Franchisees Reassert Fraud Claims against Papa Murphy’s

VANCOUVER, Wash. – A court ruled last October that franchisees could move forward with their fraud and negligent misrepresentation claims against Papa Murphy's International, in order to give more detail to their allegations. Having denied the franchisor's motion to dismiss, the judge declared, "I'm not dismissing those claims at this point. I'm going to allow further discovery to be done by franchisees."

The second amended complaint was filed in February on behalf of 19 franchisee groups, consisting of current and former store owners who owned 43 stores in eight states in the South. They allege they were defrauded by Papa Murphy's when purchasing their franchises because the franchisor withheld crucial information from them pertinent to making their decision.

The franchisees claim Papa Murphy's misrepresentations and omissions in its disclosure documents (FDD) and by its salespeople and other employees caused them personal and financial devastation. The lawsuit filed by Bundy Law Firm of Kirkland, Washington outlines how many store owners, having trusted in Papa Murphy's sales pitch, invested their life savings and 401(k)s. Many of their stories are documented in the amended complaint.

Some franchisees tell how they left successful careers to manage their Papa Murphy restaurants and have not been able to reliably take any salary from their businesses in the years they have been operating. Several franchisees have been forced to sell their homes or let properties go into foreclosure. Others have seen their marriages fall apart due to the increased stress of owning a failing business, working in their stores sixty-plus hours a week.

The litigation first hit as the "take and bake" pizza chain filed its initial public offering on May 2, 2014 under Papa Murphy's Holdings, Inc. (NASDAQ-FRSH). The amended complaint was filed last February in Clark County Superior Court on behalf of franchisees outside of Washington, operating in the southern part of the country. While Judge Scott Collier ruled that those franchise owners could not seek fraud claims against Papa Murphy's International under the state's Franchise Investment Protection Act, he also determined the store owners should be able to pursue certain allegations under another part of the state law.

The main crux of the amended lawsuit is emphasized in one sentence: "All plaintiffs [franchisees] have suffered physical and emotional stress from attempting to make a broken business model succeed." It alleges that as early as 2002, Papa Murphy's knew that a store's age and location were crucial factors in its success. Franchisees claim that the company also knew that new stores in the south and southeast would experience much lower sales. Because of that, franchisees would have to spend significantly more money on local store marketing to achieve Papa Murphy's sales. And it would take new stores in those southern regions several years longer to achieve sales which were equal to the system average. This knowledge was confirmed by the comprehensive sales, expense and profit information Papa Murphy's collected on each of its franchised stores. The southern franchisees state that the franchisor did not share that information with them when purchasing their franchises. If it had, the store owners emphatically state they would not have entered into franchise agreements.

Overview of the case

The amended complaint describes the franchisees as individuals, married couples, families and high school friends who wanted to become small business owners. Some decided to purchase a franchise because they had been downsized in the great recession and were unable to find other employment. Others decided to purchase a Papa Murphy's store to teach entrepreneurship to their children and pass the business on to them. And some hoped to supplement their retirement and stay involved in their community.

Franchisees name not only Papa Murphy's and its various entities in the lawsuit, but also individual corporate managers and directors. They are accused of systematically defrauding franchisees by convincing them to purchase a franchise through a standardized sales process. Papa Murphy's and its employees presented themselves as experts both in the franchise system and in selecting successful franchisees. At each stage of the sales process, including qualification, disclosure and approval, Papa Murphy's allegedly omitted key material facts regarding the actual average sales, expenses and profit for its new stores in southern regions.

Although Papa Murphy's required franchise buyers to provide comprehensive financial information regarding their net worth and liquid assets to determine if they were qualified, the franchisor did not present the entire truth to the prospective buyers. Franchisees claim the company did not tell them they lacked the financial resources to operate their franchise businesses. And Papa Murphy's gave them low sales, high marketing costs and a long operating period to reach "average sales", typical of new stores in their region.

Because of those omissions and misrepresentations, franchise owners claim they were forced to leave the system because of their lack of capital. In some cases, Papa Murphy's was able to obtain failing stores for pennies on the dollar only to resell the stores to new franchisees for fat profits or allow existing owners to purchase failed locations.

In giving franchisees the required franchise disclosure document (FDD), Papa Murphy's elected to make financial performance representations by disclosing the average sales for the franchise system as a whole, and for each of the high, medium and low tier of stores. They state Papa Murphy's did not provide prospective buyers with the information that new stores in their region had average sales which were well below the system average and that the majority of new stores in their region were in the lowest tier of store performance.

