Case No. 295-1761United States Bankruptcy Court, M.D. Tennessee
July 12, 1996
For the Debtor, Stephen C. Douglas, Sabine Douglas, P.C., P.O. Box 422, Crossville, TN 38557, (931) 484-5936
For Little Ceasar Enterprises, Inc., William L. Norton, III, Roger Jones, Boult, Cummings, Conners Berry, PLC, 414 Union Street, Nashville, TN 37219, (615) 244-2582
MEMORANDUM
Judge Keith M. Lundin
I. Introduction
This matter is before the Court on Little Caesars Enterprises, Inc.’s. (“LCE”) objections to William Marshall Hebblewhite’s (“Hebblewhite”) and Marshall Enterprises, Inc.’s (“Marshall” or collectively as “Debtors”) proposed disallowance of LCE’s claims in both cases. The Debtor objected to LCE’s prepetition claim of $1,093.39 representing $650.46 for debts owing to Coca-Cola and $442.93 for accrued finance charges in the Marshall Enterprise case. Also in that case, the Debtor proposed disallowance of LCE’s claim in the amount of $45,611.82 originating from Marshall Enterprises’ rejection of the McMinnville Franchise Agreement Finally, Hebblewhite proposed disallowance of LCE’s claim in the amount of $774,839.88 deriving from the rejection of the EM Foods Franchise Agreement. This $774,839.88 amount represents $19,450.85 for postpetition food and supply purchases, actually accrued postpetition fees in the amount of $27,439.12 for royalties and $39,188.86 for advertising and $688,761.05 for lost future royalties and advertising fees. For the reasons hereinafter cited, the Court finds that LCE’s claims should be allowed in the amounts of $61,146.10 and $292,542.58 in the Marshall and Hebblewhite cases respectively.
II. Factual Background
Marshall entered into a Franchise Agreement with LCE on October 7, 1988, as amended October 1, 1990 for the operation of a Little Caesar’s pizza restaurant in McMinnville, Tennessee. EM Foods, Incorporated, a corporation of which Hebblewhite was vice-president, also entered into Franchise Agreements with LCE for the operation of several Little Caesar’s restaurants in 1991. Hebblewhite individually guaranteed the obligations of EM Foods and Marshall Enterprises. Both Franchise Agreements required the Debtors to pay royalties in an amount equal to 5% of the monthly gross receipts, but in no event royalties being less than $300 per month, and to pay to the Little Caesar’s National Advertising Program (“LCNAP”) advertising fees in an amount equal to 4% of monthly gross receipts.
On February 10, 1995, Debtors received from LCE, a letter setting forth LCE’s intent to terminate the Franchise Agreements if Marshall and EM Foods (and hence Hebblewhite) did not cure all outstanding defaults within 30 days. Marshall, EM Foods and Hebblewhite filed for Chapter 11 relief on March 15, 1995 in an effort to stop the termination by LCE. The EM Foods petition was ultimately dismissed. Both Debtors rejected the Franchise Agreements in the context of bankruptcy. Based on the rejection of the Franchise Agreements and Hebblewhite’s personal guaranty, LCE then filed a proof of claim in both cases seeking damages for the rejected contract in the amount of estimated future royalties and related advertising fees to which LCE asserted it was entitled to under the language of the Franchise Agreements as well as for other pre and postpetition debts. The Debtors objected to LCE’s claim for future royalties and advertising fees under the dear language of the Franchise Agreements, and to the $1,093.39 debt in the Marshall Enterprise case, and filed notices of proposed action to disallow those claims of LCE.
A hearing was scheduled on these objections. At the hearing, Ted Toloff, LCE’s Director of Finance, testified that approximately 300 Little Caesar’s restaurants had dosed during 1994 and 1995, and that no effort had been made to collect future royalties against any of these other franchises. However, because LCE had not terminated these agreements, but rather the contracts had been rejected by the Debtors in the context of bankruptcy, and LCE perceived an ability to pay from these debtors, it was pursuing its rights under the Franchise Agreements. By not pursuing these rights against other franchise owners, LCE argued that it had in no way waived its right to collect the future royalties and advertising fees in this case.
