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SOUTHLAND CORP. v. MIR

September 19, 1990

THE SOUTHLAND CORPORATION, PLAINTIFF,
v.
KHAWAR N. MIR AND AKBAR ALI, DEFENDANTS. THE SOUTHLAND CORPORATION, PLAINTIFF, V. ASIM NASIM, DEFENDANT. THE SOUTHLAND CORPORATION, PLAINTIFF, V. KHAWAR N. MIR AND RUKHSANA K. MIR, DEFENDANTS. KHAWAR N. MIR AND RUKHSANA K. MIR, PLAINTIFFS, V. THE SOUTHLAND CORPORATION, DEFENDANT. KHAWAR N. MIR AND AKBAR ALI, PLAINTIFFS, V. THE SOUTHLAND CORPORATION, DEFENDANT. ASIM NASIM, PLAINTIFF, V. THE SOUTHLAND CORPORATION, DEFENDANT.



The opinion of the court was delivered by: Mishler, District Judge.

MEMORANDUM OF DECISION AND ORDER

The above named defendants are franchisees of 7-ELEVEN convenience stores under franchises granted by The Southland Corporation ("Southland") as follows (the dates indicating the date of the franchise agreement):

  Mir/Ali 355 Boyle Road, Selden, N.Y. September 8,
    1988 for a term of ten (10) years
  Asim Nasim 2140 Motor Parkway, Hauppauge, N Y
    March 31, 1988 for a term of ten (10) years
  Mir/Mir 725 Fulton Street, Farmingdale, N Y
    August 16, 1983, for a term of fifteen (15)
    years.

At the time the franchisees entered into the respective franchise agreements, they entered into security agreements. Southland offered the franchisees advances in order to enable them to purchase inventory required for the operation of the store. To secure the advances, the franchisees gave Southland a security interest in the inventory and in the proceeds of the sale of the inventory.

On April 24, 1990, Southland served each of the franchisees with a notice of termination of their franchise, without opportunity to cure the breach, fixing the termination date as April 27, 1990. Southland filed complaints in the office of the Clerk of this court on April 24, 1990, claiming fraud (Count I), and breach of contract (Count II), and seeking compensatory and punitive damages.

On April 27, 1990, Southland demanded payment of the indebtedness due under the security agreement and in default thereof demanded possession of the inventory and the proceeds resulting from the sale of the inventory.

On April 27, 1990, Southland filed an amended complaint, as of right, adding, inter alia, claims for possession of the inventory based on the security agreement (Count III).*fn1 Southland also moved for an order of seizure against all of the franchisees for the return of the inventory securing Southland's loan and for an order of attachment against Nasim.

On April 26, 1990, and April 27, 1990, the franchisees brought four separate actions in the New York State Supreme Court (the "State Court Actions") claiming a threatened violation of their franchise rights based upon a claimed ineffective notice of termination. The franchisees moved for a preliminary injunction by order to show cause which contained temporary restraining orders enjoining Southland from terminating the franchises. Southland removed the State Court Actions to this court.

We are presented with Southland's motion for orders of seizure and the franchisees' motions to preliminarily enjoin termination of the franchise agreements. On May 2, 18, 30 and 31, 1990, and June 8, 1990, the court conducted a hearing on the motions.*fn2

The parties agree that the following facts are not in dispute:*fn3

1. Southland is a Texas corporation with its principal place of business in Dallas, Texas. Second Amended Complaint ("Complaint"), ¶ 1. Southland maintains an office in the Eastern District of New York at 732 Smithtown Bypass, Smithtown, New York 11787. Id.

2. Southland operates and franchises the nationwide 7-ELEVEN retail chain of convenience stores. At present, there are some 6,900 stores in the nationwide 7-ELEVEN system, some 3,400 of which are operated directly by Southland, and about 3,500 of which are operated by individuals under franchises granted by Southland.

3. Southland is the plaintiff in four separate, but related,*fn4 actions, each of which was commenced by the filing of a complaint on April 24, 1990. Each of the four sets of defendants, three above named and Jameel Bukhari, operated a franchise in Nassau or Suffolk County on Long Island, New York.

