United States District Court, Northern District of Illinois, Eastern Division
April 9, 2003
DUNKIN' DONUTS INCORPORATED, PLAINTIFF,
N.A.S.T., INC., ET AL., DEFENDANTS.
The opinion of the court was delivered by: Milton I. Shadur, Senior United States District Judge
MEMORANDUM OPINION AND ODER
This action began with a Complaint by Dunkin' Donuts Incorporated ("Dunkin'") against four defendants (N.A.S.T., Inc., SK Donuts, Inc., Sunny Cherian and Robert Stambolic), based on their asserted fraud, breach of contract and trademark infringement in connection with the operation of several Dunkin' franchises in Illinois and Wisconsin (federal jurisdiction was properly invoked on diversity of citizenship grounds). Along the way Cherian and N.A.S.T. (purely for convenience collectively referred here to as "Cherian," treated as a personified singular male noun) advanced several counterclaims, including claims stemming from Dunkin's allegedly improper use of the Advertising Fund ("Fund") provided for in the parties' Franchise Agreements ("Agreements").
After Dunkin' filed a motion for partial summary judgment attacking some of those counterclaims, Cherian responded in part by dropping (1) the counterclaims asserting negligence, unjust enrichment and conversion and (2) any possible claims arising from a breach of fiduciary duty (C. Mem. 8 n. 4). That has left for current resolution Cherian's Fund-related counterclaims that charge Dunkin' with breaches of contract and of the covenant of good faith and fair dealing. For the reasons set forth in this memorandum opinion and order, most of Dunkin's effort to obtain a partial summary judgment is successful, although a minor part may have to be deferred pending further discovery.
Rule 56 Principles
Rule 56 principles impose on movant Dunkin' the burden of establishing the lack of a genuine issue of material fact (Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986)). For that purpose this Court must "consider the evidentiary record in the light most favorable to the non-moving party . . . and draw all reasonable inferences in his favor" (Lesch v. Crown Cork & Seal Co., 282 F.3d 619, 625 (7th Cir. 2002) has echoed the teaching of Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986):
A genuine issue of triable fact exists only if "the
evidence is such that a reasonable jury could return
a verdict for the nonmoving party."
As with any summary judgment motion, this Court accepts nonmovant Cherian's version of any disputed facts, but only so long as it is supported by record evidence. What follows is drawn form the parties' submissions when viewed from that perspective.*fn1
Cherian and Dunkin' entered into the Agreements (Exs. 2B, 2C and 2D to D. Compel Mem.) that set out numerous obligations for both parties. For one thing, all Dunkin' franchisees, (including Cherian) must pay 5% of gross sales into the Fund managed by Dunkin (C. St. ¶ 4). Agreement § 3E (C. St. ¶ 40) obligates Dunkin':
[t]o administer The DUNKIN' DONUTS Franchise Owners
Advertising and Sales Promotion Fund (the "Fund") and to
direct the development of all advertising and
promotional programs. One-fifth of FRANCHISEE's 5%
advertising contribution (1% of the GROSS SALES of the
SHOP) will be utilized, at the discretion of DUNKIN'
DONUTS, to provide for the administrative expenses of
the Fund and for programs designed to increase sales and
enhance and further develop the public reputation and
image of DUNKIN' DONUTS and the DUNKIN' DONUTS SYSTEM.
The balance, including any interest earned by the Fund,
will be used for advertising and related expenses.
Contributions to the Fund in excess of 5% of GROSS SALES
shall be used in accordance with the programs to which
they relate. The content of all advertising, as well as
the media in which the advertising is to be placed and
the advertising area, shall be at the discretion of
DUNKIN' DONUTS. Upon request, DUNKIN' DONUTS will
provide FRANCHISEE a statement of receipts and
disbursements of the Fund, prepared by an independent
certified public accountant, for each fiscal year of the
Fund. . . .
Ernst & Young performs an annual independent audit of the Fund (D. St. ¶ 15) "in accordance with generally accepted accounting principles" (C. Ex. A at 6). According to the audit report for fiscal year 2000, Dunkin' received $116,574,786 from advertising fee contributions from franchisees across the nation (C. Ex. A at 4), of which amount $23,051,432 was allocated to the Indirect Fund used for administrative expenses (C. Ex. A at 13). In 1999 Dunkin' received $107,535,790 from advertising fee contributions (C. Ex. A at 4), of which sum $21,124,139 was allocated to the Indirect Fund.
