Hockey Star Scores in Securities Fraud Case against Dunkin, Kainos Principals

NASSAU COUNTY, NY – After a supreme court judge made his decision last May that Patrick LaFontaine could move forward with fraud claims against Dunkin’ Brands, Inc. and other defendants, the professional hockey player scored another victory last September.

Judge Stephen A Bucaria denied all motions to dismiss his court ruling filed by Dunkin’ and the two principals of Kainos Partners LLC, and the chief operating officer of Palisade Capital Management, LLC, an SEC Registered Investment Adviser. The judge also denied Dunkin’ Brands’ request to reargue its motion to dismiss for failure to state a cause of action.

The lawsuit was filed November 23, 2009 by Zarco Einhorn Salkowski & Brito. Robert Zarco said the judge’s decision has been appealed by Dunkin’ and other defendants. In setting the stage for the case, Zarco stated, “We’re very disappointed that Dunkin’s former CEO Jon Luther would so take advantage of his extremely close and personal relationship with Patrick LaFontaine, as to cause him to invest substantially in a franchise that he knew, or should have known, was not financially viable. Many of the financial indicators made it obvious that the business in which Mr. LaFontaine invested was doomed for failure.”

The 2003 Hall of Fame hockey player has all the battle scars to show his incredible 28-year career battling adversaries on the ice while with the New York Islanders, Buffalo Sabres and New York Rangers. But little did he know that his toughest opponent would be in a legal arena with his good friend, golfing buddy and board member of his charitable foundation Jon L. Luther, former CEO and now executive chairman of Dunkin’ Brands, Inc.

For the past year, LaFontaine has been locked in the legal battle with Dunkin’ and certain principals of the now-failed franchisee entity Kainos Partners, established by Dunkin’ in 2006 to sell franchises in New York, Nevada and South Carolina. The hockey star claims Luther lured him into making substantial investments into Kainos over a three-year period by eagerly advising him of the franchisee development firm’s healthy financial condition. As LaFontaine played golf and socialized with his former friend and neighbor, he watched Luther promote Kainos as “Dunkin’ Brands Rising Star” at golf tournaments and charity events in getting investors. 

As LaFontaine started making investments on the advice of Luther, Kainos kicked into high gear in opening donut shops in the greater Buffalo area, using not only the hockey player’s celebrity status but also his money. As part of the expansion, Kainos also developed and operated a central manufacturing/bakery facility, supplying baked goods to not only its own stores but other Dunkin’ Brands franchisees. High Tides soon leaned from a Kainos board member that the Buffalo market was “pushed” on Kainos by Dunkin’ “as a favor to Jon Luther” and that it was a major cash drain on Kainos from its inception. 

In early February 2009, while waiting for a flight to the Bahamas for vacation with his family, LaFontaine learned from a fellow investor that Kainos was in deep financial trouble and fighting allegations of fraud and embezzlement, and that Palisade Capital Investment Management, LLC, was coming in to take over. Palisade Capital had $14 million invested in the Kainos development group.  Days later, LaFontaine was blind-copied by Kainos board members that Kainos had been struggling financially and operationally since its inception, a fact that was concealed from the public and High Tides by both Kainos board defendants and Dunkin’.

On July 6, 2009, Kainos and its subsidiary affiliates filed voluntary petitions for relief under Chapter 11. As part of the proposed reorganization, High Tides’ equity interest in Kainos will be reduced to an unsecured claim—its $1,752,525 investment essentially lost.

The Zarco law firm filed the lawsuit the following November in Supreme Court of the State of New York, Nassau County. Although not individually named in the legal action, Luther, now executive chairman of Dunkin’ Brands, is at the center of the allegations. Luther is also the second vice chairman of the International Franchise Association.

In January 2009, Luther was replaced as CEO by Nigel Travis.

The Making of the Lawsuit

LaFontaine’s relationship with Kainos began during a Buffalo Sabres alumni golf tournament in 2005, where Luther introduced his neighbor and friend to principals of the franchisee entity. At that time, and in the context of discussing a possible equity investment by the hockey player, LaFontaine learned that Kainos was working with Luther to develop Dunkin’ shops. The executives told him that “Jack” felt LaFontaine’s status as a former hockey icon would assist Kainos in its growth.

