The opinion of the court was delivered by: Seybert, District Judge.
Pending before the Court are the objections of Plaintiff, The
Southland Corporation ("Southland"), to the February 26, 1998
Report and Recommendation of Magistrate Judge Viktor V.
Pohorelsky. The Report recommended that this Court deny both
Southland's motion for a preliminary injunction, and Defendant
Richard Froelich's ("Froelich") motion for injunctive relief.
Upon de novo review of the report and recommendation, pursuant
to 28 U.S.C. § 636(b)(1)(C) and Fed.R.Civ.P. 72(b), the Court
adopts the recommendation to deny Froelich's motion, but declines
to adopt the recommendation to deny Southland's motion.
Southland initiated this action on March 27, 1997 against
defendant Richard Froelich,*fn1 the operator of one of
Southland's well-known 7-Eleven franchises. The complaint
contains twelve causes of action, ten of which pertain to
On April 9, 1997, Southland moved by Order to Show Cause
("OSC") for a preliminary injunction, pursuant to Fed. R.Civ.P.
65. Through the OSC, Southland sought to enjoin Froelich from
using Southland's 7-Eleven service marks, trade dress, trade
name, and trademarks during the pendency of the action. The OSC
also sought to compel Froelich to vacate and surrender the
premises of his franchise 7-Eleven store, located at Peconic
Street and First Avenue in Lakeland, New York. Southland further
sought, pursuant to Fed.R.Civ.P. 64, to seize from Froelich and
deliver to Southland the inventory and other goods held for sale,
and also the equipment that had been leased to the store.
On June 24 and 25, 1997, Magistrate Judge Pohorelsky conducted
an evidentiary hearing on Southland's motion for a preliminary
injunction.*fn3 Prior to a decision being rendered, Southland
brought a supplemental order to show cause asserting additional
grounds for the issuance of the injunction. Magistrate Judge
Pohorelsky conducted additional hearings on December 2 and 3,
1997. Approximately three weeks later, Froelich cross-moved by
order to show cause for an injunction compelling Southland to
permit him to sell his interest in the Peconic Street 7-Eleven
store. That application also was referred
to Magistrate Judge Pohorelsky, but no further evidentiary
hearings were held.
The magistrate judge issued his Report and Recommendation on
February 26, 1998, recommending that both motions for injunctive
relief be denied. On March 16, 1998, Southland filed its
objections to the Report and Recommendation. Froelich did not
object to the Report and Recommendation, and did not reply to
Southland's objections. Therefore, the recommendation to deny
Froelich's motion for injunctive relief is ADOPTED in its
entirety, and the magistrate judge's recommendation to deny
Southland's application for a preliminary injunction is
considered solely on the basis of Southland's submissions to the
A. Standard of Review of Magistrate Judge Pohorelsky's Report
Pursuant to Fed.R.Civ.P. 72(c), a party objecting to the
recommended disposition of a matter may file specific, written
objections to the magistrate judge's report and recommendation.
"The district judge to whom the case is assigned shall make a de
novo determination upon the record . . . [and] may accept,
reject, or modify the recommended decision, receive further
evidence, or recommit the matter to the magistrate judge with
instructions." Fed. R.Civ.P. 72(c).
B. Standard for Issuance of a Preliminary Injunction
The issuance of a preliminary injunction in the Second Circuit
is dependent upon the movant's demonstration of (1) irreparable
harm and (2) either a likelihood of success on the merits, or
a sufficiently serious question as to the merits of the case to
make them a fair ground for litigation and a balance of
hardships tipping decidedly in its favor. Tom Doherty Assoc.,
Inc. v. Saban Entertainment, Inc., 60 F.3d 27, 33 (2d Cir.
1995). Such relief is extraordinary and should not be granted
indiscriminately. Patton v. Dole, 806 F.2d 24, 28 (2d Cir.