To return to the 2000 year, Cherian claims that instead of the amount of administrative expenses as identified by Ernst & Young, the total cash outlays for administrative expenses in that year ($24,631,214) should have been the numerator in determining whether the one-fifth limitation on such expenses in Agreement § 3E had been exceeded (C. Mem. 3-4). Moreover, Cherian notes three categories of expenses (Events/Training Expenses, Market Development Expenses and Miscellaneous Expenses) that Ernst & Young categorized as advertising or related expenses, but that Cherian claims should instead be labeled administrative expenses (C. Mem. 4)
Additionally, the Ernst & Young 2000 audit report classified numerous expenditures — including cross-functional employees, rent, accounting services, data processing services and other operating expenses — as being allocated between the Fund and Dunkin' (D. St. ¶ 17). Cherian claims that those were improperly expensed (C. Mem. 6). Cherian also claims that Dunkin' received settlement payments from franchisees but failed to allocate the appropriate portion of those payments to the Fund (C. Mem. 6-7).
Cherian also asserts that Dunkin' improperly failed to return excess payments for field marketing expenses (C. Mem. 5). Ernst & Young's audit partner Larry Davidson ("Davidson") explained how those expenses are calculated (D. Ex. 3 ¶ 7):
In the beginning of each fiscal year, Dunkin' Donuts
estimates the amount of administrative expenses that
will be spent on the Advertising Fund for the upcoming
fiscal year. At the end of each fiscal year, Dunkin'
Donuts compares the amount budgeted for the Advertising
Fund with the amount of money actually spent. If the
amount budgeted for the Advertising Fund exceeds the
amount spent, and it is de minimis, it is deemed
immaterial in accordance with normal accounting
practices. If the amount budgeted for the Advertising
Fund exceeds the amount spent, and it is not de minimis,
monies are rebated to the Advertising Fund. Ernst &
Young verifies these expenditures in its audit of the
According to Davidson, even though Dunkin's budget overestimated field marketing expenses by approximately $86,000 in 2000, that amount was "deemed immaterial by accounting standards in light of the total expenditures of the Fund" (D. Ex. 3 ¶ 8). In 1999, when Dunkin' overestimated the same expenditures by an amount that Ernst & Young deemed material, approximately $200,000 was returned to the Fund (id.). In that respect Cherian claims that Dunkin's overestimate came to $500,000, so that it improperly retained $300,000 from the field marketing expenses (C. Mem. 5).
Allied Domecq QSR ("Allied Domecq") is an unincorporated association affiliated with Dunkin' Donuts, Baskin-Robbins and Togo's (C. Mem. 6). Allied Domecq and those three brands entered into a distributorship agreement with Pepsico that provided a $1. million rebate to Togo's Advertising Fund (C. Mem. 6). Dunkin' has a Marketing Operating Philosophy document ("Operating Philosophy") that addresses such supplier rebates (Valas Aff. Ex. B at DDI 2517):
Should any or all of Allied Domecq QSRs brands enter
into a contract that provides for a rebate for
product/supplies used in all of our Allied Domecq QSR's
brands franchised retail stores, the income will be
split proportionally among all brands, based on the
conditions of the rebate, and will be applied to each
brand's respective Advertising Funds.
In this instance no contribution was made to the Dunkin' Advertising Fund, and no proportionate split among the brands was made (C. Mem. 6).
Choice of Law
Generally a federal district court sitting in diversity must follow the choice of law rules of the state in which it sits (Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496-97 (1941)). But in this case all of the Agreements have a choice of law provision that designates Massachusetts law as applicable to disputes between the franchisor and franchisee (Ex. lB ¶ 16A, Ex. 1C ¶ 16A and Ex. 1D. ¶ 16A to D. Compel Mem.), and each side has agreed to that designation law (C. Mem. 7, D. Mem. 5-6 & n. 3). This opinion therefore looks to substantive Massachusetts law.
Request for Additional Discovery
Cherian has asked this Court to delay decision on summary judgment until he has had the opportunity to acquire more information through the discovery process (C. Mem. 1). According to Request No. 45 of Cherian's First Request for the Production of Documents (quoted at C. Compel Mem. 2), Cherian sought:
All documents showing in full and complete detail all
expenses paid by Dunkin' Donuts, Inc. with franchisee
advertising funds, including all documents showing or
describing how each such expense was related to
advertising or designed to increase franchise sales,
from 1996 to date.
In response Dunkin' produced only the Fund audit summaries by Ernst & Young and the Operating Philosophy document — it did not produce, for example, its advertising expense ledgers. Cherian then filed its Motion To Compel the production of the expense ledgers that Dunkin' maintains for its receipts and expenditures from the Fund (C. Compel Mem. 1), supported primarily by the affidavit of Cherian's attorney Rory Valas ("Valas"). Apparently having made somewhat of a career of representing franchisees against Dunkin', Valas asserts that further discovery will allow Cherian to find specific facts sufficient to withstand summary judgment.
