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SOUTHLAND CORP. v. FROELICH

United States District Court, Eastern District of New York


March 19, 1999

THE SOUTHLAND CORPORATION, PLAINTIFF,
v.
RICHARD FROELICH, DEFENDANT.

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

  MEMORANDUM AND ORDER

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.

PROCEDURAL BACKGROUND

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 Froelich.*fn2

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 Court.

LEGAL STANDARDS

A. Standard of Review of Magistrate Judge Pohorelsky's Report
  and Recommendation

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
  the merits.

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 that follows.

FINDINGS OF FACT

  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.,
    ¶ 6.

  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.,
    at 7.*fn4

  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
    would

    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;
      Pl.Ex. 8.

  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.

Pl.Ex. 2-5, ¶ 8.

  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, ¶
      9.

  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
      injunctive relief.

  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., ¶
      17.

  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., ¶
      17.

  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., ¶
      22.

  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 deductions that
      affect the daily deposit. Cadigan Aff., ¶ 24.

  31. A tape from each of the store's cash registers
      summarizing, by categories of its various keys,
      the day's entries is attached to the Cash Report.
      Since about mid-1995, a franchisee enters this
      information into a computer, which generates the
      Cash Report, which is then reviewed and approved
      by the franchisee, and transmitted to Southland's
      Accounting Center for processing. Cadigan Aff., ¶
      24.

  32. The daily Cash Report, prepared and signed by the
      franchisee or his designee, is the only device
      used to report daily sales. When the Cash Report
      is received by Southland's accounting department,
      information from the face of the Cash Report is
      entered into the computerized accounting records
      maintained by Southland. This data entry is
      performed by one of Southland's data entry
      clerks. The information on the face of the Cash
      Report is not verified by Southland. Rather,
      Southland relies on the integrity and honesty of
      its franchisees in reporting the information
      necessary for the proper functioning of the
      accounting system. This process

      is essential in determining the parties'
      respective contractual shares of gross profit.
      Cadigan Aff., ¶ 25.

  33. When a franchisee purchases merchandise and
      supplies for a store, the related invoice, bill
      or statement may be submitted, together with a
      Receiving and Inventory Transactions Report, to
      Southland for recording and direct payment by
      Southland. These payments, as well as the
      payments made by Southland for Operating
      Expenses, are charged to the franchisee through
      the Open Account, the balance of which is
      increased by the amount of the expenditures.
      Southland will pay the related invoice, bill or
      statement so long as it is willing to provide
      Open Account financing to the franchisee. As a
      general rule, most of a franchisee's invoices for
      purchases are submitted to Southland for payment,
      a practice that is encouraged by Southland to aid
      in the accurate and orderly accounting at the
      store. Cadigan Aff., ¶ 26.

  34. Alternatively, payment may be made by the
      franchisee at the store, in cash or by draft
      drawn on an account designated by Southland, in
      which case the related invoice, bill or statement
      must be submitted to Southland for verification
      and recording. If the purchase is paid by cash,
      it is reflected on the Cash Report (to account
      for the reduced amount of the deposit made to the
      store's bank account). The related bill,
      statement or invoice is turned in to Southland.
      Cadigan Aff., ¶ 26.

  35. If the purchase is paid by draft, it is reflected
      on the Receiving and Inventory Transactions
      Report and the related invoice, bill or statement
      is attached along with a carbon copy of the
      draft. Cadigan Aff., ¶ 26.

  36. Southland prepares monthly financial statements
      for each store from Southland's bookkeeping
      records and from information supplied by the
      franchisee, most notably the daily Cash Reports.
      The monthly financial statements include a profit
      and loss statement for the month and an updated
      balance sheet for the store. On the basis of
      these financial reports, the 7-Eleven Charge is
      calculated and Southland receives, as the
      7-Eleven Charge, its share of the Gross Profits
      of a franchised store. The financial reports also
      update the outstanding balance of the Open
      Account. Cadigan Aff., ¶ 27.

  37. Southland employs a retail method of inventory
      accounting system. The sheer number of items
      found in a typical 7-Eleven store makes the
      retail method of inventory accounting necessary.
      Cadigan Aff., ¶ 28.

  38. When a 7-Eleven store commences operation, a
      physical count of all inventory is made and the
      inventory is valued initially at suggested retail
      selling prices. Thereafter, the inventory is
      valued at the actual retail selling prices as
      determined by the franchisee, who reports them to
      Southland for accounting purposes. Southland
      relies on the franchisee's honesty in reporting
      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. Cadigan Aff., ¶ 29.

  39. 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. Southland
      then increases

      the Retail Book Inventory by the retail value of
      the merchandise purchased. On the other hand,
      sales of merchandise to customers reduce the
      Retail Book Inventory. Southland charges the
      amount of merchandise sales against Retail Book
      Inventory on the store's accounting records.
      Cadigan Aff., ¶ 29.

  40. The accounting system used by Southland is almost
      wholly dependent upon the honesty and integrity
      of the franchisees in reporting to Southland the
      amounts and categories of sales on the daily Cash
      Reports. Cadigan Aff., ¶ 29.

  41. To maintain the Retail Book Inventory as an
      accurate figure for the inventory actually
      present at the store, periodic physical counts of
      inventory are taken and any variance becomes an
      adjustment to the Retail Book Inventory
      accounting record. Southland maintains the right
      under the franchise agreement to conduct audits
      at the store. Cadigan Aff., ¶ 30.

  42. Variances can arise from a number of factors,
      including thefts by employees or customers, sales
      of merchandise that are not rung up on the cash
      register, or falsely deflating actual merchandise
      sales. These variances cause Inventory Shortages,
      i.e., physical counts showing that less inventory
      actually is present than is shown on the
      accounting records for Retail Book Inventory.
      Cadigan Aff., ¶ 30.