The Debtors called William Marshall Hebblewhite to testify as to the proposed disallowance of LCE’s claim. According to Hebblewhite, his stores had always met all requirements of the Franchise Agreement and had scored well on all LCE inspections. The McMinnville Store rarely ever operated above break-even, and suffered from a poor location and the influx of competition which offered delivery service that was unable at the McMinnville location. According to the debtors, LCE is attempting to collect royalties on sales averages which do not exist, and that no provision in the Franchise Agreements permits LCE to collect future royalties once the restaurants are closed. Neither Debtor challenged the LCE’s claims in Hebblewhite case for $19,450.85 for postpetition food and supply purchases, for $27,439.12 for accrued postpetition royalties, or $39,188.86 in postpetition advertising fees. Therefore, the only amount remaining in dispute in the Hebblewhite case is the $688.761.05 for lost future royalties and advertising fees.
At the conclusion of the hearing, the Court provided the parties with additional time to file briefs on the issue. The issues, as defined by the Court in conjunction of the parties were fairly narrow: (1) do the Franchise Agreements permit the collection of future royalties and advertising fees once sales ceased; (2) if so, in what amount; and (3) whether LCE is entitled to its claim of $1,093.39 representing the debt to Coca Cola and for accrued finance charges.
III. Discussion A. The Franchise Agreements
The relevant provisions of the Franchise Agreements state as follows:
X. ROYALTY
A. In consideration of the continuing right to use the Proprietary Marks trade secrets, processes, and know-how that accompany the LITTLE CAESAR franchise licensed hereunder, Franchise Owner hereby agrees to pay LITTLE CAESAR on or before the 15th day of each month, a sum equal to 5% of the gross receipts from the or the preceding calendar month.
B. The term “gross receipts” in this Agreement shall mean the dollar aggregate of all sale proceeds (whether cash, check vendor draft, credit instrument, service or delivery [where approved in accordance with this Agreement] charge, or other evidence of receipt) received by Franchise Owner directly and/or through, its agents from Franchise Owner’s operation of the licensed Restaurant and/or generated by the sale of items bearing and/or using the Proprietary Marks, excluding any sales tax.
C. Insofar as royalties are based on a percentage of “gross receipts”, as hereinbefore defined, Franchise Owner further agrees that certain minimum royalties are required, and that in no event shall the monthly royalties payable to LITTLE CAESAR be less than Three Hundred Dollars ($300.00). This provision shall be effective with the first full month’s sales after the Restaurant has opened for business.
The above monthly minimum royalties shall not apply during any periods of time when sales were depressed beyond the level which would generate the stated minimum royalty because of circumstances beyond the control of the Franchise Owner.
In the EM Foods Franchise Agreements the following sentence appears following the last sentence hereinabove quoted:
“This decision shall be made in writing at the sole discretion of LITTLE CAESAR.”
This provision does not, however, appear in the Marshall Franchise Agreement relating to the closed McMinnville restaurant. The language concerning Advertising provides as follows:
XII. ADVERTISING
Recognizing the value of advertising and the importance of standardized advertisements and promotions to further the acceptance and public image of the
LITTLE CAESAR System:
A. Upon request and without charge, LITTLE CAESAR shall provide advertising mats suitable for handbills and newspaper advertising.
B. Subject to Sub-Section C hereof, Franchise Owner will spend not less that 4% per year of gross receipts as defined in Section X.B. for its own local and regional advertising and promotion, on a weekly basis and in no event less than. Three Hundred Fifty Dollars ($350.00) per week, and upon request certify the same to LITTLE CAESAR.
C. LITTLE CAESAR has developed a nationwide co-operative advertising program which is currently administered by LITTLE CAESAR National Advertising Program, Inc., a Michigan corporation (“LCNAP”). LCNAP requires the co-operation of all Franchisees and LITTLE CAESAR requires Franchise owners to participate in LCNAP. Franchise Owner shall therefore contribute an additional nationwide co-operative advertising charge of 3% of Franchise owner’s monthly gross receipts to LCNAP, which charge may be increased at LITTLE CAESAR’s option for any period of time or indefinitely by an additional 1% of monthly gross receipts.