1986). "Irreparable harm" means injury that is actual and
imminent. Tom Doherty Assoc., 60 F.3d at 37. If a monetary
award will provide adequate compensation for the injury suffered,
a preliminary injunction should not issue. Id. at 37-38.
However, where the requested preliminary injunction will do
more than preserve the status quo, the court "should require a
more substantial showing of likelihood of success" on the merits.
S.E.C. v. Cavanagh, 155 F.3d 129, 136 (2d Cir. 1998) (quoting
S.E.C. v. Unifund SAL, 910 F.2d 1028, 1039 (2d Cir. 1990)). In
other words, the moving party must demonstrate a. clear or
substantial likelihood of success on the merits
where (1) the injunction sought `will alter, rather
than maintain, the status quo' — i.e., is properly
characterized as a "mandatory" rather than
"prohibitory" injunction; or (2) the injunction
sought `will provide the movant with substantially
all the relief sought, and that relief cannot be
undone even if the defendant prevails at a trial on
Jolly v. Coughlin, 76 F.3d 468, 473 (2d Cir. 1996) (quoting
Tom Doherty Assoc., 60 F.3d at 33-34); see also Koppell v. New
York State Bd. of Elections, 153 F.3d 95, 96 (2d Cir. 1998).
Upon consideration of an application for a preliminary
injunction, the court must follow the requirements of Fed.
R.Civ.P. 52(a), and set forth its findings of fact and
conclusions of law. Inverness Corp. v. Whitehall Lab.,
819 F.2d 48, 49 (2d Cir. 1987). This rule "serves several purposes. First,
it aids the appellate court in understanding the ground or basis
for the trial court's decision [and][s]econd, the rule encourages
the trial judge to ascertain the facts with due care and render a
decision in accord with the evidence and the law." Davis v. New
York City Hous.
Auth., 166 F.3d 432, 433-34 (2d Cir. 1999) (citations omitted).
Therefore, the Court's findings of fact, as ascertained from
the parties' pleadings, affidavits, memoranda of law, and the
extensive hearing transcripts, are set forth below. The Court's
conclusions of law are also set forth in the Discussion section
1. Southland is a Texas corporation with its
principal place of business in Dallas, Texas.
Complaint ("Cplt."), ¶ 1. Southland maintains an
office in the Eastern District of New York at 135
Maxess Road, Melville, New York. Id.
2. Southland operates and franchises the nationwide
7-Eleven chain of retail convenience stores. Cplt.,
3. Froelich is a resident of Suffolk County, New York
and in July 1996 was granted a franchise to operate
a 7-Eleven store ("Froelich Store") at Peconic
Street and First Avenue in Lakeland, New York
(store number 2423-16539). Cplt., ¶ 8; June 24 Tr.,
4. The Froelich Store is located in Market 2423,
which encompasses that part of Long Island lying
roughly east of the Sagtikos Expressway, all of
which is in Suffolk County. There are eighty-one
7-Eleven stores in Market 2423. The Market Manager
is Robert Cadigan. June 24 Tr., at 6.
5. Prior to opening his own 7-Eleven franchise,
Froelich worked for approximately fifteen years at
a 7-Eleven store operated by former defendant
Thomas Hudson ("Hudson Store"), located on Hospital
Road in East Patchogue, New York. June 24 Tr., at
7, 124-25; June 25 Tr., at 13-14.
6. Froelich has a college degree in business
management and has an accounting background. June
24 Tr., at 125-27; Selected Exhibits Submitted by
Plaintiff in Support of its Objections ("Pl.Ex.")
3, at 181.
7. In late January 1997, an investigation was
commenced by Southland concerning the operation of
both the Froelich Store and the Hudson Store. June
24 Tr., at 17-21. That investigation revealed to
Southland that for many years at the Hudson Store,
and at the Froelich Store since shortly after
Froelich began operating that store, merchandise
sales had been fraudulently reduced. June 24 Tr.,
at 19-20, 26-28, 84-85, 107-116, 142-43; Pl.Ex. 8.
