FLUSHING, Michigan – Most franchisors know that the Federal Trade Commission's Franchise Rule and state franchise disclosure laws are designed to protect franchisees and prospective buyers. Complying with franchise laws and being able to prove compliance is imperative in building a solid franchise network.

But one franchisor that can’t seem to stay within the boundaries of the law is The Coffee Beanery, as it has been deep in legal disputes with franchisees over the sale of their franchises. It has been censured by various state regulators for violations.

One major legal action has been with two franchisees in Annapolis, Maryland regarding a dispute over whether or not Coffee Beanery can sell a new “cafe concept” under the same franchise disclosure documents it uses for coffee shops, kiosks, drive-throughs and other non-food franchises. Unlike other models, the cafe franchise requires a different type of location, building, equipment and supplies. Franchisees have claimed Coffee Beanery made misrepresentations and omissions of pertinent information when they purchased their franchise. In July 2007, the Attorney General’s office issued an “order of withdrawn” for Coffee Beanery regarding its registration to sell franchises, and the coffee company then withdrew its registration.

In another case, the Illinois Securities Division issued its findings from an investigation it conducted regarding a franchisee in the Chicago area, stating the franchisor did violate the state’s franchise disclosure laws. The state regulator notified the franchise owner in 2008 that Coffee Beanery failed to disclose certain information required by disclosure document guidelines. 

The Securities Commissioner of the Attorney General’s office in Maryland issued a consent order in September 2006 against The Coffee Beanery and one of its officers. The order said that it had violated disclosure and antifraud provisions of the Maryland Franchise Law, in relation to the offer and sale of its franchises. In signing the consent order, Coffee Beanery acknowledged the Commissioner made certain conclusions: It had violated the Maryland franchise law by making material misrepresentations of fact or omissions of material fact about its franchise offering to prospects in the state; and that it violated the law by not giving prospects a copy of the offering prospectus. Coffee Beanery also agreed, as part of the settlement with the Division of Securities, to offer rescission to franchisees in Maryland who purchased the café concept. In view of their situation, they declined to take the rescission and chose to arbitrate the dispute, resulting in years of legal wrangling with the franchisor.  Currently, Coffee Beanery is not registered in the state of Maryland.

Last week The Coffee Beanery announced an opening of a new store in Skokie, Illinois by stating in its Weekly Update news bulletin this week,   

Saturday, August 8^th marked the first day of Thakur Piryani’s 2^nd store in Skokie, IL (just north of Chicago).  The store is located at the intersection of Lincoln Avenue, Skokie Blvd, and Howard Street, all main arteries. Congratulations to Thakur, his staff, and Dale on a job well done!

A telephone call to the franchisee confirmed that they had opened a Coffee Beanery cafe at the new location, and that their first store purchased four years ago was a coffee shop model that did not sell food.

According to the Franchise Bureau of Illinois Office of Attorney General, the franchisor is not currently registered to sell franchises. Although Anne Spooner, paralegal for that department, was not available to make comment, telephone calls and an email confirmed the following:

Coffee Beanery has filed two applications since withdrawing their registration in July of 2007. The first was filed on October 9, 2008 and an Order of Denial was issued due to the fact that the disclosure document was materially deficient.  They had 90 days to cure the deficiencies in order to have the Order of Denial rescinded, but failed to do so.  They filed again on April 20, 2009 and another Order of Denial was issued due to a materially deficient disclosure document.  Again, they failed to cure the deficiencies within the 90 day period and were recently sent a letter advising that the Order would not be rescinded. 

In contrast, Paul R. Fransway of Pear Sperling Eggan & Daniels, representing the franchisor, said the location in Skokie didn’t involve the sale of a franchise, that it was a current existing franchisee operating under a current franchise agreement. “There was no new franchise agreement, no additional fee. It comes under an Illinois statute that is exempt from registration,” he explained.

Illinois law explains that just because there's no franchise fee does not mean a franchise sell or offer did not occur. In an effort to protect its residents, Illinois regulation declares:

No franchisor may sell or offer to sell a franchise in this State if (1) the franchisee is domiciled in this State or (2) the offer of the franchise is made or accepted in this State and the franchise business is or will be located in this State, unless the franchisor has registered the franchise with the Administrator by filing such form of notification and disclosure statement as required under Section 16.

State regulation says that the consequences for a franchisor offering or selling a franchise while being unregistered in Illinois can be a felony offense with a fine of up to $50,000. The law also stipulates that under such circumstances, a wayward franchisor could be required to make a sizable payment to the franchisee to restore it to the point before the purchase.

