DeLuca Still Waiting for Control of Subway Ad Fund

Subway ads are funded and decided upon by franchisees.

MILFORD, Conn. – In 2006, Fred DeLuca, president of Doctor’s Associates Inc., said he was confident the courts would find that his sub sandwich company was entitled to modify its franchise agreement, which would dramatically affect the Subway Franchisee Advertising Fund Trust. But today, after much legal wrangling, DeLuca is still waiting for that court order.

For years, franchisees represented by the trustees of Subway Franchisee Advertising Fund Trust (SFAFT) had control of the company’s annual advertising budget, estimated at half a billion dollars a year. Then on June 26, 2006, DeLuca sent a letter to some 10,000 franchisees representing 25,000 units, claiming SFAFT had violated DAI’s transparency policies by not detailing expenditures. He stated, “So on April 1, the company adopted a new franchise agreement. . . [that] gives us flexibility on how to handle [franchisees’] advertising contributions.”

That event was soon followed by a lawsuit from two principal officers of SFAFT. Because the trust was not a legal entity at that time, it was first filed in state court. Then on March 7, 2007, trustee Jeffrey Offutt filed a complaint in Connecticut federal court on behalf of all SFAFT trustees. It stated that DAI’s 2006 Subway franchise agreement provides that each Subway franchisee under the new contract must pay advertising contributions to DAI, not SFAFT. The complaint reads, “If this controversy is not resolved, SFAFT may be deprived of all or most of its funding thwarting the unambiguous intent and purpose of the Trust Agreement. . .”

DAI filed a motion for leave last August to supplement its June 2007 answer to Offutt’s amended complaint, adding additional facts and naming the remaining thirteen trustees of the SFAFT in a counterclaim. That motion has been granted. DAI alleges that Offutt’s amended complaint sought a declaration that the Trust Agreement requires Subway to pay SFAFT, forever, all advertising contributions from franchisees, no matter how poorly SFAFT’s trustees might perform or how ineffective the advertising that it arranges might be in increasing sales for Subway stores. DAI said it has asked Offutt to withdraw the “groundless” case, but his response has been to assert that there is a need for many additional depositions and a trial before the court can determine the proper construction of the trust agreement, which Offutt’s complaint repeatedly alleges is “unambiguous.”

Last October, DAI moved for summary judgment, but the trustee plaintiffs filed their own motion stating they were entitled to take discovery before they file a brief on summary judgment.  The judge then stated that he could not properly consider parol evidence unless he found the trust agreement ambiguous. Now, both parties to the lawsuit have submitted their briefs and asked the judge for oral argument, but he has not responded to that request prior to this posting.

Structure of SFAFT

On November 14, 1990, Doctor’s Associates and the Franchisee Advertising Fund (FAF), which was originally set up for depositing franchisees’ weekly advertising contributions, signed the Trust Agreement. It established SFAFT as the sole provider of funding advertising and promotion of the Subway business. Lawyers for SFAFT prepared the agreement and Neal Borden, Venable LLP, had the ultimate responsibility for preparing the Trust Agreement. The agreement was executed and the FAF board of directors then became the trustees of SFAFT.

According to DAI’s counterclaim (pdf), the trust recognizes that DAI has an important continuing interest in the proper management of the trust, allowing it to inspect its accounts, books, records any time on reasonable notice, and to receive a copy of annual audited financial statements. DAI also affirms that before any amendment to the Trust Agreement takes effect, DAI must consent to it in writing.  Because SFAFT was established in 1990, DAI asserts that it did not know how well SFAFT would function over time and that it would make no business sense for it to commit to SFAFT structure in perpetuity. With the rapid growth of the Subway franchise system, the company felt it needed the flexibility to respond to evolving business conditions.

Although SFAFT’s attorney took the position that the trust should be irrevocable, DAI claims the agreement reflected its intent that if Subway altered, modified or cancelled the provisions of its franchise agreements with its franchisees, “even if such action causes the payments by the franchisees to the trust to be reduced, encumbered, or eliminated,” it would have the flexibility or right to react to changing circumstances as it saw fit. Accordingly, while DAI has no right unilaterally to revoke the trust or assert control over the funds already in the trust, the parent company claims that the Trust Agreement recognizes its right as the franchisor to change its franchise agreements and direct future franchisee advertising contributions somewhere other than to SFAFT.

DAI Asserts Claims

According to DAI, the trustees have numerous obligations in administering the Trust Fund with care, skill, prudence and diligence under terms of the policies and procedures. And, because of the enormous success of the Subway franchise system the total franchisee advertising contributions have increased dramatically over time. In addition to the fees paid by franchisees, DAI has made large financial contributions to the trust, amounting to over $100 million since 1997. As a result, SFAFT trustees are now responsible for managing approximately half a billion dollars annually. DAI further asserts that because of DAI’s role in the Subway system—under franchise agreements, licensor of the trademarks and its contributions to the trust—it obviously has an important stake in the proper administration of the trust, and in ensuring that the trustees do not waste assets by reckless, imprudent or inappropriate conduct.

Offutt’s original theory in his lawsuit against DAI was that the intent, purpose and provisions of the Trust Agreement were all “unambiguous” and that the agreement unambiguously requires DAI “to pay to SFAFT all advertising contributions made by Subway franchisees,” in perpetuity. But DAI stresses that in Neal Borden’s deposition he testified that Offutt’s claim had no foundation in language or intent of the Trust Agreement. He further claimed that there was nothing he was aware of which would prevent DAI from making a decision in creating a new franchisee advertising trust with people it appoints as trustees and start using a franchise agreement that says their contributions are going to be directed to the new trust. Borden continued affirming there was no language in the Trust Agreement that he created that would limit DAI’s right to alter, modify or cancel provisions of its franchise agreements such that payments by the franchisees to the trust would be reduced, unencumbered or eliminated entirely.

Because of Borden’s testimony, DAI stands firm that Offutt’s claims are without any basis in fact, adding, “Apparently, the Trustees are intent upon wasting trust assets, in violation of their fiduciary duties, by continuing to press Offutt’s groundless case. . . .they have also engaged in a series of actions that clearly breach the Trust Agreement and violate their duties to DAI and the franchisee-beneficiaries of the Trust.”

As part of its counterclaim, Doctor’s Associates alleges that Offutt and other trustees recently have engaged in a series of actions that flagrantly breach the trust agreement and clearly violate their duties to DAI and the Subway franchisee-beneficiaries of the trust. First, it alleges the trustees have permitted assets of the trust to be used as an interest-free loan to a former trustee to pay his lawyers to prosecute his own personal claims against DAI, with the loan to be forgiven if the claims are unsuccessful. Second, it alleges that without properly consulting DAI, the trustees have purported to convert SFAFT into a statutory trust, thereby breaching the Trust Agreement in not getting DAI’s written consent in amending the agreement. And third, DAI alleges that the trustees breached the trust requirement that they give DAI access to SFAFT’s accounts, books and records, by imposing conditions on that access that are excessive, overbearing and unreasonable.

Lee Abrams, Mayer Brown LLP, representing the SFAFT trustees, did not wish to make comment at this time. Edward “Jack” Dunham, Wiggin & Dana, representing Doctor’s Associates, Inc., stated, “I believe that our position is accurate and I suspect the judge will grant summary judgment.”

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