  43. Under the terms of the franchise agreement, a
      franchisee is responsible for all Inventory
      Shortages, which are charged directly to the
      franchisee's account at cost, not at retail
      value. Thus, in the event of an Inventory
      Shortage caused by a franchisee's selling
      merchandise without reflecting the sale on the
      store's registers, the franchisee benefits, at
      minimum, from the profit margin on the
      merchandise (retail value less cost), i.e., the
      7-Eleven Charge. Cadigan Aff., ¶ 31.

  44. However, inventory shortages may be covered up in
      several ways. For example, the franchisee may
      purchase or otherwise bring merchandise into the
      store without submitting the related invoice,
      bill or statement to Southland. A physical count
      of inventory taken thereafter thus could match
      the amount shown for Retail Book Inventory in the
      accounting records. Another way of covering
      Inventory Shortages is the selling of merchandise
      at retail prices higher than the retail prices
      reported by the franchisee to Southland. Cadigan
      Aff., ¶ 31.

  45. Unless unreported purchases of merchandise or
      sales of merchandise at inflated prices are
      "balanced" to cover only unreported revenues,
      there would be present in the store a greater
      amount of inventory than is shown on the
      accounting records for Retail Book Inventory. An
      Inventory Overage would result, and the
      franchisee would be credited with the amount of
      such overage at cost. In substance, Southland
      would pay the franchisee, by crediting his
      account, the value (at cost) of any inventory
      present in the store in excess of the amount
      shown in the Retail Book Inventory. Cadigan Aff.,
      ¶ 32.

  46. As is required by all of Southland's franchisees,
      Froelich was required by the franchise agreement
      to "deposit the Receipts [daily] in the bank or
      night depository designated by 7-Eleven, except
      cash expended by FRANCHISEE from that day's
      Receipts for Purchases or Operating Expenses . .
      ." Pl. Exh. 2-2, ¶ 10.

  47. Paragraph 10 of the franchise agreement also
      required Froelich 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 . . . keep 7-Eleven
      currently advised in writing of all of
      FRANCHISEE'S actual retail selling prices. . . ."
      Pl.Exh. 2-2, ¶ 10.

  48. 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 daily
      Cash Report. Cadigan Aff., ¶ 33.

  49. The Froelich franchise agreement defines
      "Receipts" as "all sales proceeds (whether cash,
      check, vendor draft, credit instrument, or other
      evidence of receipt), money order revenues,
      discounts or allowances received by FRANCHISEE,
      and miscellaneous income . . . and the value of
      premiums received from FRANCHISEE'S operation of
      the Store." Pl.Exh. 2-2, Ex.E.

  50. Under the heading "Franchisee's Additional
      Covenants," the Froelich franchise agreement also
      provides that "FRANCHISEE shall: . . . cause all
      sales of Inventory to be properly recorded at the
      time of sale at the retail prices set by
      FRANCHISEE." Pl.Ex. 2-2, ¶ 17. "Inventory" is
      defined as "all merchandise for sale from the
      Store." Pl.Ex. 2-2, ex. E; Cadigan Aff., ¶ 33.

  51. A franchisee's failure to accurately report and
      deposit Receipts (as defined) and to accurately
      report actual retail selling prices of
      merchandise are both material breaches of the
      franchise agreement. Pl. Exh. 2-2, ¶ 28; Cadigan
      Aff., ¶ 34.

  52. Upon termination of the franchise agreement, a
      franchisee is required to "peaceably surrender
      the Store and Equipment . . .; transfer the final
      inventory . . . to 7-Eleven; transfer to 7-Eleven
      the Receipts, cash register fund, pre-paid
      Operating Expenses, money order blanks, bank
      drafts, and Store supplies; cease using the
      Service Mark, the Related Trademarks, and the
      7-Eleven System, including the Trade Secrets;
      return FRANCHISEE'S copy of the Franchise Systems
      Manual and of the Foodservice Operations Manual;
      and return all Trade Secrets and other 7-Eleven
      System material." Pl.Exh. 2-2, ¶ 30.

  53. To date, Froelich has not surrendered his Store
      to Southland, continues to remain in possession
      of the Store, and continues to use the 7-Eleven
      Service Mark and related trademarks. Cadigan
      Aff., ¶ 35.

  54. On or about January 20, 1997 Southland's Customer
      Service Department was contacted by Mohammed
      Younis ("Younis"), who requested an appointment
      with Southland's Market Manager. On January 24,
      1997 Robert Cadigan met with Younis and his
      friend Yousef Mohamed ("Yousef") at Southland's
      Market office. Younis told Cadigan that he had
      been a partner of Froelich's in the July 1996
      acquisition of the Froelich store; that he had
      invested $30,000, of which $20,000 was a loan
      evidenced by a promissory note made by Froelich;
      and that, after expenses, Younis would receive
      40% of the profits from the Froelich store.
      Cadigan Aff., ¶ 36; see also June 24 Tr. at
      17-18, 132-34, 205-06; July 16 Tr. at 6-9, 12-14,
      22-28; Pl.Exhs. 10, 13.

  55. Froelich's application did not disclose either
      Younis's partnership interest or Froelich's
      indebtedness to Younis. Pl.Exh. 2-20; 2-21.

  56. Both Younis and Yousef, who were friends, had
      worked at the Hudson store from Spring 1990
      through June 1996. Younis and Froelich had a
      falling out — Younis and Yousef allegedly had
      caught Froelich stealing from Younis. Younis
      informed Cadigan at the January 24 meeting that
      Southland had been victimized at both the Hudson
      and Froelich stores. Younis told Cadigan that at
      both stores merchandise sales had been knocked
      down, the cash from the knocked down sales had
      been used to pay employees "off the books," that
      the Inventory Shortages had been covered up by
      charging customers retail prices higher than
      those reported to Southland, and that the sales
      tax in a taxable item, together with the price of
      the item, had been lumped together and rung up,
      falsely, as a non-taxable sale. Cadigan Aff., ¶
      37; June 24 Tr. at 17-21, 26-30, 84-85, 109-114,
      135-37, 141-44, 147-49, 183-87, 209-14; June 25
      Tr. at 16-17, 22-24, 44-46, 74-75; Pl.Exhs. 5, 6,
      8, and 15.