The lawsuit alleges that these material omissions by the franchisor were compounded by its sales team's wide spread, and unlawful, practice of making financial performance representations outside the FDD. As a supplement to the FDD, Papa Murphy's gave specific estimates as to what sales and profits franchisees could expect for their stores. The franchisees said they believed those statements because they did not appear, on their face, to be inconsistent with the FDD, and that the sales team presented themselves as experts on the subject. Franchisees contend that what their sales people knew but did not share with them was that their statements were either literally false, were based on average sales and profits for well-established stores outside their region, or that despite their claimed expertise they had no reasonable basis for their claims.

Among Papa Murphy's defendants

In addition to Papa Murphy's and its various entities, Lee Equity LLC is also named in the franchisee lawsuit because of the significant control it had over the operations of Papa Murphy's, including the appointment and approval of its executives and board members. Lee Equity acquired Papa Murphy's Holdings, Papa Murphy's Intermediate, PMI Holdings, Inc., Papa Murphy's Company Stores, Inc. and Papa Murphy's International, LLC in the middle of 2010.

Individuals named in the lawsuit include John D. Barr, chairman of the board of directors and chief executive officer in 2004; Ken Calwell, chief executive officer and president in 2011, who franchisees claim stated that the "break even" for a Papa Murphy's franchise is $5,300 in average weekly sales. In a recent survey conducted by the Papa Murphy's International Franchisee Association, less than three percent of restaurant owners surveyed stated that their breakeven was less than $6,000 in average weekly sales.

Among the named in the lawsuit are Janet Pirus, chief financial officer, responsible for directing Papa Murphy's financial planning and accounting practices, and Victoria Blackwell, senior VP and general counsel, who allegedly was hired because of her knowledge and experience of franchise law.

The 283-page multifaceted amended complaint details each franchisee's claims, and gives the causes of action against the appropriate defendants. They include for certain franchisees and against certain defendants: fraud, negligent misrepresentation, and violation of Washington Franchise Investment Protection Act.

Papa Murphy's responds to new lawsuit

Papa Murphy's declined an interview but released a statement from Jack Hardy, spokesperson for the company. In addition to saying they believe the lawsuit has no merit whatsoever and that they will defend the claims vigorously, they gave this statement:

We have actively been in mediation with the 28 plaintiff groups and of those, 8 plaintiff groups which represent a significant portion of the stores involved in the litigation, have dismissed their claims.  We are continuing to mediate with the remaining plaintiffs and are working hard to come to an amicable resolution.

 Assisting franchise owners to grow sales and increase profitability is an ongoing priority for us.  For over 30 years, we have been a strong reputable franchisor with a history of good franchise relations and very little franchise litigation.  We stand behind our concept and our strategies to grow the business.

Franchisee attorney counters

Howard E. Bundy, representing the franchisees, takes issue with Papa Murphy's statement. He reiterates that the basis of the franchisees' claims is that Papa Murphy's omitted key facts when it sold franchises to his clients. "They had a duty to tell the whole truth and did not. Papa Murphy's now tries to focus the media on the fact that some of the original plaintiffs have dismissed their claims." Bundy added that some franchisees received money for their grievances. "Consistent with their pattern of behavior, Papa Murphy's fails to mention that those dismissals were the result of confidential settlement agreements. The franchisor would apparently have the world believe that every one of those settling franchisees unconditionally surrendered," he declared.

In response to Papa Murphy's saying that assisting franchise owners is an ongoing priority, Bundy said in their latest complaint his clients have described exactly how Papa Murphy's responded to their pleas for help. "Papa Murphy's told our clients to work harder, lower their prices and give away more pizzas. Papa Murphy's never just told the truth—that based on Papa Murphy's experience, their stores located outside the Pacific Northwest or open less than ten years, had an extremely low chance of ever achieving true profitability and had a high probability of not even breaking even—even using Papa Murphy's definition."

Bundy concludes saying, "When a franchisee is working over 60 hours a week without pay, how can you ask them to work harder? When a franchisee has already liquidated most of their assets, including their retirement savings, how can you ask them to invest more? Our clients are committed to this case and to holding Papa Murphy's accountable for the deceptive statements, which cost our clients millions."

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Janet Sparks