This court had delayed ruling on that motion to compel in anticipation of the prospect that some of Cherian's counterclaims could be decided as matters of law. And as hereafter reflected in this opinion, almost all of them can be and are decided in that fashion. Just one of them poses potential questions of fact that would preclude summary judgment if Cherian can find evidence along one of the lines adverted to in Valas' affidavit, which tries to paint a picture of Dunkin's assertedly rampant Fund-related violations. Because Cherian provides no other supporting information to back up Valas' claims, this opinion must consider the effect to be ascribed to Valas' statements as well as Dunkin's right to be protected from unnecessary and burdensome discovery.
As explained later, Cherian will be allowed to proceed with discovery of the Fund expense ledgers for inquiry into a single area. But because of "the aphorism that discovery is not to be used as a fishing expedition" (EEOC v, Harvey L. Walner & Assocs., 91 F.3d 963, 971 (7th Cir. 1996), if it develops that such further discovery fails to corroborate Valas' conclusory affidavit, Cherian will be obligated to reimburse Dunkin' for all of its costs and expenses in producing the further discovery.
Allegedly Excessive Administrative Expenses
Cherian claims that Dunkin spent more of the Fund on administrative expenses than the one-fifth allowed by Agreement § 3E (C. Mem. 4). To succeed on such a breach of contract claim under Massachusetts law, Cherian must demonstrate (1) that the parties reached a valid and binding agreement, (2) that Dunkin' breached the terms of the agreement and (3) that Cherian suffered damages from the breach (Michelson v. Digital Fin. Serve., 167 F.3d 715, 720 (1st Cir. 1999)). Analysis reveals that to this point Cherian strikes out on all of his attempts to show how Dunkin' assertedly breached the terms of the Agreements — but while almost all of those shortfalls stem from failures of law, one of them represents a possibly legitimate need to obtain added facts that could perhaps be acquired through further discovery.
First Cherian points to the $24,631,214 identified in the Ernst & Young annual report for 2000 as "total Advertising Expenses" as assertedly representing the amount designated in Agreement § 3E as "franchisee advertising contributions" (C. Mem. 3-4). But according to the Ernst & Young audit, the proper number to be attached to that label is the $23,051,432 listed as "Advertising fee contributions" under the Revenues side (C. Ex. A at 13). That latter figure brings the percentage of the total franchisee advertising contributions used on administrative expenses to 19.77%, just below the one-fifth allowed by Agreement § 3E.
Cherian seems to be arguing that the accounting in that respect should be determined on a cash expenditure basis rather than on the allocation basis employed by Ernst & Young. But that contention has to be a nonstarter, because the certification of the allocation method by an independent accounting firm cannot be challenged as impermissible simply on Cherian's (or Valas') say-so.*fn2 That is after all why an independent evaluation is sought in the first place, and Cherian will not be heard to call for a different methodology just because he prefers the answer it would provide.
Cherian's next contention is that certain items categorized as advertising expenses for Fund purposes do not fit under that rubric (C. Mem. 4). Specifically Cherian identifies "Events/Training Expenses," "Market Development Expenses" and "Miscellaneous Expenses" as expenditures that he claims "any reasonable person would categorize as administrative expenses, not advertising expenses" (C. Mem. 4). Allocation of any one of those items to administrative expenses would bring that category over the 20% limit allowed by Agreement § 3E.
But here too the classifications have been made by independent auditor Ernst & Young, which places "Events/ Training Expenses," "Market Development Expenses" and "Miscellaneous Expenses" under the Expenses of the Fund (C. Ex. A at 11). According to Ernst & Young the total Expenses of the Fund (including those specific items) fall within the definition of "Advertising Costs" (C. Ex. A at 7).
Against that, Cherian's attempted reliance on a hypothetical "reasonable person" to illegitimatize those items as advertising expenses (C. Mem. 4) falls flat. Cherian's citation of the affidavit by attorney Valas (who is scarcely a Fed.R.Evid. 702 expert on the subject) does not suffice to create a genuine issue of material fact as against the Ernst & Young audit report. Cherian's request for further investigation is no better than a quest to see if he can turn up some factual basis for his claim, and it must be and is rejected under the circumstances.
