Part 2: Despite Misrepresentations by Mama Fus, Judge Rules against Franchisees

Writer’s Note: Part 2 of a two part series reports on the judge’s ruling in a lawsuit brought by franchisees against Mama Fu’s claiming misrepresentations, failure to disclose, fraud and other claims. The judge’s final decision omits findings in earlier bench ruling which had highlighted issues of misrepresentations in franchise disclosure documents. (See Part 1: Judge's Decision Masks Oral Ruling at Mama Fu's Trial)

ATLANTA – Although Judge Story’s final judgment came as no surprise on March 10, in favor of Mama Fu’s defendants granting their motion for judgment and dismissing all claims against CEO H. Martin Sprock and VP Daryl Dollinger and the other defendants, the text of the ruling was somewhat staggering. While the judge had declared in his trial ruling that he found clear misrepresentations and failure to disclose in Mama Fu’s disclosure documents, he found that they could not be reasonably relied upon or could not have resulted in injury to the franchisees, and for that reason they failed. 

The first issue addressed in the oral ruling was Mama Fu’s alleged breach of contract. Franchisees claimed that Mama Fu’s in selling franchises disclosed that it had a “developed and perfected’ system with an established reputation when it did not.  But Judge Story stated that he felt the franchise owners acknowledged that they were not looking for a perfect system but a completed system. “I think the words were something to the effect of if you operate it by the book, it will work,” he said. “That suggests a guarantee you are going to make money and clearly the agreement was not that.” He further explained that if there was a guarantee there would have been a huge statute of limitations issue problem because he thought there were problems seen early on. The judge said there were efforts to adjust the system so it was different from the system the franchisees were sold. So they had already been harmed by the system that was represented to them and that would have been a statute of limitations problem, he explained.

He also said the idea about Mama Fu’s having an established reputation was in the view of the public and that franchisees were part of the public. “Everyone knew when they got their UFOCs that there either wasn’t a store or only one company store or maybe one or two local stores.” The judge said he didn’t think that when someone tells you they have a reputation it is something you should rely on.

But Robert Zarco, Zarco Einhorn Salkowski & Brito, disputes that saying the one theme that came out during the trial was that Mama Fu’s launched its franchise prematurely. He said, “The resounding quote throughout the trial by former top executives of Mama Fu’s, and not denied by Sprock, was a common adage: ‘Fake it until you make it. We will experiment until we get it right.’”  He asserts it was not a developed system and it was not perfected. In the case, Zarco and his firm acted as franchise legal consultants to the lead counsel of Casey & Gilson law firm in Georgia.

Addressing the claims of misrepresentations in Mama Fu’s disclosure, Judge Story explains it this way in trial:

In terms of misrepresentations, there’s no question in my mind there are misrepresentations in the UFOC. There’s also no question in my mind that that alone does not constitute . . .  that cannot serve as a basis for a cause of action. The misrepresentations, or the alleged misrepresentations, fall into three categories in my view. One is alleged misrepresentations that in my view have not been proved to be knowing misrepresentations. Another is misrepresentations that were in fact misrepresentations, but did not result in any damages. And, finally, there are misrepresentations that it would have been unreasonable for a prospective franchisee to rely upon.

He said some the misrepresentations he had identified were part of the day-to-day involvement of Martin Sprock in the operations, but he felt it hadn’t been shown as an “intentional misrepresentation.”  Regarding earnings claims, he said he had some real reservations about whether there were earnings claims as were contemplated. Franchisees claimed that Mama' Fu’s used Moe’s and Pei Wei’s restaurants as an example of what they could earn on their stores, but the judge explained, “I don’t think it’s reasonable to rely on the kinds of claims made.”  Concerning start-up cost, Judge Story felt most fell within the ranges provided to franchisees. He said, “Maybe it was a crap shoot. Maybe it was the . . . the spitballs on the wall and you hit the target and lucked out in giving a range . . .”

But in ruling on the alleged kickbacks that the franchisor was taking from vendors in supplying products and equipment, Judge Story said, “A clear misrepresentation of failure to disclose was the kickbacks. But that is one where the damages . . . there’s not been evidence from which I can find there was any damage that occurred to the plaintiffs as a result of that.”