The McMinnville Agreement was amended in 1990 to provide that, like the EM Food Franchise Agreements, Franchise Owners were required to pay 4% of monthly gross receipts in advertising fees:
1. Franchise Owner shall contribute no less than three (3%) percent of monthly gross receipts to LCNAP, which amount may be (for any period of time, indefinitely and/or from time to time), and hereby is, Increased by an additional one (1%) percent of monthly gross receipts to four (4%) percent of monthly gross receipts.
2. The local and regional and co-operative advertising requirements shall be reduced from five (5%) per cent to no less than four (4%) percent of monthly gross receipts. One (1%) percent of said monthly gross receipts shall be spent on local media broadcasting.
3. During any period of time during which the LCNAP contribution is reduced to three (3%) percent of monthly gross receipts, Franchise Owner’s obligation to contribute one (1%) percent toward local media broadcast under Paragraph 2 shall be increased to two (2%) percent of monthly gross receipts. At all time, Franchise Owner may continue to apply one (1%) percent of gross monthly receipts against its local and regional or co-operative obligations.
4. All other terms and conditions of the one or more Franchise Agreements previously signed are hereby ratified and confirmed and shall continue to be in full force and effect except as superseded by this amendment.
XVI. DURATION
Unless sooner terminated as herein provided, this Agreement shall expire 20 years from the date Franchise Owner opens the Restaurant for business, this Agreement is for a Type A Restaurant and 10 years from the date Franchise Owner opens the Restaurant for business if this Agreement is for a Type C Restaurant.
XIX. TERMINATION
A. To the extent allowed by law, this Agreement shall terminate upon 15 days written notice (or such other period as maybe required by law) by LITTLE CAESAR in the event Franchise Owner makes an assignment for the benefit of creditors or if a petition in bankruptcy is filed by Franchise Owner or its creditors whether voluntary or involuntary, or a receiver is appointed, and is not discharged within 60 days, or if Franchise Owner is adjudicated a bankrupt, or if a bill in equity or other proceeding for the appointment of a receiver of Franchise Owner or other custodian of its Restaurant business or assets is filed and consented to by it, or if proceedings for composition with creditors under any state or federal law shall be instituted by or against Franchise Owner, and is not discharged within 60 days, or if the real or personal property owned by Franchise Owner at the Restaurant shall be sold after levy thereunder by any sheriff, marshall or constable, or if the Franchise Owner shall be convicted of any felony, or if Franchise Owner shall be deemed to be in default under this Agreement and all rights granted to Franchise Owner hereunder shall thereupon terminate upon 15 days written notice.
B. LITTLE CAESAR may terminate this Agreement at any time if Franchise Owner:
1. Shall be in default of any lawful provision hereof or any other Franchise Agreement with LITTLE CAESAR, or
2. Shall fail to pay any sum when due to LITTLE CAESAR and/or its affiliated corporations under this Agreement or otherwise, or
3. Shall be in arrears with respect to any indebtedness incurred in connection with its Restaurant and/or is in default under any provision in the lease for the premises where the Restaurant is located
and has failed to cure any such default, excepting those set forth in section XIX(A) above, within 30 days after the receipt of written notice thereof from LITTLE CAESAR (or such other period as may be required by law), and the Franchise Owner shall not have fully remedied such default within that time.
C. Upon termination or expiration of this Agreement, Franchise Owner shall immediately cease to be a licensee of LITTLE CAESAR, and:
I. Franchise Owner shall pay to LITTLE CAESAR all sums owing by it to LITTLE CAESAR and/or its affiliated corporations.
XXVII. CROSS-DEFAULTS:
Any default under this Franchise Agreement between LITTLE CAESAR and Franchise Owner shall constitute a default under any other Franchise Agreement and/or any Franchise Option Agreement(s) between LITTLE CAESAR and this Franchise Owner or with which this Franchise Owner may be affiliated. Upon such a default, LITTLE CAESAR may exercise all available remedies at equity or law.
B. LCE’s Prepetition Claims in the Marshall Enterprise Case
Marshall objected to $1,093.39 of the total $47,303 claim filed by LCE for prepetition debts. In the Marshall case, a confirmed plan is in effect. Under that Plan, Marshall assumed LCE Franchise Agreements for the Cookeville, Crossville, and Oak Ridge Stores, but rejected the McMinnville store.
