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Avenue Capital Sues Quiznos Former Ownership for Fraud

New Quiznos headquarters in Denver
Quiznos headquarters moves from downtown Denver. Shutters company store prototype. photo/js

DENVER—Multi-billionaire hedge fund investors Avenue Capital and Fortress Investments filed a federal lawsuit against Quiznos former owners Richard ‘Ric’ Schaden, father Dick Schaden and key executives. The complaint alleges that they engaged in a “conspiracy to defraud” when the investors took over the troubled sandwich chain in 2012.

The lawsuit claims Quiznos’ management team put together the conspiracy in an effort to induce the investment firms to purchase equity in the franchise company, inject liquidity into it by Avenue Capital, and restructure debt that Quiznos owed to the investors. It maintains that the conspiracy began in 2011 when Quiznos was experiencing economic turmoil, having seen its adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) drop nearly 50 percent over four years. It says the chain’s financial footing was then made even shakier because Quiznos had saddled the company with massive amounts of debt in a 2006 transaction. That’s when the Schaden executives realized the chain’s precarious position meant that a substantial restructuring was needed, either through an out-of-court plan or an in-court bankruptcy reorganization filing.

The hedge-fund firms alluded to the lawsuit in their Chapter 11 bankruptcy filing for Quiznos last March in Delaware court. Bankruptcy disclosure stated that the financial projections that were created through Quiznos executives gave the false impression that after the 2012 restructuring the debtors could service their debt obligations and sustain their new capital structure. The lawsuit alleges the Schaden team pressured the investors to “generate unreasonably aggressive projections for the express purpose of effectuating the 2012 restructuring.”  In the deal, Avenue and Fortress emerged as majority owners in the restructuring of $860 million in unpayable debt that was chiseled down to $570 million and swapped for and equity deal for the cash-poor franchisor. The restructuring eliminated $300 million in debt at that time, and brought majority ownership of Quiznos to Avenue Capital Group, owned by billionaire Marc Lasry.  

Avenue Capital and Fortress Investment Group claim the restructuring deal was fraught with fraud that was perpetrated by the Schaden executive team, costing them hundreds of millions of dollars. 

A report in legal journal Law360 stated in early July that several executives, including former president/CEO Greg MacDonald and CFO Dennis Smythe, named in the lawsuit, filed their own suit. They asked the court to enforce what they claimed were agreements, indemnifying them from legal action by the hedge fund investors. The executives stated in Law360, “We believe this lawsuit is a transparent attempt to shift responsibility for a failed investment and provide cover for Avenue and Fortress with their investors. There was no fraud, no misleading projections and no possible motive for the Schadens or the board to mislead anyone, including sophisticated distressed debt investors, in connection with the 2012 restructuring.”

Liz Brady DiTrapano, spokesman for the Schadens' company, Consumer Capital Partners, told The Denver Post yesterday that it was “absurd to suggest that these self-described incredibly sophisticated investors” could have been so easily duped. She reiterated previous statements adding, “There was no fraud, no misleading projections and no possible motive for the Schadens or the board to mislead anyone.”

Franchisees hit the hardest

While the bankruptcy legal wrangling continues, franchisees have become more distressed financially from the turmoil within its headquarters. Restaurants are closing at an alarming rate, many owned by highly experienced operators who have been in the Quiznos system for decades. So far, the franchisor has declined to give franchisees any assistance in improving profitability. Store owners say they have been gouged by high food costs and outrageous kickbacks through Quiznos’ American Food Distributors program (AFD).  

Through the bankruptcy process, Quiznos CEO Stuart Mathis has assured store owners that the company was not anticipating any major trouble. “We still expect to execute our plan successfully and emerge from this court supervised process on an accelerated basis,” he stated in one system-wide conference call last May. Then Mathis sent out an email to franchisees in early July declaring that Quiznos had emerged from bankruptcy. He optimistically declared, “With our financial restructuring behind us, we now have a stronger foundation to execute our comprehensive plan to strengthen performance, revitalize the Quiznos brand and reinforce our promise as a fresh, high-quality and great-tasting alternative to traditional fast food offerings.”

There was only one problem. Quiznos had not emerged from its financial restructuring. Blue MauMau discovered through the Quiznos bankruptcy hotline that while the reorganization plan had been approved, the company was still in the process of emerging from Chapter 11 reorganization.

One franchisee who did not want to be identified, said Mathis held another conference call last week. The CEO did not mention the bankruptcy. Instead, he reported that Quiznos hired a new supply chain expert, and the company was planning to install a new rebate program for franchisees. While Mathis acknowledged prices had increased 10 percent, he said the rebate program will be equal to 5 percent of purchases for franchisees who qualify.

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Quiznos new headquarters

The franchisee source said the CEO told franchisees that he was never a fan of the AFD food supply system and he wanted to get out of it. He said if it was up to him he never would have had the program in the first place, but that was now water over the dam.

Restaurant analyst John A. Gordon, of Pacific Management Consulting Group noted that restaurant financial disclosure by franchisors in general, and especially non-publicly traded, private equity held restaurant companies is very poor. Quiznos weakness had been apparent for some time, but began free fall decline in 2010.  

In 2010 Quiznos touted on its website it had 4,000 U.S. restaurants. Some franchisees are speculating that the sandwich chain today has under 1,000 traditional stores.

As a result of the bankruptcy, Quiznos moved its headquarters this summer from its prestigious downtown high rise office complex, encompassing 91,000 sq.ft. (top photo). That square footage included Quiznos’ flagship restaurant labeled “The Qube”, which is now closed.” Quiznos headquarters is now located in the Denver Tech Center, operating in a 31,000 sq.ft office space.


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