4. The complaints filed April 24, 1990 asserted systematic fraud perpetrated against Southland by defendants through the improper use of money orders that was designed to misrepresent and conceal store revenues and to deprive Southland of its contractual share of profits of the stores.

5. Defendants Akbar Ali ("Ali") and Khawar N. Mir ("Mir") are both residents of the State of New York. Ali resides at 1028 N. Hamilton Avenue, Lindenhurst, New York 11758, and Mir resides at 18 Barbara Lane, Farmingdale, New York 11735.

6. Ali and Mir are defendants in CV 90-1375. Ali and Mir have been franchised to operate a 7-ELEVEN store (No. 2423-16299) located at 355 Boyle Road, Selden, New York 11784, pursuant to a store franchise agreement dated September 8, 1988.

7. Mir and his wife, Rukhsana K. Mir (the "Mirs"), also have been franchised to operate a 7-ELEVEN store (No. 2422-23862) located at 725 Fulton Street, Farmingdale, New York 11735, pursuant to a store franchise agreement dated August 16, 1983.

8. Asim Nasim ("Nasim"), defendant in CV 90-1377, resides at 320 Nassau Road, Apartment 1E, Huntington, New York 11743. Nasim has been franchised to operate a 7-ELEVEN store (No. 2423-16050) located at 2140 Motor Parkway, Hauppauge, New York 11787, pursuant to a store franchise agreement dated March 31, 1988.

9. Jameel Bukhari ("Bukhari"), defendant in CV 90-1378, resides at 24 Thomas Drive, Hauppauge, New York 11788. Bukhari has been franchised to operate a 7-ELEVEN store (No. 2423-11211) located at 722 Townline Road, Hauppauge, New York 11787, pursuant to a store franchise agreement dated September 26, 1988.

10. The four franchised stores that are the subject of these actions are situated in two of the three markets that comprise the New York Division of Southland. One of such markets encompasses that part of Long Island lying roughly west of the Sagtikos Expressway, much of which is in Nassau County. There are sixty-seven 7-ELEVEN stores in that market including the one operated by the Mirs in Farmingdale. Gary Padilla ("Padilla") is the Nassau Market Manager.

11. The other market at issue encompasses that part of Long Island lying roughly east of the Sagtikos Expressway, all of which is in Suffolk County. There are seventy-two 7-ELEVEN stores in that market, including the other three operated by the defendants here. The Suffolk Market Manager is Robert S. Cadigan ("Cadigan").

12. The amount of damages sought by Southland, plus the value of the personal and real property which it seeks to recover, in each of the actions, exceeds $50,000, exclusive of interest and costs.

13. On April 26, 1990, and April 27, 1990, the franchisees commenced the State Court Actions seeking preliminary injunctions against termination of the franchise agreements, and in each case, a temporary stay was obtained ex parte.

14. On April 27, 1990, and April 30, 1990, the State Court Actions were removed to this court. On April 27, 1990, Southland also filed, as of right, an amended complaint and filed applications for orders of seizure (replevin) against all of the franchisees for the return of the inventory securing Southland's loan and for an order of attachment against Nasim.

15. On May 2, 18, 30, and 31, 1990, and June 8, 1990, an evidentiary hearing was conducted on (a) the applications of the franchisees for preliminary injunctions against termination of their respective store franchise agreements and (b) Southland's applications for an order of seizure (replevin) and an order of attachment.

16. On May 17, 1990, Southland issued and delivered to each of the franchisees between two and four discrete notices of termination of each of the respective store franchise agreements encompassing the following:

  (i) failure to report merchandise inventory cash
  purchases;
  (ii) failure to report merchandise purchases cash
  rebates;
  (iii) failure to record or report lottery ticket
  sales, with a resulting improper reduction in
  merchandise sales;
  (iv) failure to record or report lottery
  commissions income; and
  (v) failure to record or report amusement games
  income.