  57. These activities apparently had occurred at the
      Froelich store since Instant Lotto was placed in
      the store in September 1996. Cadigan Aff., ¶ 38.

  58. The cash registers used in the stores in the
      Market have separate keys for different
      transactions. Merchandise sales are divided into
      taxable and non-taxable categories and there is a
      separate key in which Instant Lotto sales are
      rung up. Each store has two cash registers and
      there are three eight-hour shifts that comprise
      the 24-hour period covered by a daily Cash
      Report. Once a day the franchisee or his designee
      compiles the activity on each register for the
      three most recent eight-hour shifts. Cadigan
      Aff., ¶ 38.

  59. The money collected by a franchisee from Instant
      Lotto sales, except for a small commission, is
      held in trust for the State Lottery commission.
      In order to determine total merchandise sales
      (the gross profit on which is shared by Southland
      and its franchisees), Instant Lotto sales must be
      deducted from Total Sales. Cadigan Aff., ¶ 39;
      June 24 Tr. at 26-28, 51-56, 84-85.

  60. However, the preparer of a Cash Report may
      falsely understate merchandise sales simply by
      post-voiding (or deducting) more Instant Lotto
      Sales than actually were made. As a result,
      merchandise sales are understated, and Southland
      loses its contractual share of the Gross Profit
      on the understated sales; the Inventory Shortages
      that flow from unreported sales of merchandise
      inventory could be covered up by charging
      customers for fictitious purchases and by selling
      merchandise at prices higher than the price
      reported to Southland. Each part of this type of
      scheme would be a breach of the franchise
      agreement. Cadigan Aff., ¶ 40.

  61. Both Froelich and Younis worked at the Froelich
      store. Froelich generally prepared the Cash
      Reports five days per week, while Younis prepared
      them on the two days Froelich was off. Cadigan
      Aff., ¶ 41. Because Younis had received only
      modest distributions of profit from Froelich,
      given that he had a 40% interest in the store,
      Younis complained to Yousef. Yousef suggested
      that Younis review the Instant Lotto post-voids
      at the Froelich store. Cadigan Aff., ¶ 41; June
      24 Tr. at 208-14; July 16 Tr.

      at 10-16. Sometime in November 1996, Younis
      reviewed the post-voids and found that Froelich
      had post-voided about $5300 of Instant Lotto
      sales in excess of actual Instant Lotto sales.
      Cadigan Aff., ¶ 41 June 24 Tr. at 209-12; July 16
      Tr. at 17-20.

  62. When Younis confronted Froelich, Froelich told
      Younis not to worry because he had the money;
      Froelich thereafter gave Younis his 40% interest
      on the understated profits, but their
      relationship terminated sometime in December
      1996. Cadigan Aff., ¶ 41; June 24 Tr. at 212-14;
      July 16 Tr. at 20-23, 28.

  63. Following the January 24, 1997 meeting, Southland
      spot checked the Cash Reports, with their
      attached summary cash register tapes, at both the
      Hudson store and the Froelich store. Southland
      also secretly shopped both stores to determine
      whether the prices charged at the stores were
      consistent with the retail prices reported by the
      stores to Southland. These spot checks confirmed
      the excess post-voids of Instant Lotto sales.
      Cadigan Aff., ¶ 42; June 24 Tr. at 18-21, 29-36,
      38-39; Pl.Exhs. 4-6.

  64. When Froelich's store was operated by the prior
      franchisee, the percentage of taxable sales to
      total merchandise sales was slightly above the
      Market average. In contrast, after Froelich
      assumed operation of the store in July 1996, the
      percentage of taxable sales to total merchandise
      sales was significantly below the Market average,
      and below that which the prior franchisee had
      collected as taxable sales. June 24 Tr., at
      38-39.

  65. Following a meeting on February 7, 1997 (between
      Cadigan, Younis, Yousef, Southland's attorney and
      a financial analyst), a review was made of all
      Cash Reports and attached cash register summary
      tapes at the Froelich store from September 1996
      (when Instant Lotto sales commenced) to January
      1997. Southland also reviewed the reports and
      summaries at the Hudson store. Cadigan Aff., ¶¶
      43-44.

  66. At the Hudson store, during a 37-month period
      (January 1994 to January 1997), an aggregate of
      $139,268.20 was post-voided in excess of actual
      Instant Lotto sales. Cadigan Aff., ¶ 44.

  67. At the Froelich store, during the 5-month period
      reviewed, an aggregate of $6463.50 was
      post-voided in excess of actual Instant Lotto
      sales. Cadigan Aff., ¶ 44; June 24 Tr. at 65,
      106-114; Pl.Exh. 8.

  68. During this same period of time, Froelich's store
      experienced Inventory Overages of about $5024 at
      retail price from July 1996 through December
      1996. Cadigan Aff., ¶ 45; June 24 Tr. at 88-90.

  69. Secret shops at the Froelich store confirmed that
      a number of items purchased during the shops were
      at prices higher than those reported to
      Southland. In most instances, the excess prices
      ranged between $.10 and $.60 per item. In all,
      76% of the items purchased by Southland in its
      secret shops were purchased at prices higher than
      those prices reported to Southland. June 24 Tr.
      at 34-36; Pl.Exh. 6; Cadigan Aff., ¶ 46; June 24
      Tr. at 20-21, 29-36, 40; Pl .Exhs. 4-6.

  70. Froelich personally participated in the sale of
      merchandise at his store at prices higher than
      those prices reported to Southland. June 24 Tr.
      at 148-49; Pl.Ex. 5.

  71. Froelich conceded that he had engaged in
      activities to defraud Southland at his store.
      June 24 Tr. at 162-65, 175-177. He was personally
      aware that there were excess

      post-voids occurring in his store. Id. at 175.
      Froelich personally benefitted from these
      activities. Id. at 164.

