The Complicit Loan Broker In Franchise Fraud

It is common practice in franchising for a franchisor, especially a fairly new franchisor, to steer its franchise investors to a particular loan broker, and sometimes even to a particular bank. It is also fairly customary for the loan broker or bank to pay the franchisor for the “traffic”. Banks/finance companies pay “fees” to companies that refer their customers to them for loans all the time. In this relationship, the broker also has a template business plan, complete with pro forma profit and loss information, that is provided to the franchise investor. This is typically touted as part of the “value” received by the franchise investor. The loan broker has a canned speech that he gives the franchise investor about the business plan in which he typically says something to the effect that the information is just for “form” so that the SBA lending bank has something in its file. The speech is calculated to get the franchise investor not to look too closely at the information.

The information in the business plan always comes from the franchise sales/marketing people of the franchisor. The franchisee has little or no input in the whole matter other than to sign what is put before him by the loan broker without reading it or with scant attention being paid to it. The information is almost always false in the sense that it is full of exaggerations, to put it nicely, and the pro forma financial information has little or no basis in fact. The pro forma may or may not be hedged, somewhat along the lines of the typical weasel word disclaimers one sees in every Item 19 earnings claim in every FDD these days.

As this is now considered to be the representations of the franchise investor to the SBA lending bank, there is not much concern about how responsible the statements are. The franchise investor is typically told that it is just format material required by the SBA and that no one ever reads it. Actually, while intended to cause the franchise investor not to seriously consider the reliability of the information in the business plan, it is probably true that the bank never reads the material because if the loan goes bad, it has been sold to a loan package investor when the shit hits the fan, and the government is guaranteeing it anyway – so who cares? That this entire procedure may be a federal felony receives little consideration because nobody ever gets called to account in any criminal proceeding. When the franchise investor loses everything and decides to sue/file an arbitration claim, the scenario resembles a Monty Python story.

In recent news events on franchisor Cuppy’s Coffee, a loan broker went public with a vocal repudiation of its relationship with Cuppy’s franchise operations, chock a block with “reasons”, in a statement that had that “written by a lawyer” smell all over it. When I read it I sensed that the loan broker was probably expecting to be sued by the many franchise investors who are out on a limb after writing big checks to a Cuppy’s nominee company and receiving nothing for their now disappeared money. From the claims, it seems as though Cuppy’s may have had what are considered initial franchisee fees paid to a “construction company” so they could claim that they had not received any money from these victims. It’s too blatant to be an inadvertent mistake. Apparently this particular loan broker was the company to which Cuppy’s steered all its franchise investors in arranging SBA loans.

What has the Cuppy’s loan broker sweating is that Cuppy’s, including its successors in interest, is broke and ready for Chapter 7 bankruptcy liquidation. As there is no insurance coverage for fraud claims, the risk is all about collectability of any judgment. In that scenario, the duped franchise investor can’t find a contingent fee lawyer to represent him, and if he has any snap he won’t risk his own money in a process that is unlikely to yield recovery even in the best results. That causes a search for pockets to sue. And that is what, in my less than humble opinion, has caused this loan broker to break water with its pro active public denial and hand washing ritual.

There have been few or no franchise fraud lawsuits against the lending banks and these loan brokers. If there is money to be had at the end of this rainbow, this could open up a whole new field of litigious endeavor. Here’s how it is most likely to play out.

The principals of the franchisor in this scenario will also be defendants, as they will not be protected from their own fraudulent conduct by a fiduciary shield in most states. Being an officer of a corporation usually does not have a prophylactic effect on fraud liability. Moreover, if there is a franchise investment statute applicable to the scenario, all of those statutes specifically provide for officer and director personal liability for violation of their anti fraud provisions. Those provisions all mimic the securities law fraud standard in that they prohibit making false and misleading statements in connection with the offer or sale of a franchise, and the omission to state facts that would make what is said not misleading in the light of the circumstances in which the statements were made.

This new approach, however, would attempt to cast the liability net somewhat wider, no doubt on an aider and abettor theory, entrapping the SBA lender and the loan broker. If they are complicit in a fraudulent scheme, being shown by the evidence to have acted in a pattern of conduct as a consequence of which a jury could find that they knew or should have known that the business plan information was a sham and false, liability could attach. Now isn’t that a yummy approach? It has Monty Python written all over it, doesn’t it?