8. This under reporting of merchandise sales, the
gross profit of which Southland shares with its
franchisees, was carried out by means of a scheme
which consisted of Froelich's (and Hudson's)
exaggeration of Instant Lotto sales — which are
deducted from total sales to insure proper
reporting of merchandise sales — and the deducting
of such exaggerated Instant Lotto sales from total
sales, thereby under reporting merchandise sales to
the extent of the exaggerated sales. June 24 Tr.,
at 19-20, 26-28, 84-85, 107-116, 142-43; Pl.Ex. 8.
9. The scheme operated as follows, by way of example.
If total sales, in a hypothetical day, were $3000,
of which $500 represented actual Instant Lotto
sales, the proper reporting would be: total sales
less Instant Lotto sales equals total merchandise
sales ($3000 less $500 equals $2500). Under the
franchise agreement, Southland and the franchisee
share in the gross profit (merchandise sales less
cost of goods sold) on the $2500 in merchandise
sales. June 24 Tr., at 19-20, 26-28, 84-85,
107-116, 142-43; Pl.Ex. 8.
10. The scheme at Froelich's store involved the
intentional exaggeration of Instant Lotto sales.
Using the previous example as the correct method
of reporting, Froelich would add an arbitrary
amount, in this example $300, to the actual
Instant Lotto sales of $500. This exaggeration
would result in the deduction of $800 of Instant
Lotto sales (instead of $500) from the
merchandise sales: total sales less the inflated
Instant Lotto sales equals (false) merchandise
sales ($3000 less inflated amount of $800 equals
false merchandise sales of $2200). Thus,
Southland and the franchisee would share the
gross profit only on the $2200 in reported
merchandise sales, but not the gross profit on
the diverted $300 in merchandise sales. June 24
Tr., at 19-20, 26-28, 84-85, 107-116, 142-43;
11. As a result of Froelich's intentional
understatement of merchandise sales, a
non-curable Notice of Termination was delivered
to Froelich on February 26, 1997. Pl.Ex. 2-5.
12. The material breaches of the franchise agreement
identified by Southland in the February 26, 1997
Notice were that Froelich had devised and
implemented a scheme, "utilizing fraudulent Lotto
`post-voids,' . . . to divert funds to your own
account, which would otherwise have been part of
the deposited Receipts, thereby depriving
7-Eleven of its rightful share of the Gross
Profit in respect of the unlawfully diverted
funds." Pl.Ex. 2-5, ¶ 3.
13. The effective date of termination was recited in
paragraph 8 of the Notice of Termination as
the date of your receipt of this Notice of Material
Breach and Termination, provided, however, that if
it should be determined by a court of competent
jurisdiction that this Notice of Material Breach
and Termination is not effective immediately upon
your receipt thereof, it shall be effective at 4:00
p.m., March 5, 1997 or three (3) Business Days
following the delivery to you of this Notice,
whichever is later.
14. At Froelich's request, the March 5, 1997 date was
deferred to March 7, 1997. Pl.Ex. 1, Affidavit of
Robert Cadigan ("Cadigan Aff."), April 8, 1997, ¶
15. Southland continued to investigate Froelich's
store operation, at Froelich's request, to
determine whether there was any basis for
Southland to change its mind regarding the
termination of the franchise agreement. Cadigan
Aff., ¶ 10.
16. On March 26, 1997 Froelich's attorney was
notified that grounds for reconsideration of the
termination did not exist, and that Southland
intended to file a complaint in federal court the
next day. Id.