  72. On March 7 and May 6, 1997, Froelich, in the
      presence of his attorney, provided sworn
      statements to Southland and its attorneys. Pl.
      Ex. 3; Cadigan Aff., ¶ 53. Froelich admitted his
      participation in the scheme at the Hudson store.
      Pl. Ex. 3, at 52-62. Froelich testified that,
      while he worked at the Hudson store, Hudson was
      concerned about "pulling" enough money from the
      store to pay employees, including Froelich, "off
      the books," and to make up for the Inventory
      Shortages by overcharging customers and by
      ringing up taxable sales as non-taxable sales.
      Id. at 47-49, 84-92, 96-101, 141-43, 169.

  73. Froelich also admitted, among other things, that
      he had post-voided excess Instant Lotto sales at
      his own store. Id. at 144-45.

  74. During the time that Froelich managed the Hudson
      store, he instructed employees how to "make up
      money," including how to charge customers amounts
      for merchandise not actually purchased and to
      charge customers prices higher than those
      reported to Southland. June 24 Tr. at 183-87;
      Pl.Exh. 15.

  75. During Froelich's last year as manager of the
      Hudson store, the post-voids totaled
      approximately $1100-1200 weekly. June 24 Tr. at
      136-37. Froelich was aware that the money being
      "pulled" from the Hudson store came from
      merchandise sales. June 24 Tr. at 137.

  76. Froelich was aware that taking cash from the
      store by excessive Instant Lotto post-voids would
      generally result in inventory shortages. He also
      was aware that there were not actual inventory
      shortages at the Hudson store. June 24 Tr. at
      143-44.

  77. An examination of Froelich's business and lottery
      bank accounts revealed that Froelich paid Younis
      thousands of dollars therefrom. Froelich knew
      that if he had not siphoned cash from merchandise
      sales to deposit into the business/lottery
      account, he would have had to use his personal
      funds to pay Younis. June 24 Tr. at 169-70;
      Pl.Exh. 14.

  78. In an apparent effort to shield his activities,
      Froelich post-voided in small amounts to avoid
      detection. June 24 Tr. at 95.

  79. The State Lottery Commission notifies the
      Froelich store by an electronic terminal,
      generally, the amounts payable to the commission
      several days prior to the date that the account
      is to be "swept." If there is a shortfall in the
      amount of funds in the lottery account, a
      franchisee is not permitted to deduct the funds
      from merchandise sales at the store. June 24 Tr.
      at 115-16.

  80. Froelich had the ultimate responsibility to
      determine whether prices of merchandise being
      sold at his store were at the prices reported to
      Southland. June 25 Tr. at 46. Froelich
      acknowledged that it was his responsibility to
      monitor his employees. June 25 Tr. at 73-74.
      Froelich had represented to Southland that he had
      tremendous knowledge of 7-Eleven and its
      operations, that he enjoyed being hands-on even
      though he had good employees, that it was
      important to retail bills correctly, and that
      Froelich would spot-check any paperwork done by
      anyone else. June 25 Tr. at 74-75.

  81. Although he was subpoenaed to appear in court on
      July 3, 1997, Younis did not appear because
      allegedly

      he had been threatened by a person named "Malik,"
      an individual who used to work with Froelich at
      the Hudson store and at Froelich's own store.
      July 16 Tr. at 30-36.

  82. By its Notices of Termination and its follow-up
      written and oral demands, Southland demanded (a)
      repayment by Froelich of his Open Account
      indebtedness to Southland; (b) return of the
      store premises and equipment; and (c) if the Open
      Account indebtedness was not repaid, possession
      of Froelich's inventory, proceeds and other
      collateral that secure Froelich's Open Account
      indebtedness. Cadigan Aff., ¶ 56.

  83. Froelich refused Southland's demands in all
      respects and Froelich continues to be in
      possession of, and sell, Southland's collateral
      securing Froelich's Open Account indebtedness.
      Cadigan Aff., ¶ 56. Froelich continues to hold
      himself out as a 7-Eleven franchisee. Id.

  84. During the application process to become a
      7-Eleven franchisee, Froelich did not disclose
      that he had a partner. June 24 Tr. at 41.

  85. The goodwill payment of $125,000 made by Froelich
      to the prior franchisee was not shared with
      Southland, which has no role in negotiating the
      goodwill purchase price. June 24 Tr. at 41.
      Froelich also paid a franchise fee to Southland
      which totaled approximately $77,500. Id. at 42.
      Twenty-five percent of the franchise fee paid to
      Southland went to the prior franchisee. Id.

  86. During the qualification process to become a
      franchisee, Froelich, in writing, represented to
      Southland that his "premium or goodwill payment
      will have no effect on [his] right or the right
      of [Southland] to terminate [Froelich's]
      agreement pursuant to its terms." June 24 Tr. at
      128-131; Pl.Exh. 9.

  87. Although new franchisees normally go through nine
      weeks of in-store training and another week of
      classes in Dallas, Froelich requested and was
      granted a training waiver because of his
      experience as manager of the Hudson store for
      more than ten years. Froelich participated in a
      "test-out" program in which a Southland
      representative, on a regular basis, evaluated
      Froelich's knowledge of the material taught in
      the training class. June 24 Tr. at 42-46.

  88. The total amount of Southland's losses due to
      Froelich's allegedly fraudulent activities is in
      the vicinity of $6000 to $7000. June 24 Tr., at
      93-94.