17. On May 21, 1990, Southland moved by Order to Show Cause to further amend its complaint. On May 30, 1990, the Court granted Southland's motion, Southland's second amended complaint was deemed served as of such date, and proof was received concerning the events described in the May 17, 1990 notices of termination.

The 7-ELEVEN Franchising System

18. Southland's essential financial interest is in receiving a percentage of the Gross Profit (Net Sales less Cost of Goods Sold) derived from operation of a franchised store, which percentage is designated in the store franchise agreement as the 7-ELEVEN Charge. The Net Income in which the franchisee has the sole interest is the amount remaining after deducting Operating Expenses (such as payroll and similar expenses) and the 7-ELEVEN Charge from the Gross Profit. Operating Expenses do not include store repairs, replacement of equipment, insurance, real property taxes, any rental charge, electricity, heat or other utility costs, all of which are borne by Southland.

19. In addition to providing the franchisee with a store ready to be operated, bookkeeping services and Southland's extensive expertise relating to successful operation of 7-ELEVEN stores, Southland, if a franchisee so requests, also finances the operation of the store under the terms of the store franchise agreement. Although franchisees are free to obtain their own financing, most franchisees, including defendants, utilize Southland's offer to finance the franchisee's operation. To secure the obligation owed to Southland under such financing, a franchisee, as the defendants herein have done, grants Southland a security interest in the franchisee's inventory and proceeds thereof.

20. Prior to the opening of a store, the franchisee purchases an initial inventory, with the franchisee paying only part of the purchase price for the initial inventory and Southland financing the balance. The amount financed by Southland and owed by the franchisee to Southland is maintained in an account known as the Open Account. Subsequent purchases, expenses and revenues flow through the Open Account. Essentially, the Open Account is a running working capital account which reflects the cash operation of the store. The balance of the Open Account at any point in time represents that amount of money which Southland has loaned or advanced to the franchisee to finance the operation of the 7-ELEVEN store.

21. After operation of a store commences, the franchisee is obligated to ring up accurately, on a cash register provided by Southland, all sales of merchandise (with those transactions that are subject to sales tax and those that are not being separately identified), money orders, cigarettes, lottery tickets, and other sales; cash payments to vendors and casual labor, and other cash transactions. In the two Markets in which the defendants' stores are situated, the franchised stores use cash registers manufactured by Norand*fn5; they have separate keys for taxable sales, nontaxable sales, money orders, cigarettes, lottery tickets, etc. To ring up a sale, the amount of each item is entered on the register and the appropriate key is depressed. This in turn registers the amount of each sale. The cash register automatically maintains a running total for all entries on each key and prints out a summary tape of those totals as part of the daily reporting a franchisee is required to make to Southland.

22. A franchisee also is required to deposit on a daily basis the cash received from each day's operation of the store. These deposits are made to a bank account designated by Southland and Southland credits the franchisee for the deposits in reduction of the outstanding balance of the Open Account.

23. The franchisee is required to furnish Southland with a daily Cash Report indicating the amount of sales for the day, the amount of cash deposited and any additions or deductions to or from cash that affects the daily deposit. A tape from the cash register that summarizes, by categories of its various keys, the day's entries into it, and tissue copies of all money orders issued by the store during the day being reported, are required to be attached to the Cash Report. Money orders bear consecutive serial numbers, and the tissue copies therefore allow Southland to account for all of them, avoiding loss from theft, non-reporting, etc. The tissue copy does not show the payee of the money order because the payee is filled in by the purchasers after purchase of the money order. The tissue copy does, however, show the dollar amount of the money order issued.

24. It is from the cash register summary tape that much of the information required for the Cash Report is derived. After the cash register summary tape is printed out, the register's various subcategories of information (other than a running grand total of all sales) are "zeroed out," so that the next day's summary tape will reflect only that day's transactions.