Section 365 (b) of the Bankruptcy Code states in relevant part as follows:
(b)(1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee. —
(A) cures, or provides adequate assurance that the trustee will promptly cure, such default;
(B) compensates, or provides adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and
(c) provides adequate assurance of future performance under such contract or lease.
II U.S.C. § 365 (b)(1) (Clark Boardman Callaghan, 1995). LCE argues that because the Franchise Agreements were cross-defaulted, in order to cure the defaults in the assumed agreements for Cookeville, Crossville, and Oak Ridge, the Debtor is under an obligation to cure the defaults under the McMinnville Agreement.
Marshall makes two arguments with respect to the Coca-Cola debt and accrued finance charges. First, Marshall asserts that the $442.93 was imposed as late charges on LCNAP advertising fees and is a prepetition claim for unmatured interest as of the date of filing. Accordingly, the unmatured interest claim should be disallowed under § 502 (b)(2). Secondly, Marshall argues that the confirmed plan did not provide for interest to general unsecured creditors, and therefore, the $442.93 should be disallowed. With respect to the Coca-Cola debt, Marshall asserts that through the continued use of Coca Cola products at the remaining franchise locations, this debt will be forgiven by Coca Cola through credits.
I. LCE’s Cross-Default Argument
At least two provisions in the Code preclude LCE’s argument. In the context of § 365, cross-default provisions may be unenforceable for several reasons: (1) the only limitations on the ability to assign and assume leases under § 365 (c), and any contractual restriction on assumption other than those found in § 365 are specifically proscribed by § 365 (f); (2) § 365 (e)(1)(A) renders ineffective any contractual provision conditioned upon the financial condition of the debtor, and the inability to perform under one franchise agreement should not serve as a marker to preclude assumption of another franchise agreement and (3) cross-default provisions may circumvent the limits set by § 502 (b)(7) as to damages LCE may claim for a rejected contract. In other words, a cure of all defaults on all executory contracts as a condition to assumption of any executory contract could put LCE in a position of recovering an amount in excess of that allowed by statute. Inre Sambo’s Restaurant, 24 B.R. 755, 757-58 (Bankr. C.D. Cal. 1982); In reBraniff, Inc. 118 B.R. 819 (Bankr. M.D. Fla. 1990) (cross-default provisions are unenforceable in bankruptcy where provisions restrict debtor’s ability to assume an executory contract); In re SanshoeWorldwide Corp., 139 B.R. 585, 597 (S.D.N.Y. 1992) (contractual limitations on the ability to assign unexpired leases other than those specified in § 365 (c) are prohibited under § 365 (f)); In reWheeling-Pittsburgh Steel Corp., 54 B.R. 772, 779 (Bankr. W.D. Penn. 1985) (cross default provisions would be enforceable where they do not restrict the ability of the debtor to assume and assign).
The Court finds that the cross-default provisions in these Franchise Agreements are unenforceable in that they restrict the ability of the debtor to assume the Cookeville, Crossville and Oak Ridge Agreements. Enforcement of the cross-default provisions would be in contravention of § 365. Accordingly, the cross-default provisions do not give rise to an obligation of the debtor to cure the McMinnville Agreement in order to assume the Cookeville, Crossville and Oak Ridge Agreements.
2. II U.S.C. § 502 and Unmatured Interest
The Debtor argues that the $442.93 should be disallowed as unmatured interest under § 502, and furthermore, that the confirmed plan in the Marshall case did not provide for interest to general unsecured creditors. The Court finds that the $442.93 does amount to post-petition interest on a general unsecured prepetition claim. Accordingly, $442.93 of LCE’s claim for accrued financed charges on the LCNAP advertising fees is disallowed as unmatured interest pursuant to § 502 (b)(2).
3. The Coca-Cola Debt
The Debtor asserts that LCE’s claim for the $650.46 Coca-Cola debt should be disallowed in that it will be “forgiven” for future and continued use of Coca-Cola products at the remaining franchises. LCE argues that it should not be made to wait for application of the credits and should receive immediate repayment. LCE contends that any future credits earned will be credited to Marshall in the form of a check.