DISCUSSION

I. Analysis of Preliminary Injunction Factors

By seeking a preliminary injunction that would bar Froelich from using its trademarks, service marks, and trade dress during the pendency of this action, Southland clearly seeks relief that would alter the status quo, rather than maintain it. This requested alteration of the status quo is even more apparent when one considers that Southland also seeks to compel Froelich to surrender possession of the Peconic Street store and its inventory pending the outcome on the merits. Moreover, the Court finds that the relief requested by Southland on its preliminary injunction application is substantially all the relief sought by the complaint, and that the relief sought cannot be undone if Froelich were later to succeed on the merits at trial. Thus, the Court must consider not only irreparable harm, but also must require Southland to meet a heightened standard by demonstrating that there is a "clear" or "substantial" likelihood that it will succeed on the merits*fn5 of its claims. See Cavanagh, 155 F.3d at 136.

A. Irreparable Harm

1. Trademark Infringement

"The unauthorized use of a [trade]mark by a former licensee invariably threatens injury to the economic value of the goodwill and reputation associated with a licensor's mark." Church of Scientology Int'l v. Elmira Mission, 794 F.2d 38, 43 (2d Cir. 1986). In the trademark infringement context, "a showing of likelihood of confusion establishes . . . irreparable harm." Hasbro Inc. v. Lanard Toys, Ltd., 858 F.2d 70, 73 (2d Cir. 1988); see also Home Box Office, Inc. v. Showtime/The Movie Channel, Inc., 832 F.2d 1311, 1314 (2d Cir. 1987) (same). Moreover, a court must find irreparable harm when the movant "shows that it will lose control over the reputation of its trademark pending trial." Church of Scientology, 794 F.2d at 43 (quoting Power Test Petroleum Distrib. v. Calcu Gas, Inc., 754 F.2d 91, 95 (2d Cir. 1985) (citing 2 McCarthy, Trademarks and Unfair Competition § 30.15 (2d ed. 1984))).

Pursuant to the franchise agreement between Southland and Froelich, the latter was licensed to use the former's 7-Eleven service mark, 7-Eleven system, and the 7-Eleven trade dress and trade secrets. Pl. Ex. 2-2, ¶ 5. Southland alleges that the franchise agreement, and hence, the license to use the trademarks, was terminated by a non-curable Notice of Termination dated February 26, 1997.

During the pendency of the evidentiary hearings and decision on its first order to show cause, Southland issued two Supplemental Notices of Material Breach and Termination to Froelich, dated June 24, 1997 and October 17, 1997. In its arguments to the magistrate judge, Froelich vehemently contested the validity of each of these notices of termination. See Defendant Richard Froelich's Post-Hearing Brief, dated December 8, 1997, at 3-5. Froelich contends that Southland has attempted to manufacture a case in order to discredit him and to terminate the franchise agreement. Id.

Thus, whether there is, in fact, any irreparable harm to Southland as a result of Froelich's alleged infringement of Southland's trademarks, service marks and trade dress depends on whether Froelich's use of Southland's marks is unauthorized. Whether Froelich's use of Southland's marks is unauthorized depends on the validity of Southland's termination of the franchise agreement with Froelich. If the franchise agreement was properly terminated, Froelich's license, i.e., his privilege, to use Southland's marks, also was revoked, and irreparable harm is established as a matter of law. On the other hand, if the franchise agreement was not properly terminated, then Froelich's license to use Southland's marks remains intact. This issue is considered infra.

2. Interference with Real Property Rights

A real property owner's inability to make productive use of its own property may constitute irreparable harm. Persaud v. Exxon Corp., 867 F. Supp. 128, 141 (E.D.N.Y. 1994) (Seybert, J.). Irreparable harm in this context flows from the owner's inability to make better use of the site, or the owner's lack of control over features, fixtures, and equipment located on the site. Id.; see also Shell Oil Co. v. Altina Assoc., Inc., 866 F. Supp. 536, 541-42 (M.D.Fla. 1994) (ordering terminated service station operator to vacate leased premises); Shell Oil Co. v. Czar, Civ. No. N-88-38, 1988 WL 404539, at *6 (D.Conn. Apr.19, 1988) (same).

Under the franchise agreement, Froelich leased the store and its equipment from Southland. Pl.Ex. 2-2, ¶ 6. The parties' intentions were to create only a landlord-tenant relationship. Id. The agreement further provides that in the event of a breach by Froelich, Southland was entitled "to invoke all rights and remedies, judicial and otherwise, available to a landlord, including summary proceedings for possession of leased property . . . [or] to terminate, cancel, or declare a forfeiture of the lease." Id. Thus, by the plain language of the agreement, in the event of a breach by Froelich, Southland is authorized to take possession of its property and equipment.

The February 26, 1997 termination notice issued to Froelich by Southland informed Froelich that upon the effective date of the termination of the agreement, the lease and/or sublease of the store and its equipment also would terminate. Pl. Ex. 2-5, ¶ 6. The June 24, 1997 notice and the October 17, 1997 notice contained language indicating that Froelich was to "surrender and turn over possession of any and all rights in and to the Premises to 7-Eleven" upon the effective date of the termination. Pl.Exs. 20-1, 20-2, ¶ 7. As mentioned previously, Froelich contests the validity of these three termination notices.

Whether there is any irreparable harm to Southland's real property rights depends on whether the termination notices were valid. If the agreement was properly terminated, then Froelich's right of possession of the premises also was terminated, and he had an affirmative obligation to surrender the premises and inventory to Southland. However, if there was no valid termination of the agreement, then Froelich's right of possession remained in force, and Southland has suffered no irreparable harm. This issue is also discussed infra.

B. Substantial Likelihood of Success on the Merits

1. Trademark Infringement

"In a Lanham Act case a showing of likelihood of confusion establishes . . . a likelihood of success on the merits. . . ." Hasbro, Inc., 858 F.2d at 73. In the licensing framework, where the alleged unauthorized user of the trademark continues to use the identical, previously licensed trademark, after revocation of the license, likelihood of confusion is established. Church of Scientology, 794 F.2d at 44-45; see also S & R Corp. v. Jiffy Lube Int'l, Inc., 968 F.2d 371, 375 (3d Cir. 1992) (concurrent use of the same mark by franchiser and terminated franchisee is highly likely to cause consumer confusion about affiliation with franchise); Seligco Food Corp. v. Atlantic Processing, Inc., 214 U.S.P.Q. 624, 629 (E.D.N.Y. 1981) (Mishler, J.) ("[u]se of the mark after termination of the licensing agreement, by definition, constitutes trademark infringement."); Coit Drapery Cleaners, Inc. v. Coit Drapery Cleaners of New York, Inc., 423 F. Supp. 975, 978 (E.D.N.Y. 1976) (Mishler, J.) ("continued misrepresentation that the [terminated licensee] is still part of the franchiser's organization will cause further confusion in the public mind").

