Sugarlips Bakery, LLC v. A&G Franchising, LLC, 3:20-cv-00830

CourtUnited States District Courts. 6th Circuit. United States District Court of Middle District of Tennessee
Writing for the CourtALETA A. TRAUGER UNITED STATES DISTRICT JUDGE
PartiesSUGARLIPS BAKERY, LLC et al., Plaintiffs, v. A&G FRANCHISING, LLC et al., Defendants.
Docket Number3:20-cv-00855,3:20-cv-00843,3:20-cv-00836,3:20-cv-00854,3:20-cv-00832,3:20-cv-00838,3:20-cv-00831,3:20-cv-00833,3:20-cv-00848,3:20-cv-00846 3:20-cv-00847,3:20-cv-00844,3:20-cv-00835,3:20-cv-00830,3:20-cv-00845,3:20-cv-00837,3:20-cv-00834
Decision Date24 January 2022

SUGARLIPS BAKERY, LLC et al., Plaintiffs,
v.

A&G FRANCHISING, LLC et al., Defendants.

Nos. 3:20-cv-00830, 3:20-cv-00831, 3:20-cv-00832, 3:20-cv-00833, 3:20-cv-00834, 3:20-cv-00835, 3:20-cv-00836, 3:20-cv-00837, 3:20-cv-00838, 3:20-cv-00843, 3:20-cv-00844, 3:20-cv-00845, 3:20-cv-00846 3:20-cv-00847, 3:20-cv-00848, 3:20-cv-00854, 3:20-cv-00855

United States District Court, M.D. Tennessee, Nashville Division

January 24, 2022


MEMORANDUM

ALETA A. TRAUGER UNITED STATES DISTRICT JUDGE

Defendants A&G Franchising, LLC (“A&G”), Alan Thompson, and Gina Butler have filed a Motion to Dismiss (Doc. No. 25), to which the consolidated plaintiffs have filed a Response (Doc. No. 31), and the defendants have filed a Reply (Doc. No. 34). For the reasons set out herein, the motion will be denied, with one small exception.

I. BACKGROUND[1]

A&G is a Tennessee limited liability company with its principal place of business in Tennessee. (Doc. No. 1 ¶ 4.) Although A&G has now been dissolved as a formal business entity, it was, at one time, the franchisor of Gigi's Cupcakes (“Gigi's”), a chain of bakery shops.

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According to A&G's 2015 pitch to potential franchisees, “[a] Gigi's Cupcakes bakery shop unit offers a variety of upscale cupcakes baked onsite, prepared and packaged specifically for delivery, take-out and onsite consumption.” (Doc. No. 1-3 at 1.) The plaintiffs-who operated Gigi's franchises in states other than Tennessee[2]-refer to A&G as the “prior franchisor” of the Gigi's business, which the court takes to mean that the brand continues to exist, but not as operated by A&G. (See also Doc. No. 1 ¶ 39 (noting A&G's intent to sell the franchise system to a third party).)

By 2013, A&G had become “operationally insolvent”-that is, incapable of sustainably paying its ordinary business costs through its existing revenues.[3] (Id. ¶¶ 20-21, 27.) The company's net operational losses in 2013 were relatively small, but they did not remain so; by the end of 2014, the annual net loss was nearly $650, 000. (Id. ¶¶ 21-22.) Nevertheless, A&G continued to recruit and enter into agreements with new franchisees. There is, at least as far as the plaintiffs allege, nothing inherently unlawful about A&G's decision to continue expanding despite its insolvency; a business is not required to cease functioning the moment it fails to make money. What is generally illegal, however, is resorting to fraud in order to recruit business partners who otherwise would not want to stake their own success on the future of a business incapable of sustaining itself. The plaintiffs in these cases allege that A&G-and its operators, defendants Alan Thompson and Gina Butler-did just that.

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Each plaintiff's story of how he, she, or it came to pursue a Gigi's franchise is unique in its particulars. These seventeen cases have been consolidated, however, because all of the parties agree that the franchisees' legal claims are, at least in most respects, fundamentally the same. (See Doc. No. 20 (Joint Motion to Consolidate Cases).) Specifically, each plaintiff's claims are “based on standardized Franchise Disclosure Documents (‘FDDs') and Unit Franchise Agreements (‘UFAs') for Gigi's Cupcakes franchises.” (Id. ¶ 3.) Some plaintiffs' claims are based on slightly different versions of those documents than others, because aspects of the documents were revised over time. The parties, however, have jointly informed the court that the respective versions of the documents are “largely identical” and that, “[i]n most, if not all, cases, the material language at issue in Plaintiffs' Complaints is exactly the same.” (Id. ¶ 2 & n.2.) Each UFA includes a clause stating that Tennessee law shall govern “any dispute between” the parties. (Doc. No. 1-1 at A-45.)

The Federal Trade Commission (“FTC”) “requires franchisors to furnish prospective franchisees with disclosure documents”-that is, FDDs-“at least 14 calendar days before the prospective franchisee signs the franchise agreement.” Arruda v. Curves Int'l, Inc., 861 Fed.Appx. 831, 835 (5th Cir. 2021) (citing 16 C.F.R. § 436.2(a)). An FDD must contain certain required information about the franchisor and the business being franchised, see 16 C.F.R. § 436.5, and “[a]ll information in the disclosure document” must “be current as of the close of the franchisor's most recent fiscal year.” 16 C.F.R. § 436.7(a). The plaintiffs assert, upon information and belief, that A&G's FDD was “created, read, and approved” by Thompson and Butler. (Doc. No. 1 ¶ 17.)