In my experience, the franchisor’s people will actually try to convince everyone that they didn’t lie to the franchisee to fraudulently induce him to invest in their franchise. If they lied at all, they lied to the loan broker, and there is no law against lying to loan brokers, right? Wrong! The only reason to lie to a loan broker is to facilitate the loan broker using that information to obtain bank loans, hence it is at least a bank fraud felony. But this is a civil suit and the bank is not the plaintiff. In civil claims the essence of a claim is that there was improper conduct that proximately caused you injury, as a consequence of which injury you suffered damages. If the case can be postured by the defendants as bank fraud and the bank isn’t a plaintiff, where does that leave the franchise investor plaintiff? Competently analyzed that should leave the plaintiff with a theory of liability that he was the real and ultimate target of the fraudulent conduct, and he is injured by it because he was caused to submit unreliable information to the lending bank and it is his name on the promissory note, regardless of whether anyone will, as a practical matter, ever come after him to repay the loan.

The loan broker will claim in defense that what he provided all came from the franchisor, and if it was false information, he had no idea in the world about that and is totally innocent. Now this isn’t a bad defense, as it now imposes on the plaintiff a duty to prove by clear and convincing evidence (somewhat more than proving a claim by a preponderance of the evidence) that the loan broker knew when he was passing out these business plans that the information they contained was improper. The loan broker, if he has a good lawyer, will claim that his function is only to facilitate loans, and that he owed no duty to the franchisee or to the bank to vet the information provided by the franchisor – that he had a right to rely on the franchisor to provide proper information. This is a pretty good defense unless the “drunken party” witness can be found. The “drunken party” witness will be a disgruntled former employee of either the franchisor or the loan broker that was present at the dinner party where the loan broker and the director of franchising joked about the shit they were getting away with and how since the government pays off the loan in the end, no one is injured. Ha Ha Ha! The perfect crime! Really?

The bank, of course, if it is made a defendant, will claim it owed no duty to do the franchise investor’s due diligence for him. After all, they had no exposure and guaranteed repayment and a profit. If the franchise investor wanted to protect himself from fraud, that is his own responsibility. He can’t just do nothing by way of competent due diligence and expect banks to clean up his mess. That is a very good defensive position. It could be improved a bit by some better draftsmanship in loan agreements than presently appears. Unless the bank loan officer can be placed at that drunken dinner party, the bank is home free. If the loan officer was at the party, the bank will claim that he was acting outside the scope of his authority. Since participation in some fraudulent scheme is in fact outside the scope of the loan officer’s authority, I expect the bank will get off the hook in the end.

Now lets consider the cross examination of the Plaintiff by all the defense lawyers. The plaintiff franchise investor will be assaulted on the witness stand in approximately the following manner.

The franchise agreement he signed will have the following provisions to which he agreed when he signed it. It will have a provision that says that the contract contains all the terms of the agreement, and that there are no other agreements of any kind – the merger/integration/entireties clause. The franchise agreement will have a provision in which the franchisee investor acknowledges that he was not provided by the franchisor or anyone acting for the franchisor with any information other than what was contained in the FDD. The franchise agreement will also contain a provision in which the franchise investor agrees that if he was given any information other than what is contained in the FDD, he did not rely upon it in making his franchise investment decision. Did he read the contract before he signed it? Did he, as he was admonished to do, take it to a lawyer or other advisor for help in understanding what it was that he was agreeing to? What kind of lawyer did he take it to? How much did he pay for the lawyer’s services? Did he ask the lawyer about the lawyer’s experience in vetting franchise investments? What did he do to try to find a lawyer that regularly does franchise investment due diligence? Did he find any who did that a lot and fail to hire them? Why didn’t he hire the most experienced lawyer? Did anything happen or was anything said about the numbers in the pro forma contained in the business plan? Tell us about that. You say that the loan broker told you that it was necessary that the pro forma showed you making a nice profit in order to get loan approval? Did that raise any red flags in your mind? Did you even ask whether showing a profit, as stated in the pro forma, was true or reliable? Did it really happen, or didn’t you bother to ask that. Did you go back to your lawyer about the loan broker saying that to you? You relied on the loan broker for his expertise? Tell us what you knew about his expertise. Oh, he was the loan broker than the franchisor referred you to and you didn’t ask any questions, right? You just wanted the money. Hmmmm! (Objection. Sustained – but too late.)

What is the likelihood that a franchise investor, on these facts and with this testimony, will get a favorable verdict? Anyone care to guess? Since it may be a somewhat novel case, what is the likelihood that a favorable verdict will be upheld on appeal? Anyone care to guess?