Here, Froelich's right to use Southland's trademarks was created by the franchise agreement. The valid termination of that agreement would also terminate Froelich's right to use the marks. Coit Drapery, 423 F. Supp. at 978. Therefore, the likelihood of confusion, and thus whether Southland is substantially likely to succeed on the merits of its trademark infringement claim, is dependent upon whether the franchise agreement was validly terminated.

2. Interference with Real Property Rights

The same principle discussed above is also determinative here. Froelich's right to possess the real property at issue was created by the franchise agreement, and likewise is terminated by the valid termination of the agreement. Whether Southland is substantially likely to succeed on the merits of its claim of interference with real property rights thus depends on the validity of the termination of the agreement.

II. Termination of the Franchise Agreement

Southland's objections, although numerous,*fn6 can be narrowed down to one simple argument: Southland argues that it was entitled to terminate the franchise agreement without opportunity for cure because the material breaches committed by Froelich went to the core or essence of the contract, and thus termination was justified under the fraudulent circumstances presented. Pl. Obj., at 59-70.

This Court agrees with Southland's argument. Without actually deciding the precise date of the termination of the franchise agreement, the Court finds that Southland has established a substantial likelihood of success on the merits of its claim that the franchise agreement was terminated, and that it was entitled to terminate the contract without opportunity for cure. Pursuant to the franchise agreement, and under common law principles, the agreement was terminated at the very latest in October, 1997.

As a result of this determination, Southland has established that it is substantially likely to succeed on the merits of its trademark infringement claim and on its claim of interference with real property. Southland also has demonstrated the requisite irreparable harm flowing from the unauthorized use of its trademarks and the unauthorized possession of its real property. Thus, plaintiff's application for a preliminary injunction pending the resolution of this case will be granted.

A. Southland's Notices of Material Breach and Termination

Paragraph 28 of the franchise agreement contains detailed language concerning the termination of the agreement by Southland. Pl.Ex. 2-2. This paragraph includes numerous breaches, which, if committed by the franchisee, provide Southland with the right to terminate. As the magistrate judge pointed out, prominent in that paragraph are provisions requiring Southland to give the franchisee notice of any material breaches and giving the franchisee the right to cure. See Report and Recommendation ("R & R"), at 15-16. This opportunity to cure applies to virtually all material breaches, unless the franchisee has received two notices of material breach within the three-year period immediately preceding a third notice of material breach. In the case of a third notice of material breach within a three-year period, there is no right to cure.

The first notice of material breach and termination sent by Southland to Froelich was dated February 26, 1997. In this notice, Southland described the scheme by which Froelich used fraudulent Lotto "post-voids" to divert funds from the store's deposited Receipts, which thereby deprived Southland of its contractual share of gross profit. Pl.Ex. 2-5, ¶ 3. Southland also indicated that the resulting inventory shortages were covered up by Froelich by selling merchandise at prices higher than those reported to Southland. Id. Southland estimated, at that time, that it had been deprived of its share of approximately $7500 of diverted Receipts. Id. As a result of what it termed "willful, fraudulent, intentional activities" on Froelich's part, Southland advised Froelich that these breaches violated "the very core of the contractual relationship," and gave notice to Froelich that the agreement was terminated. Id., ¶ 4. Thus Southland, rather than relying on paragraph 28 of the Agreement to terminate the agreement, asserted its alleged right to rescind based on common law principles. Paragraph 28 was not mentioned at all in the February 26, 1997 notice of termination. Southland also notified Froelich that the breaches "may not be cured." Id.

Regarding the allegations in this notice of termination, the magistrate judge found that an aggregate of $6463.50 of excess instant Lotto sales were post-voided at the Froelich store during the five-month period ending January 31, 1997. R & R, at 9. The Froelich store reported an inventory overage of $5024. Id. During the three-year period ending January 31, 1997 at the Hudson store (a period of time during which Froelich had managed and was employed by the Hudson store), an aggregate of $139,268.20 in excess Lotto sales had been post-voided. Id. The Hudson store, during this period of time, had inventory overages of $23,580. Id.

Froelich admitted that he had knowledge of various fraudulent activities at the Hudson store, but argued — in the face of clear evidence to the contrary — that he had not engaged in those activities at his own store. Froelich testified that the funds obtained through the Lotto post-void scheme at his own store were used to pay obligations to the state lottery commission. Significantly, the magistrate judge also stated that he "was not particularly persuaded by the testimony" Froelich gave during the evidentiary hearings. R & R, at 17 and 19.

Southland issued a supplemental notice of material breach and termination to Froelich on June 24, 1997. Pl.Ex. 20-1. This notice detailed Froelich's "acceptance of secret cash rebates from . . . various vendors . . . which [Froelich] failed to disclose to or deposit in a bank account designated by 7-Eleven." Pl.Ex. 20-1, ¶ 3. The notice also pointed out the defendant's submission to 7-Eleven falsely inflated invoices that did not accurately reflect the true cost of merchandise purchased. Id. Once again, 7-Eleven did not rely on paragraph 28 of the agreement, but instead stated that the listed breaches were "willful, fraudulent, intentional activities . . . that constitute[d] Material Breaches of the Agreement and violate the very core of the contractual relationship." Id., ¶ 4.

