Dunkin' Donuts v. Grand Central Donuts

A federal judge has ruled that franchisees may explore Dunkin's ulterior motive in terminating their franchise agreements.

For the past decade, Dunkin' has faced allegations of  spying, intrusions into franchisee's love lives, and assorted bare-knuckles tactics in terminating franchisees.

One of the nation's leading franchise journalists was threatened with a lawsuit if she wrote about the tactics taught by Dunkin' at an American Bar Association meeting; ironically Dunkin's outside law firm justifies higher assessments of attorney fees to franchisee-Defendants based on their "national reputation" achieved by presenting at the ABA meetings.

Now a federal judge has ruled that Dunkin' must disclose documents which may shed more light on the controversial practices followed by the Dunkin' attorneys.

Dunkin' Donuts Franchised Restaurants LLC v. Grand Central Donuts Inc (19 July 2009) is a set of allegations familiar to franchise industry observers.

• Between 2003-2005, the franchisees opened 5 locations.
• In February 2006, they allege that Dunkin told them that Dunkin would be buying their stores.
• The franchisees refused.
• Dunkin commenced an audit in June 2006.
• On September 24, Dunkin told the zees that they had filed inaccurate W-2 forms and transferred an interest in the franchises.
• Dunkin told the franchisees that their franchises were terminated.
• On September 26, Dunkin brought suit in federal court.

A steady stream of franchisees from Detroit to Brooklyn to Ohio and Rhode Island have told similar tales of being pushed out by Dunkin' at fire-sale prices, many losing their life savings when they refused the Dunkin' offer.

In many cases, Dunkin' alleges underreporting, and the Dunkin' personnel charged with audits are paid based in part on how much they claim the franchisee underreported sales.

Since December 2001, Dunkin' has inserted a clause into franchise agreements stating that failure to comply with tax laws is grounds for termination, and routinely "audits" the franchisee's tax returns and reports to the IRS; one franchisee who sued Dunkin in 1999 got hit with four dozen counts of a criminal tax fraud. More recently, Dunkin' has taken to involving itself in the payroll and employment practices of franchisees, and engaging in mass terminations on (for example) the grounds that a franchisee has not paid overtime wages to employees, notwithstanding that at the same time Dunkin' avoids vicarious liability in employee tort suits by maintaining that it does not maintain control over the franchisee's employees.

Such mass terminations are immensely profitable for Dunkin', which collects significant legal fees and is able to reward selected franchisees.

Customarliy, the allegations are that Dunkin' wants to force small operators to sell to favored operators at below-market prices: the Brooklyn case involved stores which were coveted by mega-franchisee Konstantino Skrivanos, known as "The Greek."

On June 19, 2009 Magistrate Judge Marilyn D. Go ordered the production of Dunkin' emails to the Grand Central franchisees, but it is unlikely that many recent emails will turn up. On Ocober 4, 2007, Dunkin' Director of Operations Len Hohmann had warned fellow Dunkin' execs: "moving forward, please do not email... and let's communicate by phone."

Past efforts to claim pretextual termination and violation of the implied covenant of good faith and fair dealing have generally been unavailing for franchisees.

But in Grand Central Donuts the franchisee attorney pointed out that Massachusetts law applied, and the court held that:

Under Massachusetts law, a party may breach the implied covenant of good faith and fair dealing without breaching the express terms of the contract... notwithstanding an express contractual right to terminate, including the termination of a franchise agreement, 'under some circumstances a party to a contract is not free to terminate it according to its terms'...

Even if [Dunkin'] had objectively reasonable grounds for terminating the franchise agreements, whether [Dunkin'] had an ulterior motive for terminating the agreements may be relevant to [franchisee's] counterclaims...  

The [franchisees] could have fairly expected that Dunkin would exercise its rights to terminate and reject new stores in good faith, rather than for the purpose of profiting from a transfer of ownership or favoring other franchisees.