mediators who have a very, very successful track record and settle 90 to 95 percent of the cases they're involved in. The franchisees chose not to select any of those people, so we don't get any good indication from them, but we're going forward in good faith and will see what happens.

As far as the franchised dealers' association, does Shakey's have any relationship with them?
They would like to work together with the association, but the association has chosen not to. It does not invite Shakey's to its meetings. It has its attorneys at its meetings several times a year, and at least a good portion of the meetings, so far as I understand it, is spent on developing litigation tactics against Shakey's. Shakey's would like an association that spends more time working on new products and the uniformity of stores and disciplining those members that are not running clean stores, the problem stores. And Shakey's would be eager to work with an association if the association was not in a litigation frame of mind all the time.

By the way, most of the individual franchisees and the association have the same attorney, and that attorney has filed several lawsuits against Shakey's over the last several years. It's a significant part of his practice. We've recently learned they have a litigation fund approaching $200,000, and in my opinion, most of this is simply the law firm attempting to use as much of that $200,000 as they can.

What is the current state of Shakey's in terms of units, expansion plans, new menu and prototype programs, etc.?
There are 63 units. Shakey's will soon be filing a new registration to sell franchises with California and other states and will engage on a program of selling franchises to new franchisees.

Could that filing be hurt by any of this current litigation?
It's premature to say. I don't think the franchisees will be successful in the litigation. If they were successful in obtaining a monetary judgment, it certainly could negatively affect the franchisor.

What does the company envision for the future of Shakey's?
Predicting the future is fraught with problems. Suffice it to say that the company expects to sell more franchises, increase sales, resolve the litigation and generally get on with the business of selling pizza and related products through its stores.


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Risks: Independent franchisee association, Sincerity, Misrepresentations, Right to associate and right to harass, National press coverage, United States, 20031006 Strained Relations

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