Illinois Franchise Bureau Responds

In an effort to get clarification on this new transaction by Coffee Beanery and its attorneys, attempts were made to talk with Franchise Bureau Chief Casandra Karimi.  The Attorney General communications office requested specific questions in writing. The following was submitted:

• Under Illinois franchise regulations, is it permissible for the franchisor to allow the existing franchisee to open a new franchise in the state, in addition to its first franchise, under his original UFOC (now FDD), when the franchisor is not registered in Illinois?
• Does it matter that the franchisor did not make him pay a franchise fee for the new franchise?
• Does it matter that the new franchise is a “café concept” when his first franchise is a “coffee shop” concept?
• Was Coffee Beanery required to disclose to the franchisee (and his attorney) that they were not registered in the state when he purchased his second franchise in Skokie?   If so, how are they required to disclose it?
• Did Coffee Beanery disclose that information to the franchisee at the time they sold him the store in Skokie?. If so, how was it disclosed?
• Would Coffee Beanery be allowed to open the Skokie store as a company-owned store without being registered in Illinois?

The Franchise Bureau responded with this statement that it wanted to quietly understand the details of this recent franchise transaction:

Generally, the relationship between a franchisor and a franchisee is dictated by the franchise agreement. When this franchisee purchased initially the franchisor was registered. We also generally do not want to restrict the franchisee from making their business profitable. We will reach out to the franchisee to get details of this second transaction.

New York franchisee attorney Paul Steinberg said he thinks this looks like a rogue franchisor that is saying they don’t really care about the law. “From the prospective of the franchisee, they don’t have any choice. They will have to go to arbitration if they claim they were harmed.” Steinberg thinks where these people are making a mistake is when they get a high profile franchisor like Coffee Beanery which has lots of clout and is so aggressive and contemptuous, they are almost begging for a pushback from the regulators. "From a long term perspective, I think that is a very foolish game that they are playing,” he asserted. 

But Steinberg said that the real question is, “Was the franchisee who just opened the new store in Illinois aware that the Coffee Beanery had attempted to re-register but then was denied registration based on the issue of it being materially deficient?”  He said, “That’s a fairly serious thing.”

UPDATE TO ARTICLE: Illinois Mail Boxes Etc franchisee Cathy Gordon asked the franchise bureau chief for answers to questions presented in this article last Friday.  As far as she was concerned, they had not yet answered the questions and she wanted to know, "What is the law in Illinois? Can an unregistered franchise be sold in Illinois?" Because this was a second transaction entered into while Coffee Beanery had been twice denied on their registration, Gordon asked, "Can one FDD [franchise disclosure document] serve as disclosure for multiple stores purchased with different business models at different times?"

Cassandra Karimi answered Gordon's questions with this statement:

My office was unable to answer Ms. Sparks’ questions in the allotted time because we do not have the facts necessary to do so.  This is why we indicated that we would reach out to the franchisee in question.  In general, a franchisor must be registered to offer or sell franchises in Illinois.  There is an exemption, however, that applies to existing franchisees making certain changes and/or additions to an existing franchise agreement.  This exemption is found in Section 7 of the Act.  The Act anticipates that an existing franchisee may need to make changes or expansions to its business in order to maximize profitability.  The franchisor would not need to be continuously registered during the entire term of the franchise agreement for this exemption to apply.

In 2007, The Coffee Beanery had been accused of a "bait and switch" situation, where franchisees were first sold on one concept and then enticed to purchase another. Harry M. Rifkin, attorney for franchisees in Maryland had stated that there was a lot of disclosure issues, mainly in that the franchisor did not differentiate between the traditional coffee shop model and the new cafe concept., including information in the financials. The newer model featured an extended menu of hot and cold food, which required a different layout for meal preparation, additional equipment and more staff.

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Related reading:

• Former Administrator Talks About Red Flags of Franchise Fraud ...
• IFA Files Amicus in Support of Coffee Beanery
• Coffee Beanery Petitions Supreme Court to Address Big Issues on Arbitration
• Coffee Beanery Attempts to Stay Mandate Pending Supreme Court Petition
• Sixth Circuit Denies Coffee Beanery Petition for Rehearing
• Coffee Beanery Franchisees Win on Appeal; Arbitration Decision Vacated
• Maryland Launches New Probe into Coffee Beanery Violations
• Coffee Beanery Violates Illinois Franchise Act
• Coffee Beanery Not To Sell Franchises in Illinois