According to Zarco, the franchisees’ counsel did not seek damages for the undisclosed kickbacks. He said, “What the Mama Fu’s franchise operators testified to in court was that they would not have purchased their franchises if they had known about the kickbacks.”

In his closing remarks regarding the misrepresentations, Judge Story declares, “Because I find there’s not been misrepresentations that could reasonably be relied upon or that resulted in any injury to the plaintiffs, I find that all the claims that are supported or that are buttressed upon misrepresentation or fraud would fail for that reason.”

Judge Story stated he did not know if there was enough evidence to pierce the corporate veil, another allegation brought by the franchisee plaintiffs. “But I will just say, because, Mr. Sprock, you got an ongoing business out there of some kind. If there had been a judgment against you in this case, there is a chance that you and every business you own as well as your personal bank account could have come into play in paying that judgment,” he said. He further addressed Sprock saying that he was not about to tell him how to do his business, especially when he is surrounded by the legal talent that he has, but he had been surprised at the way some of this has been done in terms of . . . and I understand that you are the CEO of all these.”  He said he understood the umbrella operation, “but the idea of a corporation is that it protects . . .it’s a separate legal entity and it protects other from individual liability and so forth . . .”  He also thought there were some real questions about commingling and that could be troublesome.  But he emphasized, “I’m not finding the corporate veil could have been pierced. I’m just saying there’s some real issues there that probably need to be considered.”

At the end of his oral ruling at trial on February 26, Judge Story said that everyone went into this investment thinking it could make everyone a lot of money. “And I wish everyone had made a lot of money,” he said. “But like any investment, there are risks.” He likens it to the people who have invested in the stock market, saying they too didn’t do anything wrong. “Some things work, some things don’t. But I don’t think anyone went into this trying to beat folks out of their money.” 

But in closing, the judge said in terms of the law which he must uphold and apply as he understands it, he rules in favor of the Mama Fu’s defendants. “And the up side of it is that my word is not the final say. You have the right to have my decision reviewed by a court of appeals. And if I have erred in any way, I assure you they will correct me.”

Uniqueness of the Decision

DLA Piper’s Scott McIntosh said he felt Judge Story’s decision was consistent with applicable law, but stated, “What makes this case more noteworthy than some of the others was the number of plaintiff' groups involved.” He said at the time of trial, after a summary judgment ruling dismissing one plaintiff group and a voluntary dismissal of certain plaintiff entities and individual, there were still 10 different groups.  He said, “On both sides of the aisle, I think everybody had gone into the Mama Fu’s venture hoping and expecting that this would be a very successful franchise system. Unfortunately, it didn’t work out for anybody, not the franchisor or the franchisee.”  But he continued, “Also, the court found that there was no credible proof of any intent by the franchisor to defraud or mislead any of the plaintiffs. Ultimately, everybody was hoping and expecting that this would be a very successful system, but it just didn’t work out in the time frame that was at issue here.”

Zarco feels that they were proceeding under negligence per se, a misrepresentation kind of claim, and a fraud claim for failure to properly disclose in the UFOC disclosure documents. He said typically they would rely on a deceptive claim. He explained, “What is unique about this case is that there was a disclosure claim made in a state which had no Little FTC Act, and because the FTC does not provide a private right of action the franchisees did not have the ability to avail themselves of the FTC Rule. Therefore we were seeking legal relief through the common law of fraud and misrepresentation, which is permitted by case law but it is not as strong as a deceptive and unfair trade practices act claim.”

Related reading:

• Part 1: Judge's Decision Masks Oral Ruling at Mama Fu's Trial
• Court rules for Raving in Mama Fu's suit – Nation’s Restaurant News
• Sprock and Team Just Getting its Second Wind --Winning Mama Fu's
• Mama Fu's Franchisees Set for Trial Armed with Expert Report
• New CEO Speaks on Mama Fu’s Acquisition
• Mama Fu’s Biggest Franchisee Buys Noodle Chain