Mr. Steak, Inc. v. River City Steak, Inc., Civ. A. No. C-1787.

• Decision Date: 30 September 1970
• Docket Number: Civ. A. No. C-1787.
• Citation: 324 F. Supp. 640
• Parties: MR. STEAK, INC., a Colorado corporation, Plaintiff, v. RIVER CITY STEAK, INC., an Iowa corporation, Defendant.
• Court: U.S. District Court — District of Colorado

324 F. Supp. 640

MR. STEAK, INC., a Colorado corporation, Plaintiff, v. RIVER CITY STEAK, INC., an Iowa corporation, Defendant.

Civ. A. No. C-1787.

United States District Court, D. Colorado.

September 30, 1970.

Sanford B. Hertz, Robert W. Hite and Robert R. Hoadley, Jr., Denver, Colo., for plaintiff.

Schneider, Shoemaker, Wham & Cooke by Robert S. Wham and Joffre M. Johnson, Denver, Colo., for defendant.

MEMORANDUM OPINION AND ORDER

ARRAJ, Chief Judge.

This matter is before the Court on plaintiff's motion to dismiss certain of defendant's counterclaims for failure to state a claim upon which relief can be granted. Alternatively, plaintiff has moved for summary judgment on those counterclaims.

This suit is a consequence of the sale by Mr. Steak to River City Steak of a franchised restaurant operation upon an initial investment of thirty-five thousand dollars and payment of weekly fees derived from the restaurant's gross sales. The franchise agreement was executed April 2, 1968, stipulating location of the restaurant in Mason City, Iowa. By an addendum dated October 3, 1968, the site was ultimately transferred to Sharon, Pennsylvania. There the restaurant was constructed according to plans and specifications furnished by plaintiff on premises leased by it and subleased to defendant at the same rental. As required by the franchise agreement, the defendant executed a "restaurant manager's agreement" with Mr. Zenk, who had been recruited and trained by Mr. Steak.

After a period of losing operations, River City Steak defaulted on rental, insurance and weekly franchise payments, and plaintiff commenced this action to recover those monies. Defendant's counterclaims, numbered four through seven, arise from the same series of transactions and relate to Mr. Steak's failure to register its franchise system as a security under the Securities Act of 1933, 15 U.S.C. § 77a et seq., and the Colorado Licensing and Practice Act, CRS, ch. 125 (1963). Defendant claims relief because of statements made by Mr. Steak concerning the size, character and market potential of Sharon, Pennsylvania, which induced it to relocate the franchise there. River City Steak contends that those statements were fraudulent and misleading within the anti-fraud provisions of section 12(2) and section 17 of the Securities Act of 1933, 15 U.S.C. § 77l (2), § 77q, of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and regulation 10b-5 thereunder, 17 C. F.R. 240.10b-5, and of section 125-1-1 of the Colorado Licensing and Practice Act, CRS, ch. 125 (1963). Mr. Steak's motion questions the propriety of applying the registration provisions and penalties of federal and state securities law to its franchise operations.

For purposes of testing the sufficiency of plaintiff's complaint, a motion to dismiss for failure to state a claim admits all well-pleaded facts and allegations, Gardner v. Toilet Goods Ass'n, 387 U.S. 167, 87 S.Ct. 1526, 18 L.Ed.2d 704 (1967); Ryan v. Scoggin, 245 F.2d 54 (10th Cir. 1957), but not unwarranted inferences or conclusions of law predicated thereupon. Ryan v. Scoggin, supra; Ward v. Hudnell, 366 F.2d 247 (5th Cir. 1966).

Defendant contends that we are not bound by the form, generic name or characterization employed by the parties to describe their agreements. We agree. See S. E. C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 64 S.Ct. 120, 88 L. Ed. 88 (1943); United States v. Herr, 338 F.2d 607 (7th Cir. 1964). The Supreme Court noted in Joiner:

In applying acts of this general purpose, the courts have not been guided by the nature of the assets back of the particular document or offering. The test rather is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect. In the enforcement of an act such as this it is not inappropriate that promoters' offerings be judged as being what they are represented to be. 320 U.S. at 352-353, 64 S.Ct. at 124.

See also S. E. C. v. United Benefit Life Ins. Co., 387 U.S. 202, 87 S.Ct. 1557, 18 L.Ed.2d 673 (1967); Continental Marketing Corp. v. S. E. C., 387 F.2d 466 (10th Cir. 1967), both of which emphasize economic reality in determining the nature of a particular offer or sale. We must consider in toto the economic effect of various contracts and leases executed by the parties as they reflect facts necessary to delineate the legal character of these transactions.