LaFontaine made his first investment of $500,000 in 2007, after consulting with Luther. From there the hockey player made other investments, again on the advice from Luther, according to the lawsuit.  After his first investment, his company became the owner of 500 Class A Units of Kainos on July 1, 2007. It was intended that a portion of the profits High Tides would realize would be contributed to LaFontaine’s Companions in Courage charity foundation for children. LaFontaine made another investment in August 2008 of $252,000, bringing the total to $1.75 million.

According to the complaint, High Tides plaintiffs allege that on December 1, 2008 Kainos’ chief financial officer Christopher Cortese advised LaFontaine that Kainos’ board was looking for yet another round of funding to support its “incredible growth.” He stated that the price for any units sold in any new round of funding would be priced at $1,250 per unit, given the fact that Kainos, which at that time had a value of $40 million, would have a value of $77 million after closing.

Two weeks after Kainos’ CFO valued the company at $77 million, Kainos was without money to continue operations. 

The litigation highlights that in 2006, Thomas H. Lee Partners LP, Bain Capital Partners and the Carlyle Group purchased Dunkin’ Donuts for $2.43 billion. As part of this purchase, and through a complicated securitized structure, “Dunkin’ Brands burdened itself with secured debt estimated to be in excess of one billion dollars—a debt that needs to be retired,” according to the complaint. It further states that “on information and belief, Dunkin’ is also preparing an initial public offering, whereby it hopes to offer common stock to the general public for the first time, for the benefit of itself and its investors.”

Latest Court Order

While the May court order dismissed some of the seven allegations related to fraud, negligent misrepresentation and omission against certain defendants, Judge Bucaria allowed the aiding and abetting fraud claims against Dunkin’ and two principals of Kainos, Kenneth Kellaway and Don DeMichele, as well as Jeffrey Serkes, the chief operating officer of Palisade Capital Management, LLC, an SEC Registered Investment Adviser with approximately $2.2 billion of assets under management, that invested $10 millions in Kainos through one of its affiliates.

The judge stated that with the two Kainos directors, a reasonable inference arises that they had knowledge of Kainos’ true financial condition, as did Serkes, based upon Palisade’s significant investment in the franchisee company. And, that there is a reasonable inference that they provided substantial assistance to the other Kainos principals involved in defrauding LaFontaine. He stated that all three “had an incentive to assist the other directors in touting the company.”

Judge Bucaria stated, “Finally, it may be inferred that Dunkin’ Brands, as the master servicer, had knowledge of the financial condition of one its franchisees.” After denying Dunkin’ and Kainos’ defendants’ motions, he stated, “This is an action for securities fraud.”

When asked if his law firm had seen any changes in the litigation arena with Dunkin’ since Nigel Travis took over Luther’s position in January 2009, Zarco stated, “We do not understand why Nigel Travis, who professed upon entering the company, that he was going to address and resolve all legal disputes that were pending, has taken no action to resolve this particular case. In light of the substantial liability that Dunkin’ faces as a result of the judge’s decision.”

Ronald D. Degen of O’Rourke & Degen, attorney for Dunkin’ Brands stated he was not authorized by Dunkin’ to make comment on the litigation. 

Michelle King, Dunkin’ Brands’ director of global communications issued this statement:

Dunkin’ Brands is aware of the lawsuit that was recently filed by High Tides, LLC, an investment company owned by Pat LaFontaine. Mr. LaFontaine's investment was not with us, but with Kainos Partners Holding Co. LLC, which formerly owned and operated Dunkin' Donuts restaurants in Buffalo, Las Vegas and South Carolina. While we have great respect for Mr. LaFontaine and regret that his firm lost money, we are not responsible for these losses.

Dunkin' Brands recently took ownership of the Kainos restaurants in New York and Las Vegas, which have since shown improvement.

As this is an ongoing legal matter, we are not able to provide further information.

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Related Reading:

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• Dunkin’ Donuts to Gobble Up Kainos Franchises
• Another Major Dunkin Franchise, Kainos, Goes Bankrupt
• Franchisor Dunkin' Purchases Bankrupt Las Vegas and Buffalo Restaurants
• Dunkin' Brands Reorganizes with CEO Nigel Travis at the Helm
• Dunkin' CEO Replaced by Papa John's CEO
• Dunkin' Chair Says Franchisees Pleased With Handling of CEO Succession
• Dunkin' Explains CEO and Management Changes to Franchisees