The Court agrees that the Debtor is the more appropriate party to await payment of any future credits. LCE is owed the money presently, and regardless of the possibility of future credits, the Court finds that LCE’s $650.46 claim for the Coca-Cola debt should be allowed. When applicable, any future credits earned by continued and future use of Coca-Cola products shall be paid by LCE to the Debtor.
C. LCE’S Claims for Future Royalties Advertising Expenses
1. The End of the Franchise Agreements
On February 10, 1995, LCE sent both Debtors letters stating LCE’s intent to terminate the Franchise Agreements if the Debtors had not cured all defaults within 30 days of the letter. LCE took no further action with respect to termination of the Franchise Agreements. On March 15, 1995, both Debtors, in an effort to stop the termination of the Franchise Agreements, filed Chapter 11 voluntary petitions. At the time of filing, the Franchise Agreements were not yet terminated, and the Debtors must have recognized this fact in filing the petitions and of the later rejection of the Franchise Agreements.
According to the provisions of the Franchise Agreements, LCE was given the right to terminate only after giving written notice to the Franchise Owner. If the Franchise Owner had not cured all outstanding defaults within 30 days of the notice, LCE had the right to terminate. In this case, although the 30 days had passed, LCE had not acted upon its right to terminate at the time the debtors filed the bankruptcy petitions. In other words, the Franchise Agreements were still effective as of the filings, and remained so until rejected by the Debtors.
The Debtors rejected all but the Cookeville, Crossville, and Oak Ridge Franchise Agreements. Notwithstanding any intent to terminate by LCE, the Debtors are the breaching parties, and therefore must now put LCE in as good of a position as it would have been had the Debtors not breached.
2. Damages as a Result of the Rejection
Section 365 (g) states in relevant part as follows:
(g) Except as provided in subsections (h)(2) and (i)(2) of this the rejection of an executory contract or unexpired lease of the debtor constitutes a breach of such contract or lease —
11 U.S.C. § 365. (Clark, Boardman, Callaghan, 1995). The Debtors’ rejection of the Franchise Agreements gave rise to contractual damages pursuant to the Code’s own terms. Accordingly, LCE is entitled to damages as a result of the Debtors’ breach as provided in the Franchise Agreement. The parties differ sharply as to the amount of the contractual damages.
3. The Advertising Fees
The Franchise Agreements provide for the payment by the Franchise Owner to LCE for a national advertising campaign as a percentage of the Franchise Owner’s gross monthly sales. Specifically, the contracts call for the Franchise Owner to contribute 4% of the franchise’s monthly gross sales, as that term is defined in the contract to LCNAP. Monthly gross sales are defined as:
the dollar aggregate of all sale proceeds (whether cash, check, vendor draft, credit instrument, service or deliver [where approved in accordance with this Agreement] charge, or other evidence of receipt) received by the Franchise Owner directly and/or through as agents from Franchise Owner’s operation of the licensed Restaurant and/or generated by the sale of items bearing and/or using the Proprietary Marks, excluding any sales tax.
There is no provision in the contract for how the LCNAP is to be determined in the event that the franchise closes and no gross receipts are generated. LCE argues that it should be based upon the average sales of the last twelve months of actual reported net revenues. Although this basis appears reasonable, there is absolutely no provision in the contract allowing that calculation. The only language dealing with the LCNAP fees owed states that the Franchise Owner must contribute 4% of its monthly gross receipts. In this case, those monthly gross receipts from the date of the closings of the restaurants are zero.
The Court has no choice based on the language of the contract but to deny LCE’s claim for future LCNAP fees in both cases.
4. Future Royalties
The royalty requirements in the Franchise Agreements provide that the Franchise Owner is to contribute 5% of its monthly gross receipts to payment of royalties to LCE. The Agreements also state, however, that in no event, shall royalties be less than $300 per month. The only time that payment of royalties was excused was when sales were depressed beyond the level which would generate the stated minimum royalty because of circumstances beyond the control of the Franchise Owner.”[1]
The Debtors argue that the sales were depressed to the point that the minimum royalties could not be met, and the reasons for this sales depression were due to circumstances beyond the Debtors’ control. LCE argues that it is entitled to the lost future royalties as a result of the Debtors’ breach pursuant to § 365 (g), and that no provision in the law or the parties’ contracts provide otherwise.