17. Southland filed its complaint in this Court on
March 27, 1997 and submitted an Order to Show
Cause on April 8, 1997 seeking preliminary
18. Southland is the largest operator and franchiser
of convenience stores, with a worldwide network
of over 14,000 7-Eleven company-operated and
franchised locations. In the United States and
Canada, there are approximately 3,000 7-Eleven
stores that are operated by individuals under
franchises granted by Southland. Cadigan Aff., ¶
19. Southland requires, and the franchise agreement
for each store provides for, accounting systems
and controls that are designed to provide
accountability for the operation of the store, as
well as to determine and account for the "equity"
position of the franchisee, i.e., the
franchisee's Net Worth in the store's operations,
which the franchisee is obligated to maintain
above a certain minimum level. Cadigan Aff., ¶
20. The franchisee's Net Worth is defined in the
franchise agreements as "the cash register fund,
the Cost Value of the Inventory, Store supplies,
receivables, prepaids, refundable deposits, and
any portion of the initial cost of an alcoholic
beverage license employed in FRANCHISEE's
operation of the Store which is charged to the
Open Account and carried on the Bookkeeping
Records . . .; less FRANCHISEE's payables and
accruals from FRANCHISEE's operation of the
Store, as reflected on the Financial Summaries."
Pl.Ex. 2.-2, Exh. E.
21. Southland exercises great control over the
selection of store sites and their subsequent
operation. For example, Southland selects the
location of each store, purchases the land and
constructs the store, or leases an appropriate
structure, and prepares the store for operation,
including the provision of all equipment
necessary for it operation. Such equipment
includes shelves, counters, cash registers,
lighting and other fixtures, heating and cooling
equipment, signs, and parking lot preparation.
Cadigan Aff., ¶ 18.
22. Each store generally represents an investment by
Southland of hundreds of thousands of dollars by
the time it opens. Under the franchise agreement,
a franchisee is leased the store and equipment,
and is licensed to use the 7-Eleven Service Mark,
related trademarks, trade dress and system of
operations, which licenses automatically
terminate upon the end of the franchise
relationship. Cadigan Aff., ¶ 18.
23. Pursuant to the terms of the franchise agreement,
the franchisee does not acquire ownership of the
store, its premises or any of the physical plant.
Rather, these remain the property of Southland.
The franchisee's ownership interest is in the
store's inventory, and the franchisee's primary
ongoing financial interest is in the Net Income
derived from the store's operations, which the
franchisee draws against on a weekly basis.
Cadigan Aff., ¶ 19.
24. The term Net Income is defined in the franchise
agreement as "Gross Income less operating
Expenses." Pl.Ex. 2-2, Exh.E.
25. Southland's financial interest is in receiving a
percentage of the "Gross Profit" (Net Sales less
Cost of Goods Sold) derived from operation of the
store, which percentage is designated in the
franchise agreement as the "7-Eleven Charge." The
Net Income in which the franchisee has an
interest, as mentioned above, 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 certain 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. Cadigan Aff., ¶ 20.
26. In addition to providing the franchisee with a
ready-to-operate store, and bookkeeping services,
Southland also, upon request, will finance the
operation of the store under the terms of the
franchise agreement. Most franchisees elect, as
did Froelich, to utilize Southland's financing.
To secure the obligation owed to Southland under
such financing, a franchisee, as did Froelich
here, grants Southland a security interest in the
franchisee's inventory and in the premium and
going value concern, if any, of the store.
Cadigan Aff., ¶ 21.
27. Thus, prior to opening a store, a franchisee
purchases an initial inventory, with the
franchisee paying only part of the purchase price
from his funds 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
reflecting the cash operations of the store. The
balance of the Open Account at any given time
represents the amount of money that Southland has
loaned or advanced to a franchisee to finance the
operation of the store. Southland reserves the
right to terminate its financing at any time.
Cadigan Aff., ¶ 21; Pl.Exhs. 2-2 and 2-16.
28. After operation of a store commences, a
franchisee must ring up accurately, on cash
registers 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,
all cash payments to vendors and casual labor,
and all other cash transactions. Cadigan Aff., ¶
29. 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
which are applied in reduction of the outstanding
balance of the Open Account. Cadigan Aff., ¶ 23.
30. A franchisee is further required, under the
Franchise Agreement, 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 bona fide ...