Franchise transfer among acquaintances goes wrong

A recent opinion out of the Bankruptcy Court for the Northern District of Ohio highlights the intersection of a number of things that may come to head when a franchise transfer among parties who are friends or acquaintances goes wrong. (In re Conte, Case No. 21-13189, 2022 WL 17968888 (Bankr. N.D. Ohio Dec. 27, 2022)).

The story of an attempted sale of a franchise gone wrong highlights the importance of choosing a reputable business partner when exploring a potential sale of a franchise, and to make sure all background information is truthful and reliable – even if the potential buyer or partner is a friend or acquaintance.

In the case detailed below, the franchise seller thought he was doing a favor by obtaining a waiver of the franchise transfer fee and arranging a special management agreement – but it was for naught. After the Bankruptcy Court’s decision, both parties are now left without a business and the franchise seller is left with an uncollectible judgement against his former business partner.

In 2018, Fadi Bukzam, a franchisee of Giorgio’s Oven Fresh Pizza in Northeast Ohio, offered to sell his franchise to an acquaintance, Ms. Conte, who ran a local coffee shop. Even though Conte had no experience running a pizza restaurant, Bukzam was impressed by Conte’s coffee shop, and agreed to assist Conte with her franchise application once she said she was interested.

Conte provided Bukzam with her financial information, and Bukzam helped Conte prepare a personal financial statement that included details about her and her husband’s car, home, life insurance, business inventory, and cash assets. Bukzam saw Conte’s vehicle and home, but did not verify the other information Conte included on her personal financial statement.

For several months, Conte worked as Bukzam’s employee at the pizza franchise to learn the business, and the parties entered into a management agreement and lease to sell the franchise to Conte, payable in monthly installments. Bukzam, who was good friends with the franchisor of the Giorgio’s Oven Fresh Pizza franchise, obtained a waiver of the $15,000 transfer fee for Conte. The agreement allowed Conte to manage the franchise, but for two years the franchise never earned a profit.

At the end of 2020, Conte notified Bukzam that she was closing the franchise location, and their relationship soured. Conte and Bukzam disputed how many payments were made under the management agreement, but Conte made much less than the required amount of payments. By April 2021, Bukzam and his franchise entity, GBAZ, obtained a judgment against Conte for the unpaid amounts under the management agreement. Conte filed for bankruptcy before Bukzam could execute on the judgment. The assets listed on Conte’s bankruptcy schedules did not conform to what she had claimed on her personal financial statement.

In Conte’s bankruptcy, Bukzam claimed that the judgment he obtained against Conte should be deemed nondischargable because of the allegedly false statements in Conte’s financial statement for her franchise application. The court considered whether the statements Conte made were “materially false,” or whether it “paints a substantially untruthful picture of the debtor’s financial condition.” While Conte testified that Bukzam helped her inflate her financial position to gain franchise approval, the court found that Conte’s misstatements were material.

The court then needed to consider whether Bukzam and GBAZ “reasonably relied” on the information in the financial statement, and whether the Contes provided the financial statement “with the intent to deceive.”  Conte testified that that she repeatedly claimed that she could not purchase the franchise outright, and the court noted that “for the purchase to go through, the Contes needed to show a higher net worth than what they actually had.”

The court found that Bukzam likely knew the figures in the financial statement were false, and that Bukzam entered into the management agreement with Conte because of her “personal attributes rather than her net worth.” Courts also consider whether there was a relationship of trust between the two parties in considering whether reliance on a financial statement was reasonable, and the court noted that Bukzam either “knew the information. . . was false or looked the other way when faced with multiple red flags that should have caused it to investigate further.” Bukzam and GBAZ were unable to satisfy the elements required to show that it reasonably relied on Conte’s misrepresentations in the financial statement, and the debt could not be deemed non-dischargeable.

If you are exploring a similar sale or transfer of your franchise business, make sure you obtain trusted advisors to guide your path.