25. The daily Cash Report is prepared and signed by the franchisee, or one of the franchisee's trusted employees or other agents, and is the only device used to report daily sales.*fn6 It is at the heart of the Southland accounting system. When it is received by Southland's accounting department, information from it is entered into the accounting records maintained by Southland on computer. Although the tissue copies of all money orders issued are routinely reviewed to assure that all money order issuances are reported, the cash register summary tape, which generally is received folded up and stapled to the back of the Cash Report, is not routinely compared with the Cash Report to assure that numbers have been accurately transcribed onto the Cash Report.

27. Southland prepares monthly financial statements for each store from Southland's bookkeeping records and from information supplied by the franchisee, particularly the store's daily Cash Reports. The monthly financial statements include a profit and loss statement for the month and an updated balance sheet for the store, as well as comparative information from prior periods or cumulative information for the year to date. Based on these financial reports the 7-ELEVEN Charge, through which Southland receives its share of the Gross Profits of the store, is calculated. The financial reports also update the outstanding balance of the Open Account.

28. Southland operates what is known as a retail method of inventory accounting system. When a 7-ELEVEN store commences operations, a physical count of all inventory is made and the inventory is valued "at retail," i.e., at the retail selling price of each item of inventory. The retail selling prices are determined by the franchisee, who reports them to Southland for accounting purposes; Southland must rely on the franchisee's honesty in reporting to Southland the retail selling prices. This Opening Inventory is the initial balance in the Retail Book Inventory maintained in the store's accounting records by Southland. When a franchisee purchases merchandise for a store, the invoice, bill or statement is transmitted to Southland together with the value of the purchased merchandise at retail (again, Southland must rely on the honesty of its franchisee in this retail valuation). Southland then increases Retail Book Inventory by the retail value of the merchandise purchased. Sales of merchandise to customers of the store reduce its Retail Book Inventory. Although the first entry on the daily Cash Report for a store is the gross amount of sales for the day, that number is actually a calculated number derived last from the other reported categories of cash transactions. Southland charges the gross amount of sales against Retail Book Inventory on the store's accounting records. Because of the large variety of items carried by a 7-ELEVEN store, it is not practicable to keep a running count, by computer or otherwise, of each kind of item sold. Thus, the accounting system must rely upon the integrity of the amounts and categories of sales reported by each store on its daily Cash Reports.

29. To maintain the Retail Book Inventory as an accurate figure for the inventory that actually is present in a store, periodic physical counts of the inventory present in a store are taken and any variance becomes an adjustment to the Retail Book Inventory accounting record. Variances can arise from any one or more of a number of factors. Thefts by customers or employees, the taking of merchandise by a franchisee for personal use, and sales of merchandise that are not rung up on the cash register are some of the factors that can lead to variances that cause Inventory Shortages, i.e., physical counts showing that less inventory actually is present than is shown on the accounting records for the Retail Book Inventory.

The Relevant Provisions of the Store Franchise Agreement

31. Defendants are required by the store franchise agreement to:

  prepare and furnish to 7-ELEVEN, on forms and at
  times acceptable to and as requested by 7-ELEVEN:
  (i) daily summaries of Purchases; (ii) daily
  reports of Receipts. . . . FRANCHISEE also shall
  deliver or furnish to 7-ELEVEN copies of . . .
  invoices for Purchases. . . . (¶ 10).

The requirement regarding summaries of Purchases is encompassed by the Receiving and Inventory Transactions Report and the requirement regarding reports of Receipts is encompassed by the Cash Report. The store franchise agreement contains, at page 4 of Exhibit E to it, the following definitions:

  `Purchases' means all of FRANCHISEE's purchases
  of merchandise for sale from the Store.
  `Receipts' means all sales proceeds (whether
  cash, check, vendor draft, credit instrument, or
  other evidence of receipt), [or] money order
  revenues . . . received by FRANCHISEE . . . from
  FRANCHISEE's operation of the Store.

Under the heading "Franchisee's Additional Covenants," the store franchise agreement provides:

  FRANCHISEE shall: . . . (v) cause all sales of
  Inventory to be properly recorded at the time of
  sale at the retail prices set ...

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