The A&G FDD began with a “State Cover Page” that was, in essence, a letter to the potential franchisee, explaining the document and some aspects of the proposed transaction. The State Cover Page included a list of “RISK FACTORS” for the potential franchisee to “consider” before buying a franchise. (Doc. No. 1-3 at PageID #156.) Prior to 2017, however, the list of risk

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factors made no mention of the company's financial struggles. (Doc. No. 1 ¶ 24.) For example, the 2015 version listed the risks as follows:

1. THE UNIT FRANCHISE AGREEMENT AND AREA DEVELOPMENT AGREEMENT REQUIRE YOU TO RESOLVE DISPUTES WITH U.S. BY LITIGATION IN THE JUDICIAL DISTRICT WHERE OUR HOME OFFICE IS LOCATED, WHICH IS CURRENTLY IN WILLIAMSON COUNTY, TENNESSEE OUT-OF-STATE LITIGATION MAY FORCE YOU TO ACCEPT A LESS FAVORABLE SETTLEMENT FOR DISPUTES. IT MAY ALSO COST YOU MORE TO LITIGATE WITH U.S. IN TENNESSEE THAN IN YOUR OWN STATE.
2. THE UNIT FRANCHISE AGREEMENT AND AREA DEVELOPMENT AGREEMENT REQUIRE THAT TENNESSEE LAW GOVERNS EACH AGREEMENT (UNLESS AN ADDENDUM IS ATTACHED TO YOUR AGREEMENT WHICH PROVIDES OTHERWISE), AND TENNESSEE LAW MAY NOT PROVIDE THE SAME PROTECTIONS AND BENEFITS AS LOCAL LAW. YOU MAY WANT TO COMPARE THESE LAWS.
3. THERE MAY BE OTHER RISKS CONCERNING THIS FRANCHISE.

(Doc. No. 1-3 at PageID #157.)

The FDD also included a section designated as “Item 19, ” with the heading “FINANCIAL PERFORMANCE REPRESENTATIONS.” (Doc. No. 1-3 at 29.) Item 19 featured two prominent tables, designated as “Table 1” and “Table 2.” (Id. at 30-31.) Table 1 purported to provide the following aggregate information regarding “28 [Gigi's stores] which were open more than 12 months as of January 1, 2014”: total net sales; cost of goods sold (“COGS”); labor, location, advertising, and operating expenses; and earnings before interest, depreciation, taxes, and amortization. (Id. at 30.) Table 2 provided per-store averages of the same information, based on the same 28 stores. (Id. at 31.)

The plaintiffs assert that the Item 19 tables were false and/or misleading in several ways. First, the plaintiffs allege that the labor costs in the figures were “understated by at least 20-33%, ” because they did not “take into account reasonable salaries paid to franchise owners who work at

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the store, ” instead treating that substantial portion of labor costs as zero. (Id. ¶ 31.) Second, some of the stores used to calculate the figures in the Item 19 tables were not, in fact, franchises at all, but rather stores owned by A&G itself. Those stores, accordingly, did not have to pay any franchise royalties, making them inherently more profitable in a way that a franchised store could not be. (Id. ¶ 32.) These franchisor-owned stores, moreover, used at least some personnel who were paid out of central corporate accounts, not the budgets of the stores themselves, further skewing the figures. (Id. ¶ 33.)

Next, the plaintiffs allege that the net sales and COGS figures are simply outright misstated and cannot plausibly be reconciled with A&G's operating losses. (Id. ¶ 34.) Even if the figures were not actually falsified, the plaintiffs assert, they were “cherry picked”; there were actually nearly 70 stores that had been open more than 12 months as of January 1, 2014, and the stores included in the table were not representative. (Id. ¶ 35.) The existence of these other stores could be learned from closely reading the FDD, but that information was featured far less prominently than the large, “eye-catching” tables in Item 19. (Id. ¶ 36.) The plaintiffs claim that, if they had understood the actual performance of Gigi's franchises generally, as opposed to merely from an inflated picture of the selected stores, they would not have gone forward with their franchises. (Id. ¶ 39.)

Item 19, as the defendants point out, included the following disclaimer:
Some Units earned this amount. Your individual results may differ. There is no assurance you'll do as well.
Your results will vary depending on a number of factors which you should consider carefully in evaluating this information and in making any decision to purchase a franchise. These factors include: business skills, motivation, quality, effort, and effectiveness of the individual franchisee and of the franchisee's staff and management; the quality of your customer service; location of your Franchised Business; market conditions and raw material (for example, sugar and flour) price volatility; weather and climate conditions; the effectiveness of your marketing
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efforts; the quality and effectiveness of your staff; income and demographic characteristics in your particular market area; the degree and quality of [remainder of sentence missing].
You should conduct an independent investigation of the costs and expenses you will incur in operating your Unit. We encourage you to consult with your own accounting and business advisors to assist you in preparing your budgets and projections, and to assess the likely or potential financial performance of your Gigi's Unit. We also encourage you to contact existing franchisees to discuss their experiences with the System and their business.
Written substantiation of the data we used in preparing the above table will be made available upon reasonable request.
Other than the preceding financial performance
...

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