Coraud LLC v. Kidville Franchise Co.

• Decision Date: 15 August 2015
• Docket Number: No. 14–cv–9105 (JSR).,14–cv–9105 (JSR).
• Citation: 121 F.Supp.3d 387
• Parties: CORAUD LLC, Plaintiff, v. KIDVILLE FRANCHISE COMPANY, LLC, Andrew Stenzler, Harry R. Harwood, Jr., Ash Robinson, and Joseph Sexton, Defendants.
• Court: U.S. District Court — Southern District of New York

121 F.Supp.3d 387

CORAUD LLC, Plaintiff,

v.KIDVILLE FRANCHISE COMPANY, LLC, Andrew Stenzler, Harry R. Harwood, Jr., Ash Robinson, and Joseph Sexton, Defendants.

No. 14–cv–9105 (JSR).

United States District Court, S.D. New York.

Signed Aug. 15, 2015.

William Michael Garner, Garner & Ginsburg, PA, Minneapolis, MN, for Plaintiff.

Kevin Michael Shelley, Kaufmann Gildin & Robbins LLP, New York, NY, for Defendant.

MEMORANDUM ORDER

JED S. RAKOFF, District Judge.

In April 2012, husband and wife Paul and Catharine Wilder formed plaintiff Coraud LLC ("Coraud") for the purpose of entering into a franchise agreement with defendant Kidville Franchise Company, LLC ("Kidville"), a franchisor of child entertainment facilities. The investment proved unsuccessful and, after a year-and-a-half of operating at a loss, Coraud filed this lawsuit against Kidville and certain of its officers and employees, asserting violations of state franchise laws and various common law causes of action. Now pending before the Court is Coraud's motion for summary judgment, in which it asks the Court to (1) enter summary judgment finding Kidville liable for violations of Sections 683 and 687 of the New York Franchise Sales Act ("NYSFA") and for negligent misrepresentation, (2) dismiss Kidville's counterclaim for breach of contract, and (3) enter summary judgment finding co-defendant Andrew Stenzler, Kidville's former Chief Executive Officer, liable for materially aiding in a violation of the NYSFA. Stenzler, for his part, cross-moves for summary judgment dismissing him from the case.¹

The pertinent facts, either undisputed or, where disputed, taken most favorably to defendants, are as follows. Wilders first became interested in opening a Kidville franchise after visiting Kidville's Hoboken, New Jersey facility with their own children. Plaintiff's L.R. 56.1 Statement of Undisputed Facts ("Pl.'s 56.1 Statement"), ECF Dkt. No. 35, ¶ 5. At the time, the Wilders had been contemplating starting a business so that Catharine Wilder, who had previously worked in the health care field, could pursue a second career. Declaration of Paul Wilder ("P. Wilder Decl."), ECF Dkt. No. 32, ¶ 3. Although the Wilders had saved $450,000 for this purpose, see Pl.'s 56.1 Statement ¶ 5, neither had any experience running a small business, building out a commercial space, or working with commercial landlords, see P. Wilder Decl. ¶ 5.

In 2011, the Wilders reached out to Kidville to learn more about the possibility of becoming franchisees, and Kidville provided them with its Franchise Disclosure Document ("FDD"). Pl.'s 56.1 Statement ¶ 10. The FDD is an offering prospectus that, under Section 683 of the NYSFA, franchisors, except in circumstances not relevant here, must register with the state of New York, distribute to potential franchisees, and update on an annual basis. Of particular relevance to the instant motions is "Item 7" of the FDD, which the franchisor must disclose certain specified categories of expenses related to the franchisee's "estimated initial investment" as well as a total estimate of those costs. See N.Y. Comp.Codes R. & Regs. tit. 13, § 200.2. Item 7 of Kidville's 2011 FDD lists sixteen different categories of expenditures, with estimates of the costs for most categories and accompanying footnotes that explain qualifications pertaining to some of those estimates. Declaration of Michael Garner ("Garner Decl."), Attachment 9, Item 7, at 19–20.² For an "annex facility" (the cheaper and smaller alternative of the two types of franchise outlets that Kidville offered for sale) Item 7 discloses a total estimated initial investment of $259,405 to $417,750, exclusive of the cost of purchasing or leasing real estate and placing a security deposit with a landlord. Id. at 20.

After receiving Kidville's FDD, the Wilders continued to investigate the opportunity by speaking with other Kidville franchisees. During the relevant time period, Kidville had four franchisees, each of whom had opened an annex facility in 2010. P. Wilder Decl. ¶ 12. The Wilders reached out to three of these franchisees and were able to speak with two. Id. Catharine Wilder testified at her deposition that a Kidville franchisee operating in Scarsdale, New York told her that he had "invested" $500,000 and was bringing in $20,000 to $25,000 in revenues per month, which was "much lower" than the Wilders' "numbers ... in [a] business model" that they had created based, on what they had been told by Kidville. Declaration of Rammy Harwood ("Harwood Decl."), Ex. B, Deposition of Catharine Wilder ("Catharine Wilder Depo."), at 84:12–17. The Wilders reported this conversation to Joe Sexton, Kidville's Senior Manager of Franchise Development, who, according to Catharine Wilder, stated that the Scarsdale franchisee "was not a reliable source" and "not a good operator." Id. at 83:20–24.

