The Franchise Memorandum

A federal court in New Jersey recently granted Steak n Shake's motion to dismiss a franchisee's fraud and misrepresentation claims in Cornerstone Inv. Partners, LLC v. Steak N Shake Enters., Inc., 2015 U.S. Dist. LEXIS 87533 (D.N.J. July 6, 2015). Steak 'n Shake has traditionally offered franchises for large "Classic" restaurants offering a full menu 24 hours a day. In January 2011, Steak 'n Shake began offering smaller "Signature" restaurants with a more limited menu and hours of operation. Plaintiff Cornerstone and Steak 'n Shake began negotiations for a Signature franchised restaurant in January 2012, approximately two weeks after the Steak 'n Shake's first Signature restaurant had opened. As a result, the FDD provided to Cornerstone contained initial investment information and financial performance representations based on Classic restaurants. Although Cornerstone repeatedly requested cost estimates for the new Signature model, Steak 'n Shake explicitly declined, orally and in writing, to provide it. But, allegedly, Steak 'n Shake orally advised Cornerstone that it could rely on the data associated with Classic restaurants because the Signature model would have lower food and labor costs. After Cornerstone executed a franchise agreement for the newer concept, it began to experience significant operating losses stemming from unexpectedly high costs. Cornerstone later filed a complaint against Steak 'n Shake alleging multiple counts, including fraud and misrepresentation and breach of the duty of good faith and fair dealing, as well as violations of the New Jersey franchise statutes.

In considering Steak 'n Shake's motion to dismiss, the court primarily focused on Cornerstone's fraud and misrepresentation claims, noting that many of the other allegations relied on the same facts and assumptions. To successfully state a claim for New Jersey common law fraud, the plaintiff was required to allege that Steak 'n Shake knowingly made a material misrepresentation with the intention that Cornerstone would rely on it, and that such reliance occurred and resulted in damages suffered by Cornerstone. The court found that although Cornerstone generally alleged that Steak 'n Shake withheld material information regarding certain operating costs, Cornerstone failed to specifically allege how it was misled, or that Steak 'n Shake failed to disclose any information required to have been included in the FDD. The FDD plainly stated that the Signature restaurant was a new concept and that the historical financial representations related to the Classic. In dismissing the good faith and fair dealing claim, the court noted that Cornerstone could not have reasonably relied on the alleged oral representations because the FDD expressly stated that no Steak 'n Shake representative is permitted to make historical cost information representations outside of those provided in Item 19. The court dismissed all of Cornerstone's claims, without prejudice.