LCE claims lost future royalties for the remainder of the term of the contracts for each of the rejected Franchise Agreements. As stated earlier, LCE did not terminate the Franchise Agreements, the Debtors did. Accordingly, LCE is entitled to any damages proximately caused by the Debtors’ breach in order to put itself in as good of a position as it would have been absent the breach. The Court finds that the Franchise Agreements impose obligations on the Debtors to make LCE whole again.
The amount of the damages that LCE is entitled to is equal to the amount of damages which stem directly from the Debtors’ breach. In other words, LCE is entitled to damages as provided in the contract which flow from the Debtors’ breach. LCE calculated the lost future royalties based on the sales figures by taking the last twelve months of reported sales for each franchise, multiplying those figures by the number of months remaining on each franchise, and dividing to get a monthly average. This average was then multiplied by 5% for royalties and reduced to present value by using a factor of 8.25%.
The Court disagrees with this calculation. The proof at trial tended to show that the McMinnville store operated at or below break-even for most of its operation, and that the depressed sales were due to poor location, the influx of competition and general sales declines across the country. LCE never demonstrated to the Court that over the remaining term of the Franchise Agreement that the figures used to calculate its lost future royalties figure were in any way indicative of the future performance of the McMinnville store. In other words, LCE’s figures are too speculative based on the testimony heard at trial about the performance of the McMinnville store and the possibility that the McMinnville store would continue to perform at a level which would fail to produce even the minimum royalty due to circumstances which were beyond the Franchise Owner’s control.
Accordingly, the Court finds that the proper measure of damages for lost future royalties for LCE at the McMinnville location equates to the $300 monthly minimum royalty payment over the remainder of the Franchise agreement reduced to its present value at a factor of 8.25%. The Court therefore finds that LCE has an allowed claim for lost future royalties in the amount of $14,289.00 stemming from the Debtor’s breach of the McMinnville Franchise Agreement.
As for the EM Franchise Agreements, the Court finds, as above, that the proper measure of damages in that case is the $300 monthly minimum royalty payment for the remaining term of the Franchise Agreements reduced to its present value at a factor of 8.25%. Accordingly, LCE’s claim for future lost royalties in the Hebblewhite case is allowed in the amount of $209,463.75[2] as a result of the Debtor’s breach of the EM Foods Franchise Agreements.[3]
IV. Conclusions
Having found that Marshall and Hebblewhite were the breaching parties to the Franchise Agreements, the Court finds it proper to award LCE damages that were proximately caused by the Debtors’ breaches. In the Marshall case, the Court finds that the Debtor’s proposed disallowance of $1,093.39 of LCE’s $47,300.03 prepetition claim is sustained to the extent of $442.93. LCE, therefore has an allowed prepetition claim of $46,857.10. LCE also filed a proof of claim for $45,611.82 representing lost future LCNAP advertising fees and royalties of this $45,611.82, the Court finds that LCE has an allowed claim in the amount of $14,289.00. This figure represents the $300 monthly minimum royalty payment multiplied by the number of months remaining in the Franchise Agreement (44), and calculated to present dollars by a factor of 8.25%. No future advertising fees are awarded to LCE. LCE has a total allowed claim of $61,146.10 in the Marshall case.
In the Hebblewhite case, Debtor objected to the $774,839.88 claim filed by LCE as a result of Hebblewhite’s guaranty of the EM Foods Franchise Agreements. No challenge was made by the Debtor at trial to the following amounts: $19,450.85 for postpetition food and supply purchases; $27,439.12 for accrued postpetition royalties; and $39,188.86 in postpetition advertising fees. Hebblewhite did, however, challenge the $688,761.05 for future royalties and advertising fees. The Court finds that LCE is not entitled to any future LCNAP advertising fees. As far as lost future royalties, the Court finds that LCE is entitled to future royalties of $300 per month for the remainder of the Franchise Agreements at a present value discount of 8.25%. Accordingly, LCE has an allowed claim in the amount of $209,463.75 for lost future royalties, and a total claim in the Hebblewhite case of $295,542.58.
It is therefore so ORDERED.