Ex-Smashburger CEO Lawsuit Dismissed, Hardly Over

DOVER, Del. - After the former Smashburger CEO filed a lawsuit last July against the chain and owners Consumer Capital Partners for deceptively cheating him out of millions of dollars in stock, a Delaware court granted Smashburger's motion to dismiss the lawsuit last December.

But it is far from over. Now the parties must decide, with the help of an independent firm, what the valuation and payment of the former CEO's interest should have been, according to Smashburger's limited liability agreement.

The litigation triggered lawsuits from both sides to determine what David Prokupek's payout should be. Prokupek filed a second lawsuit asking the court to allow him access to Smashburger's financials in order to find out if the company met certain performance benchmarks that would entitle him to more shares in the company. But in its ruling, the Court of Chancery denied his request, stating Prokupek, as a former member of the company, lacked standing to pursue inspection of Smashburger's books and records for a valuation to be determined.

Prokupek began his career as Smashburger's chief executive when he was first hired by owner Richard "Rick" Schaden when the chain first started in 2007. The CEO was credited with elevating the company to have "the fastest growth in quick-service restaurant history," according to the Denver Business Journal. Under Prokupek's leadership, Smashburger also became the country's second-largest "better burger" franchise, second to Five Guys.

Prokupek's lawsuit was kindled after Rick Schaden and his equity team asked him to groom the privately-held hamburger chain for an equity sale in 2013. In doing so, Smashburger executives required him to give up certain rights under his employment contract in exchange for arranging a potential sale or public offering. Prokupek said he was told by Schaden's group that the arrangement would add value to the company and grow his stake in Smashburger.

But after the auction process began in August 2013 to sell the company, Prokupek abruptly left Smashburger in November without explanation. News reports surfaced telling that the chain's ownership team had fired Prokupek, offering him a severance package with fewer shares than his employment contract stipulated. The stock price fell below what was offered by several bidders.

Prokupek had filed his lawsuit against the chain and its owners in July 2014, followed by a second legal action, which asked for access to Smashburger's financials "so he can see if the company met certain performance benchmarks that would entitle him to more shares in the company." The former CEO claimed that Smashburger owners understated the chain's financial performance to minimize its contractual obligations to him.

Allegations of financial deception against Rick Schaden, his Consumer Capital Partners and management team are nothing new. For the past decade the group has been involved in similar litigation, first with hundreds of Quiznos franchisees through class action lawsuit. Presently, Avenue Capital and Fortress Holdings, multi-billion-dollar lenders, who supported Quiznos through its financial struggle in 2012, is suing the Schaden group in Denver district court as Quiznos continues its bankruptcy process. The lenders allege Schaden and others conspired to overvalue the sandwich chain in the 2012 restructuring of the company.

Ongoing litigation to determine valuation of payoff

The Court of Chancery ruled on December 30, 2014 that Smashburger exercised the right under its limited liability company agreement, to redeem all of Prokupek's equity interests in Smashburger. Prokupek was provided a notice of redemption and paid by check for the fair market value of his equity interest as determined by Smashburger's manager.

The court further ruled that because Prokupek demanded to inspect financials of the company after he "ceased to be a member," and after he received notice and was paid off, he was not entitled to that information.

In order to determine the valuation of and payment for Prokupek's interest in Smashburger, under the LLC agreement, the parties requested on January 7, 2015 the court allow an independent "Special Master" to make a final ruling. Vice Chancellor John W. Noble stated in his letter of opinion on March 27, regarding Smashburger Master LLC v Prokupek. The question then was how much should a judge intervene into the efforts of the independent firm and the Special Master? Noble added, "In contemplating this fundamental consideration, some blind alleys were traversed."

The chancellor said three primary issues had to be addressed: the selection of the independent firm to perform the valuation; whether discovery should be stayed; and whether Prokupek's counterclaims can survive. Noble said if the independent firm can, in its professional judgment, follow the terms of the parties' agreement, it should do so.

After the judge's detailed analysis of the process of resolving the issues, he said the attorneys for both parties were requested to confer and to submit implementing form of order. "This request is made in part because counsel are likely in a better position to fine-tune some aspects of the process the Court has set forth above."

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Janet Sparks