Actually, what I have just described happens very frequently, based upon what impoverished franchise investors tell me. It’s really too bad that they never seem to have the money to pay for what is needed to prosecute that claim. Of course, they might have avoided the debacle had they hired a really good franchise investment due diligence lawyer. But they cost much more than the lawyer who doesn’t know what he’s dealing with. Wow! Think of the legal fee he saved!

Writer's note: This is a follow on article to my tutorial about SBA loan fraud bank due diligence in connection with underwriting franchise loans. A recent situation noted on the leading franchise blog site, involving Cuppy’s franchising prompts me to revisit this subject.

Profile picture for user Richard Solomon



How I wish I had read an article like this 12 months ago. This type of article should be covered on a major publication small business section..
As a matter of fact I did question many of the items w/ respect to the loan broker and the franchisor. I even questioned my better half, other franchisees, etc as to who in the world is driving the sales volumes which were reflected on the pro forma. I knew at that point I was stuck and failed to do the math re: which would be worse - to walk away losing a downpayment as a failure before we even host a grand opening? or to move forward on a project with dubious prospects? We got very lucky in that our bank made the decision for us. We've now discovered thru vendors who will help us complete this project that we were lined up to pay more than double what we should have paid. There was too much fluff in the construction agreement. I agree I should have done more due diligence. that whole hindsight thing. I also should have recorded all of my conversations with the construction personnel, franchisor and loan brokers.
And to answer Mr Steinberg - I have been in contact with the SBA, our states attorney general, & our attorney. There has also been certified correspondence with Elite and Cuppy's. I did listen and understand. I hope there are others reading and understanding too. Good luck.

Sunk Cost Fallacy

Guest writes: " I knew at that point I was stuck and failed to do the math re: which would be worse - to walk away losing a downpayment as a failure before we even host a grand opening? or to move forward on a project with dubious prospects?"

In fact, this is decision which everyone faces but doesn't know it. 

Michael Webster PhD LLBFranchise News

Oh, and by the way, if you go to this loan broker's web site

you will see that every franchisor he touts as his client is a definite FranWhack.

What does that tell you?

It ought to tell you that he is just some bottom of the barrel lowlife piece of crap, probably living hand to mouth.

If he had any "real" franchise clients, he would have mentioned them. His web site is more a "stay away" warning than a positive business building advert.--

Richard Solomon,,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School

No one coming to me for due diligence would ever

be allowed to write a check to some third party for anything in pursuance of a deal that has not been "filled out" yet.

My fees are higher than whoever you went to, but you bought into the scam and my clients would never ever have bought into the Java Joe/Cuppy situation.

I may not be "cost friendly", but I am value friendly.--

Richard Solomon,,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School

Loan Broker

Richard, nice article.

But what I find puzzling is this.

How can the franchisor provided information to the loan broker, an agent of the franchisee, which amounts to an earnings claim when the franchisor disclaims making earnings claims in their Item 19?

Shouldn't every franchisee who has obtained a loan through a broker, who produced a business plan, to purchase a franchise from a franchisor who claimed to make no earnings claim make a complaint to a) the state regulator, and b) the FTC?

Couldn't hurt.  I wonder what Mr. Cantone thinks about this state of affairs. 

Michael Webster PhD LLBFranchise News

How can they indeed? Well, Michael, it works like this.

In the mind of the jailhouse lawyer crooked franchisor, providing information to help a franchise investor obtain a loan and complete a business plan (which it all total crapola anyway), is not considered (by them) to be the making of an earnings claim. In the weasel word play of franchising there is the FDD, and then there is everything else. The position that we weren't defrauding the franchisee; if anything we gave the bank false information by providing it for the franchise investor's business plan, is not just some cynical homorous thaing I made up. That's how it really goes down.

As for running to the cops, I never do that. The cops have other priorities and agendas than my priorities and agendas. If they do act, they act in their own manner, which - as we saw in the Coffee Beanery case - may not be useful to my client. Finally, once the cops are involved, your ability to reach a settlement is impaired, because while you can turn off your case, you can't turn off the government's activity.

Running to the cops is something I never do and never will do. There aint no free lunch available at the government enforcement store.

Richard Solomon,,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School


Richard writes: "Running to the cops is something I never do and never will do. There aint no free lunch available at the government enforcement store."

I must drop by and rob your condo some day. 

The lunch has been paid for with your tax dollars - might as well try to get some useful service from the institutions which you have paid for.

But, I agree with your cautionary remarks also.  The CB case notwithstanding, in some cases the only feasible strategy is use the regulators clout. 

Michael Webster PhD LLBFranchise News