Magistrate Judge Pohorelsky found that Froelich essentially admitted having participated in this kickback scheme and that the testimony about Froelich's participation was unrebutted. R & R, at 11. Moreover, the record is clear that Froelich discussed with these vendors the fact that the invoices were to be inflated by ten percent, prior to the first issuance of an inflated invoice. Pl.Ex. 3, at 217-18. Inflated invoices were given on a weekly basis for four weeks. Id., at 217.

Southland issued another supplemental notice of material breach and termination on October 17, 1997. Pl.Ex. 20-2. This notice, of course, was the third in a ten-month period. This notice of material breach accused Froelich of selling significant quantities of high volume categories of merchandise at prices higher than the retail prices reported to 7-Eleven. Id. ¶ 3. Again, 7-Eleven stated that it considered the breaches to be "willful, intentional activities . . . that constitute[d] Material Breaches of the Agreement and violate[d] the very core of the contractual relationship." Id.

The magistrate judge described the breaches alleged in the October 17, 1997 Notice, finding that in twenty-eight of forty-four secret "shops" conducted at Froelich's store, at least one item was purchased at a price higher than that reported to Southland. R & R, at 12. The magistrate judge also found that many of the "shops" involved repeating purchases of the same item on different days. Id. Most of the price differences were in the $.10 to $.30 range. Id.

Regarding these "shops," Southland points out that the Froelich store was shopped forty-four times over twenty-nine days in five different months, and that over forty-six products were purchased. Pl.Ex. 21-1 and 23. Fifteen of the forty-six products were sold at prices higher than those reported to Southland. Given the extent of the evidence supporting Southland's claims of material breach, the Court holds that, in each of these notices, Southland was within its rights as a franchiser to rescind the contract without opportunity to cure. Therefore, the franchise agreement between Southland and Froelich was terminated no later than October 20, 1997.

B. Common Law Rescission

The reason that Southland was entitled to rescind the agreement, despite the apparent restrictions of paragraph 28, is found in the common law contract principle that holds that a material breach that goes to the root of the matter or the essence of the contract constitutes grounds for rescission without opportunity to cure. Southland Corp. v. Mir, 748 F. Supp. 969 (E.D.N.Y. 1990) (Mishler, J.). Southland argues that Froelich's actions were of a sufficiently serious nature that the breaches frustrated the essential purpose of the agreement and went to the core of the franchise relationship. As such, Southland contends that its termination of the agreement, without opportunity for cure, was appropriate and lawful.

This Court agrees that the principles of common law rescission of a contract under New York law, as discussed and applied in Mir, apply to the facts presented here. First, the fact that "fraud" was not included in paragraph 28's list of material breaches does not prevent the parties from having intended that termination for fraud was nevertheless contemplated by the agreement. See Mir, 748 F. Supp. at 983. "Unless a contract provision for termination for breach is in terms exclusive, it is a cumulative remedy and does not bar the ordinary remedy of termination for `a breach which is material, or which goes to the root of the matter or essence of the contract.'" Id. (quoting Olin Corp. v. Central Indus., Inc., 576 F.2d 642, 647 (5th Cir. 1978)) (citations omitted). There is nothing in paragraph 28 of the franchise agreement that indicates that the contract could only be terminated for the reasons stated therein.

Southland argues that the fraud allegedly committed by Froelich, including the Lotto post-voids, the invoice kickbacks, and selling prices higher than those reported to Southland, is fraudulent conduct that goes to the very essence of the contract. Fraud is "[a] false representation of a matter of fact, whether by words or by conduct, by false or misleading allegations, or by concealment of that which should have been disclosed, which deceives and is intended to deceive another so that he shall act upon it to his legal detriment." Black's Law Dictionary 660 (6th ed. 1990). Froelich's actions here indicate that Southland is substantially likely to succeed on the merits of its claim that Froelich committed fraud, which, in turn, justified Southland's termination of the franchise agreement without opportunity for cure. See L.K. Comstock & Co. v. United Eng'rs & Constructors, Inc., 880 F.2d 219, 232 (9th Cir. 1989) (holding that party may rescind contract, despite clause governing its termination, where breach frustrates the purpose of the agreement). Thus, the question squarely is presented: did the alleged breaches of the franchise agreement by Froelich violate Southland's rights under the contract such that the breaches go to the root of the matter or essence of the contract?

As in Mir, which also interpreted a contract between Southland and its franchisees, the franchise agreement here implies a covenant not to engage in schemes or gimmicks that deprive Southland of its contractual share of the gross profit. See Mir, 748 F. Supp. at 983-84. "In every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of that contract, which means that in every contract there exists an implied covenant of good faith and fair dealing." Kirke La Shelle Co. v. Paul Armstrong Co., 263 N.Y. 79, 87, 188 N.E. 163, 167 (1933); see also Restatement of Contracts 2d, § 205 ("[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.").

Southland's contractual share of the gross profit is 52%. Pl.Ex. 2-2, Exh.D, ¶ (j). The magistrate judge found that Froelich had post-voided Instant Lotto sales, which resulted in an understatement of total merchandise sales. R & R, at 10-11; see also Pl.Ex. 3, at 144-45. The intentional understating of merchandise sales, for any reason, deprives Southland of its proper share of the store's gross profit.

The magistrate judge also found that during the five-month period ending January 31, 1997, an aggregate amount of $6463.50 in excess of actual instant lotto sales at the Froelich store was post-voided. Id., at 9. The magistrate judge further found that Froelich had admitted to participating in a kickback scheme with two vendors and failing to report the kickbacks to Southland. Id., at 11. This evidence, despite Froelich's after-the-fact explanations for his conduct (which the magistrate judge described as "not particularly persuasive") clearly establishes that Froelich knowingly and willingly deprived Southland of its right to 52% of the gross profit to which it was entitled under the agreement.