Cherian's third argument is that advertising expenses were used "to pay for supposed cross-functional employees and other employees who had little, if any, involvement with advertising or marketing and whose primary, if not sole, responsibility was over operational issues" (C. Mem. 6). Once again that runs into the wall of the independent audit:
Ernst & Young analyzed the impact of cross-functional employees and approved the manner and extent to which "certain expenses related to payroll, market research, professional fees, travel, office supplies, public relations, equipment rental, utilities, depreciation and other miscellaneous charges were allocated" (D. St. ¶ 17). In response Cherian attempts to point to Valas Aff. ¶ 32, but that simply states a different view without evidentiary support. Again Cherian fails to meet the Rule 56 requirement of identifying a bona fide factual issue.
Cherian may or may not fare better as to his fourth contention, which asserts that "Dunkin' improperly expensed operational expenses through the Fund including various costs of its regional offices, such as rent, office supplies, and automobile expenses" (C. Mem. 6). Ernst & Young audited those expenditures and found that "[o]ther expenditures are similarly paid in accordance with their use by the Fund: "The Fund is also charged for rent, accounting services, data processing and other operating expenses by Dunkin' Donuts, Inc."' (D. Ex. A ¶ 6), but Valas Aff. ¶ 31. refers to Dunkin' documents that purportedly support Cherian's position. Because that speaks of (without however naming) documents that are assertedly known to Valas, Cherian will be required to supplement that statement with an identification of such documents within 14 days after the issuance of this opinion — and if that can be done, further discovery will be allowed to pinpoint any genuine issue of material fact on that score.
In his fifth attempt to establish an abuse of the Fund, Cherian claims that Dunkin' received settlement payments from franchisees for their failures to pay advertising fees, but it failed to meet a purported requirement to place a portion of those funds into the Fund (C. Mem. 6-7). But having made that claim, Cherian has not identified any source of a legal obligation on Dunkin's part to put such settlement amounts into the Fund. Tellingly, Cherian failed even to mention that claim in his Amended Complaint. No discovery to fish out information on the topic will be permitted.
Field Marketing Expenses
Cherian's next attempt to show a breach of contract by Dunkin' asserts that it unlawfully retained Fund money allocated to field marketing expenses (C. Mem. 5). On that score Cherian argues that while Dunkin' received from the Fund, as the estimated expenses for that purpose, $4 million in 2000 and $3.8 million in 1999, it failed to spend those entire amounts on acceptable marketing expenses. As stated earlier, Cherian claims that Dunkin' improperly retained portions of the field marketing expenses totaling $86,000 in 2000 and $300,000 in 1999 (C. Mem. 5)
But Ernst & Young's Davidson has responded directly to that by stating that Cherian's claim "is not accurate" (D. Ex. 3 ¶ 7). Davidson continues (id. ¶ 8):
In 2000, Dunkin' Donuts overestimated the field
marketing expenses of the Advertising Fund by
approximately $86,000. This amount was deemed
immaterial by accounting standards in light of the total
expenditures of the Advertising Fund. In 1999, Dunkin'
Donuts overestimated the expenses of the Advertising
Fund. This amount was deemed material and approximately
$200,000 was reallocated to the Advertising Fund.
Again Valas Aff. ¶ ¶¶ 20-22, which simply recite the same numbers together with an added assertion that the $200,000 reallocation in 1999 was the result of a $500,000 overestimate of which Dunkin' kept the $300,000 balance (id. ¶ 22),*fn3
do not really address the relevant issue: What does GAAP call for in such a situation? In that respect Ernst & Young has expressly certified that the audit was conducted "in accordance with generally accepted auditing standards" (D. Ex. 3A at DDI 2279). With Cherian not having put that determination in issue (something that would not be dependent More is said on this subject in the next paragraph of on discovery, but is rather a function of audit principles), his claim fails in Rule 56 terms.
Before this opinion moves to the next topic, however, a further word should be said about Valas Aff. ¶ 22, which adverts to an initial $500,000 overestimate in Field Marketing Expenses for 1999 — a figure that does not appear in any of the Dunkin' documents in this case. Dunkin' suggests that the only potential source for such an assertion would appear to be a prohibited one — documents from the dismissed action in Dunkin' Donuts v. Curcio, NO. 01 C 5687 (M.D. Ill.) that were restricted from disclosure by the September 3, 2000 dismissal order in that case. In that respect, this Court's January 8, 2003 oral ruling denied Cherian's request to use documents obtained in the Curcio case because Cherian's counsel Valas could not affirmatively show that the documents would have become known if he had not been involved in the Curcio case. Some further explanation by Valas is necessary — and promptly.