We note initially that since the leasing agreement merely transfers the right to occupy the premises, consideration of its terms is unnecessary. Turning to the franchise agreement, we find that Mr. Steak is not granted, nor does it assume, the power to direct the daily operations of the restaurant. True, the franchise agreement specifies in great detail the relation between the two parties, and does accord Mr. Steak extensive supervisory powers, but the parties disagree as to the significance of those powers.

The majority of terms contained in the franchise agreement could be found in many other business contracts. For example, Mr. Steak is responsible for constructing and equipping the establishment and training the manager. The franchisee, on the other hand, must carry insurance, maintain trade secrets, submit to periodic inspections, appoint a specified agent to receive process, and cannot compete with Mr. Steak or sell or assign without Mr. Steak's approval. In exchange, and upon the payment of fees specified in the franchise agreement, the franchisee is granted the exclusive right to vend under the Mr. Steak name in a certain territory.

Other provisions in the agreement are designed to further tangible interests of Mr. Steak. Requiring the franchisee to use certain uniforms, to buy certain products to the exclusion of all others, to allow Mr. Steak the exclusive right to train its manager, to spend specified sums on prepared or approved advertising, and to allow Mr. Steak to participate in the initial hiring and opening of the restaurant are justified, we think. Since Mr. Steak's national image and reputation depend in large measure upon the quality of food and service at individual restaurants, it has an abiding interest in maintaining uniformly high standards to promote its own continued growth. We think that such provisions are justifiable as an eminently practical way for Mr. Steak to insure its future economic stability, and are not merely convenient tools to circumvent the protective provisions of federal securities law.

Some of the other terms of the agreements cause us more difficulty and our analysis of them is critical to characterization of the agreements before us. Provisions relating to the restaurant manager are an example. The franchise agreement specifies that either the franchisee or Mr. Steak, if the former fails to act, can select the manager. Mr. Zenk was selected by Mr. Steak without consultation with defendant. Following training by Mr. Steak, the manager is charged by the franchise agreement with operating "a sanitary, efficient and high quality Mr. Steak restaurant," as defined by Mr. Steak directives. The agreement also specifies his salary and requires an investment in the franchisee's stock. In the present case, Mr. Zenk was required to invest five thousand dollars and assign his stock to Mr. Steak. Upon termination, the manager is guaranteed a like amount or the actual value of his stock, whichever is greater. The agreement further provides that the manager "shall be the only person who shall be permitted to actively manage the Mr. Steak restaurant," and states:

The ASSOCIATE hereby irrevocably grants to MR. STEAK the power to supervise, instruct and direct the actities, duties and functions of the Investor-Manager and in the event the Investor-Manager does not comply with any directive or recommendation by MR. STEAK, then the ASSOCIATE hereby agrees that MR. STEAK can, at its absolute discretion, remove said Investor-Manager from the active operation of the ASSOCIATE'S MR. STEAK restaurant herein and replace him with another individual chosen by MR. STEAK * * *

The franchisee has no voice in his replacement.

While these provisions would seem to accord Mr. Steak de facto control over the entire restaurant operation by exercising control over the manager chosen by it, their impact is somewhat lessened by terms contained in the restaurant manager's agreement, which is referred to in the franchise agreement and which relates to similar duties. That agreement provides:

The INVESTOR-MANAGER agrees to continually maintain a general reputation in his business community for honesty, integrity, good credit and conduct a Mr. Steak restaurant in an honest and upright manner and to operate the restaurant according to all standards set up by the ASSOCIATE and MR. STEAK. (Emphasis added.)

The manager is also responsible for conducting operations according to standards and recommendations of Mr. Steak, and the franchisee can inspect only during reasonable business hours. However, while the manager is given the "sole right to manage and control the daily operation and affairs of the Mr. Steak restaurant," his conduct "is subject to approval by the ASSOCIATE and MR. STEAK, INC." Paragraph eight of the agreement grants the franchisee the right to terminate the manager's employment upon two weeks written notice to him and Mr. Steak. Although these provisions may conflict with the termination clause of the franchise agreement, we think it is evident that the franchisee was intended to retain some power over the conduct of his business. A thorough reading of the documents in question convinces us that Mr. Steak is accorded absolute discretion to terminate the manager only for violation of its directives, and that either party may terminate for other reasons. The legal effect of these provisions will be considered infra.

The second set of provisions that we find troublesome relates to...