Having found substantial evidence of the repeated violation of the franchise agreement by Froelich, the Court holds that these violations, under New York law, go to the "root of the matter or essence of the contract." See Mir, 748 F. Supp. at 984; see also Wisser Co. v. Mobil Oil Corp., 730 F.2d 54, 59 (2d Cir. 1984) (under Petroleum Marketing Practices Act, franchisee's selling of misbranded gasoline was a breach so serious that it undermined the entire contractual relationship, eliminating opportunity to cure). It is clear that the nature of the breaches, occurring over at least five-month span of time at Froelich's store (and for years before that under Froelich's watch at the Hudson store), are such that the relationship between Southland and Froelich has been altered irrevocably and cannot be revived. Southland has been deprived of its contractual right to receive "the fruits of [its] contract" with Froelich. See Kirke La Shelle, 263 N.Y. at 87, 188 N.E. 163. Thus, Southland was entitled to terminate the agreement, without opportunity to cure, for the reasons set forth in each of its notices of material breach and termination.*fn7 See S & R Corp., 968 F.2d at 375, 377 (holding that dispute over termination of franchise agreement does not prevent issuance of preliminary injunction and that franchiser has independent ability to determine whether termination is appropriate). Thus, having determined that the termination of the franchise agreement was valid, the Court finds that Southland is substantially likely to succeed on the merits of its claims of trademark infringement and violation of real property rights, and that it has shown irreparable harm on both of these claims. Southland's application for a preliminary injunction is GRANTED.

III. Southland's Application for an Order of Seizure

Southland also seeks an order permitting it to replevy the secured inventory and proceeds of the Froelich store. See Order to Show Cause, April 9, 1997, ¶ 2. In particular, Southland seeks an order seizing from the defendant all of the goods held for sale at the Froelich store and all of the equipment formerly leased by Southland to Froelich. Id.

Rule 64 of the Federal Rules of Civil Procedure governs this request. The rule states, in relevant part, that

  all remedies providing for seizure of . . . property
  for the purpose of securing satisfaction of the
  judgment ultimately to be entered in the action are
  available under the circumstances and in the manner
  provided by the law of the state in which the
  district court is held. . . . The remedies thus
  available include arrest, attachment, garnishment,
  replevin, sequestration, and other corresponding or
  equivalent remedies.

Fed.R.Civ.P. 64. The issuance of an order of seizure for chattels in New York is governed by Article 71 of the CPLR.

Upon the opening of his store, Froelich was provided financing by Southland for its operation. Pl.Ex. 2-2, Exh.D. To secure the obligation owed to Southland, Froelich granted Southland a security interest in the store's inventory. Pl.Ex. 2-16. The amount financed was placed in the Open Account, the balance of which represents the amount of money that Southland has loaned or advanced to the franchisee. Pl.Ex. 2-2, Exh.D. Southland reserves the right to terminate its financing at any time. Cadigan Aff., ¶ 21; Pl. Ex. 2-2 and 2-16.

Upon termination of the Franchise Agreement, franchisees are required to

  [p]eaceably surrender the store and equipment . . .;
  transfer the final inventory . . . to 7-Eleven;
  transfer to 7-Eleven the Receipts, cash register
  fund, prepaid Operating Expenses, money order blanks,
  bank drafts, and store supplies; cease using the
  Service Mark and the 7-Eleven System, including the
  Trade Secrets; return FRANCHISEE'S copy of the
  "Franchise Systems Manual"; and return all Trade
  Secrets and other 7-Eleven System material.

Pl.Exh. 2-2, ¶ 30. The Court has determined, supra, that the franchise agreement between Southland and Froelich terminated no later than the end of October 1997. Froelich remains in possession of the store and its inventory, despite the language of the franchise agreement which governs surrender of the premises, inventory and equipment following termination.

The Security Agreements provide Southland with the right to repossession of the inventory. Pl.Ex. 2-16, ¶ 5; see also N YU.C.C. § 9-503 ("[u]nless otherwise agreed a secured party has on default the right to take possession of the collateral."); In re Yale Express Sys., Inc., 370 F.2d 433, 437 (2d Cir. 1966); Mir, 748 F. Supp. at 986-87; Honeywell Info. Sys., Inc. v. Demographic Sys., Inc., 396 F. Supp. 273, 277 (S.D.N.Y. 1975). To establish a cause of action under Article 71, a plaintiff must show that it has an immediate and superior right to possession of the goods. Dubied Mach. Co. v. Vermont Knitting Co., 739 F. Supp. 867, 872 & n. 4 (S.D.N.Y. 1990) (quoting De Weerth v. Baldinger, 658 F. Supp. 688 (S.D.N.Y.) rev'd on other grounds, 836 F.2d 103 (2d Cir. 1987)).

Given Southland's termination of the franchise agreement, Southland has satisfied the prerequisite for the issuance of an order of seizure. Thus, the application for an order of seizure is GRANTED.

IV. Issuance of a Preliminary Injunction and Order of Seizure

Southland is directed to submit a proposed order of preliminary injunction and seizure to the Court, in compliance with Federal Rules of Civil Procedure 64, 65(c), and 65(d), within five (5) days of receipt of this Memorandum and Order. In accordance with Fed.R.Civ.P.64, the Court conditions the issuance of an order of preliminary injunction on Southland's giving of security in the amount of $75,000.

In the interim period, Froelich is ORDERED not to interfere with the real property, inventory, or other chattels that are the subject of this Memorandum and Order or of Southland's April 9, 1997 Order to Show Cause. Froelich also is ORDERED not to interfere with Southland's rights under the franchise agreement, the security agreement, any other agreement between he and Southland. Froelich is further ORDERED to perform no acts inconsistent or otherwise not in harmony with this Memorandum and Order.

CONCLUSION

For the reasons stated above, the Court ADOPTS IN PART the Report and Recommendation of Magistrate Viktor V. Pohorelsky, dated February 26, 1998.

Southland's application for a preliminary injunction and an order of seizure is GRANTED. Froelich's application for a preliminary injunction is DENIED. Orders to issue.

SO ORDERED.


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