Catharine Wilder also spoke with the Kidville franchisee operating in Hoboken. Similar to the Scarsdale franchisee, the Hoboken franchisee stated that the "build-out cost was higher than" the number that was in Item 7, and she also added that the Wilders would not be able to provide as many classes (a source of revenue) per day as they had anticipated.Id. at 85:24–86:20. The Hoboken franchisee refused, however, to provide the Wilders with her financial data. Id. at 86:21–23. Catharine Wilder testified at her deposition that she informed Sexton of this conversation as well.

Apparently undeterred by these conversations, the Wilders engaged "experienced" franchise attorneys to review the "franchise documents," formed plaintiff Coraud, and, through it, entered into a franchise agreement with Kidville on April 13, 2012. See P. Wilder Decl. ¶ 29; Pl.'s 56.1 Statement ¶ 18. The Franchise Agreement provided Coraud with a ten-year license to operate an annex facility. Garner Decl., Attachment 25 ("Franchise Agreement"), ¶ 1.D. It also obligated Coraud to "[e]stablish[ ] a brand fund" to which they "agree [d] to contribute ... monthly amounts" based on gross sales and to pay Kidville a royalty based on gross sales. Id. ¶¶ 3.B, 9.B. After signing the Franchise Agreement, the Wilders "proceeded to find space, go through zoning hearings, hire contractors, build out the space, [and] hire employees." P. Wilder Decl. ¶ 13.

Through the process of opening the franchise, Coraud alleges that it learned of numerous material misstatements and omissions in Item 7 of the FDD. Specifically, Coraud contends that the estimated cost for leasehold improvements excludes expenses that Kidville tacitly but incorrectly assumed that the landlord would pay for and otherwise failed to reflect Kidville's actual experience; that the estimate for a security deposit incorrectly asserted that some landlords require only one month's rent; that the estimate for lawyers' fees failed to account for the costs associated with zoning hearings; that the estimates for training expenses did not include the cost of paying labor; that the estimate for computers did not include installation expenses; and that Item 7 failed to mention at all the cost of paying labor during any delays in opening. All told, the Wilders spent $743,826, more than $300,000 above the top-end estimate, to open their facility in Westfield, New Jersey. Pl.'s 56.1 Statement ¶ 103.

After incurring these costs, Coraud opened its facility in June of 2013. P. Wilder Decl. ¶ 13. In its first year of operation, Coraud made no profit, and its "resources were being depleted." Pl.'s 56.1 Statement ¶ 104. Further, because the initial investment had "far exceeded [the Wilders'] budget, [Coraud] had very little margin to work with once [it] started." Id. ¶ 103. By April 2014, less than a year after opening, the Wilders informed Kidville that they believed they had legal claims, and in November 2014, Coraud filed this suit and attempted to sell the franchise. Id. ¶¶ 105–06. Unable to find a buyer, Coraud sold certain equipment and inventory and, in February 2015, closed its doors. Id. ¶ 106.

"A party moving for summary judgment bears the burden of establishing that there exists no genuine issue of material fact warranting a trial." Gummo v. Vill. of Depew, N.Y., 75 F.3d 98, 107 (2d Cir.1996). "[T]he burden of the nonmovant to respond arises only if the motion is properly supported—and therefore summary judgment only is appropriate when the moving party has met its burden of production under Fed.R.Civ.P. 56(c) to show initially the absence of a genuine issue concerning any material fact. If the evidence ... does not meet this burden, summary judgment must be denied even if no opposing evidentiary matter is presented." Amaker v. Foley, 274 F.3d 677, 681 (2d Cir.2001) (internal quotation marks, citation, and emphasis omitted). "In ruling on [a motion for summary judgment], the district court must view the evidence in the light most favorable to the party opposing summary judgment and must draw all permissible inferences from the submitted affidavits, exhibits, interrogatory answers, and depositions in favor of that party." Gummo, 75 F.3d at 107.

The Court turns first to Coraud's claim under the anti-fraud provisions of the NYSFA. In relevant part, Section 687 of the NYSFA (which is largely but not entirely modelled on S.E.C. Rule 10b–5) states,

It is unlawful for a person, in connection with the offer, sale or purchase of any franchise, to directly or indirectly:

(a) Employ any device, scheme, or artifice to defraud.

(b) Make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. It is an affirmative defense to one accused of omitting to state such a material fact that said omission was not an intentional act.

(c) Engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

N.Y. Gen. Bus. Law § 687(2). "To state a claim under § 687, [a pl...