Distribution of Marketing Rebate
Cherian next claims that Dunkin's sister brand Togo's received a $1 million rebate from a marketing agreement with Pepsico that should have been split proportionately among Togo' s, Dunkin' Donuts and Baskin-Robbins (C. Mem. 6). Here too Cherian seeks to rely primarily on Valas' unsupported affidavit for support, but that deficiency need not be explored further because Cherian's counterclaim lacks any foundation to begin with. Simply put, because Cherian and Dunkin' never reached an agreement as to the distribution of rebate funds, Cherian (and other Dunkin' franchisees as well) have no right to share in the supplier's rebate.
Cherian attempts to argue that Dunkin's earlier-quoted Operating Philosophy provides the operative terms as to supplier rebates (C. St. ¶ 20). But that document is not a contract between Dunkin and Cherian (indeed, it is not a contractual undertaking on Dunkin's part at all). Instead the Operating Philosophy itself expressly specifies that "[i]t is not intended to supersede or take the place of any terms contained in the franchise Agreement or any other agreements the Franchisee has with Dunkin' Donuts Incorporated and/or its affiliate companies" (Valas Aff. Ex. B at DDI 2514)
Finally (and really conclusively), nowhere do the Agreements make any reference at all to any such document. To the contrary, the Agreements contain an explicit and typical integration clause that says the Agreements "and the documents referred to herein shall be entire, full and complete agreement" between Dunkin' and Cherian (D. St. ¶ l4A). In sum, Cherian simply has no right to sue for a claimed violation of the Operating Philosophy.*fn4
Fair Franchising Standards
Still another instance of a groundless claim by Cherian is provided by its current assertion that Dunkin' breached its contract by violating certain of The American Association of Franchisees and Dealers Fair Franchising Standards ("Association"). Even apart from the troubling (if not indeed dispositive) fact that there is no hint of such a claim mentioned in Cherian's counterclaims, it is fundamental that Dunkin's duties to Cherian are defined by the Agreements, not by some set of guidelines proposed by an outside organization. With Cherian and Dunkin' having entered into a detailed and integrated document such as the Agreement, its provisions cannot be trumped (or modified) by such external criteria as the standards of the Association.
Covenant of Good Faith and Fair Dealing
Cherian next advances an asserted breach by Dunkin' of the covenant of good faith and fair dealing. Massachusetts law implies such a covenant in every commercial contract, even those between sophisticated businesspeople (Anthony's Pier Four. Inc. v. HBC Assocs., 583 N.E.2d 806, 821 (Mass. 1991)). That requires contracting parties to deal with each other honestly and in good faith, not only in their performance of the contract but also in their enforcement of the contract terms (Hawthorne's. Inc. v. Warrenton Realty, Inc., 606 N.E.2d 908, 914 (Mass. 1993)).
Dunkin' moves for partial summary judgment on that aspect of Cherian's counterclaims as well. In opposition, Cherian recites the same arguments and the same unsupported Valas affidavit that have already been discussed in the breach of contract section of this opinion.
What has been said in that section controls here as well. Nothing in Cherian's submission suggests that any areas in which Dunkin' has fulfilled its contractual obligations are somehow tainted by its not having treated Cherian honestly and in good faith in doing so. To the extent then that Cherian's breach of contract claims fail as a matter of law, they must succumb in terms of the implied covenant as well. By the same token, as to the one area in which Cherian has properly identified a potential question of material fact that warrants further discovery, that will apply to both types of claims of Dunkin's asserted breach: contractual and implied.
Finally Cherian requests "entry of an injunction which would require Dunkin' to disgorge itself and to return to the Advertising Fund all amounts unlawfully taken from the Advertising Fund and to use those funds for advertising and marketing" (C. Mem. 14). That must obviously be denied for now, subject to potential future consideration if Cherian is ultimately found to be entitled to some relief.
For by far the most part Dunkin' has shown its entitlement to a partial summary judgment, although one limited area may remain open for possible further factual development. As the prevailing party in almost all respects, Dunkin' will be expected promptly to tender a proposed form of order that embodies the holdings in this opinion (and of course to provide a copy of that proposed order to Cherian for its comments as well). In that regard Dunkin's counsel should consider whether there is any room for a possible Rule 54(b) determination at this point (though that may seem doubtful in light of the limited possible discovery contemplated here).
Lastly, because Cherian's counterclaims have not yet been fully resolved, counsel should be mindful of the Supreme Court's teaching in Curtiss — Wright Corp. v. General Electric Corp., 446 U.S. 1, 8, 10-11 (1980) if at a future point Dunkin' were to prove successful on its own claims while Cherian's counterclaims still remained short of a final resolution. In that event, consideration of the possible propriety of a Rule 54(b) determination would be appropriate.