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Schwartzco Enters. LLC v. TMH Mgmt., LLC

United States District Court, E.D. New York

November 17, 2014

SCHWARTZCO ENTERPRISES LLC, a New York Limited Liability Company; THE MEAT HOUSE-ROSLYN, LLC, a New York Limited Liability Company; and ARNOLD M. SCHWARTZ, an individual resident of New York, Plaintiffs,
v.
TMH MANAGEMENT, LLC, a New Hampshire Limited Liability Company; TMH VENTURES, LLC, a New Hampshire Limited Liability Company; MEAT HOUSE FRANCHISING, LLC; a New Hampshire Limited Liability Company; JUSTIN ROSBERG, an individual resident of New Hampshire; THOMAS BROWN, an individual resident of New Hampshire; and KERRY MILLER, an individual resident of Massachusetts, Defendants

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For the Plaintiffs: David J. Meretta, Esq., Scott T. Kannady, Esq., Of Counsel, Brown & Kannady, Denver, CO.

For the Plaintiffs: Richard L. Rosen, Esq., John A. Karol, Esq., Of Counsel, The Richard Rosen Law Firm, PLLC, New York, NY.

For Thomas Brown, Defendant: William C. Kelly, Esq., Of Counsel, Tompkins McGuire Wachenfeld & Barry LLP, Newark, NJ.

NO APPEARANCES: The Defendants TMH MANAGEMENT, LLC, a New Hampshire Limited Liability Company; TMH VENTURES, LLC, a New Hampshire Limited Liability Company; MEAT HOUSE FRANCHISING, LLC; a New Hampshire Limited Liability Company; JUSTIN ROSBERG, an individual resident of New Hampshire; and KERRY MILLER, an individual resident of Massachusetts.

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MEMORANDUM OF DECISION AND ORDER

ARTHUR D. SPATT, United States District Judge.

On February 19, 2014, the Plaintiffs Schwartzco Enterprises, LLC (" Schwartzco" ), a New York limited liability company; the Meat House -- Roslyn LLC (" TMH Roslyn" ), a New York limited liability company; and Arnold M. Schwartz, an individual resident of New

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York (collectively the " Plaintiffs" ) filed a complaint containing 17 causes of action against the Defendants TMH Management, LLC (" TMH Management" ); TMH Ventures, LLC (" TMH Ventures" ); Meat Housing Franchising, LLC (" MHF" ); Justin Rosberg (" Rosberg" ); Thomas Brown (" Brown" ); and Kerry Miller (" Miller" )(collectively the " Defendants" ). In essence, the Plaintiffs alleged that the Defendants orchestrated a fraudulent scheme involving the sale of MHF franchise and area developer rights to the Plaintiffs in violation of certain state franchising laws and regulations, among other statutes.

Each of the Defendants defaulted, except for Brown, a managing member of MHF. Only one claim, the fifteenth cause of action sounding in an alleged violation of the New York Franchise Sales Act, N.Y. Gen. Bus. Law § § 680, et seq. (the " NYFSA" ), directly referenced Brown.

On July 24, 2014, Brown moved pursuant to Federal Rule of Civil Procedure (" Fed. R. Civ. P." ) 9(b) to dismiss the complaint for failure to plead with the requisite particularity.

On September 19, 2014, the Plaintiffs cross-moved pursuant to Fed.R.Civ.P. 15(a) for leave to file an amended complaint. The proposed amended complaint contains 21 causes of action, none of which are specifically directed toward Brown alone.

In opposing the Plaintiffs' cross-motion to amend the complaint, Brown primarily contests the futility of the proposed causes of action. Indeed, Brown does not argue that the proposed amendment was prompted by bad faith on the part of the Plaintiffs or that the Plaintiffs unduly delayed in seeking leave to amend. Rather, Brown conclusorily asserts that he " would certainly be prejudiced by allowing such an amendment, which consists no less than 74 pages and often reads as a legal brief, because it would force him to expend significant additional resources in responding thereto and unnecessarily delay his rightful dismissal from this litigation." (Brown's Reply Br., at 10.) The Court notes that to the extent the proposed amended complaint contains legal arguments, Brown has had ample opportunity to respond to those arguments, thereby minimizing any prejudice.

Where, as here, the Plaintiff seek to amend his complaint while a motion to dismiss is pending, a court " has a variety of ways in which it may deal with the pending motion to dismiss, from denying the motion [to dismiss] as moot to considering the merits of the motion in light of the amended complaint." Roller Bearing Co. of Am., Inc. v. Am. Software, Inc., 570 F.Supp.2d 376, 384 (D. Conn. 2008)(internal quotation marks and alteration omitted). " An amendment to a pleading is futile if the proposed claim could not withstand a motion to dismiss pursuant to Fed.R.Civ.P. 12(b)(6)." Annunziato v. Collecto, Inc., 293 F.R.D. 329, 333 (E.D.N.Y. 2013)(citing Lucente v. Int'l Bus. Machs. Corp., 310 F.3d 243, 258 (2d Cir. 2002)). " Therefore a proposed amendment is not futile if it states a claim upon which relief can be granted." Waltz v. Board of Educ. of Hoosick Falls Cent. School Dist., No. 1:12-CV-0507 (GTS)(CFH), 2013 WL 4811958, *4 (N.D.N.Y. Sept. 10, 2013)(citations omitted).

" As the [P]laintiffs do not seek to add new defendants and [Brown] had sufficient opportunity to respond to the proposed amended complaint, the merits of the motion to dismiss will be considered in light of the proposed amended complaint." Haag v. MVP Health Care, 866 F.Supp.2d 137, 140 (N.D.N.Y. 2012). " Indeed, if the proposed amended complaint cannot survive the motion to dismiss, then plaintiffs'

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cross-motion to amend will be denied as futile." (citing Dougherty v. Town of N. Hempstead Bd. of Zoning Appeals, 282 F.3d 83, 88 (2d Cir. 2002)).

I. BACKGROUND

Unless otherwise stated, the following facts are drawn from the proposed amended complaint, and construed in a light most favorable to the non-moving parties, the Plaintiffs.

A. The Parties

Schwartz, a surgeon, is the 100% owner of Schwartzco.

The Meat House franchise system includes butcheries that prepare and sell retail meats, fine cheeses, wine, groceries, prepared foods, and other gourmet food items.

TMH Management was established by The Meat House franchise system to manage The Meat House stores and franchises. Rosberg and the non-party Jason Parent (" Parent" ) are the co-founders and members of TMH Management, and Rosberg is its registered agent.

TMH Ventures was established by The Meat House franchise system to facilitate investment in and development of The Meat House brand. According to a 2012 Franchise Disclosure Documents (" FDDs), TMH Ventures " is an operations management company created to undertake joint business ventures with Area Developers in California, Florida, Oklahoma and New York." Rosberg and Brown are co-founders and members of TMH Ventures, and Rosberg is its registered agent.

MHF was established by the Meat House franchise system for the purpose of selling Meat House franchises. MHF is the franchisor and holder of the trademark for The Meat House franchise system. Rosberg is MHF's registered agent. Rosberg is also allegedly a " control" person of MHF under § 691(3) of the NYFSA.

The non-party Parent is the Managing Member and President of MHF and co-founder and member of TMH Management and TMH Ventures. Parent is also allegedly a " control" person of MHF under § 691(3) of the NYFSA.

Brown is the Chief Businesses Development Officer, Executive Vice President of Sales & Marketing, and a Managing Member of MHF, as well as an officer of TMH Management and TMH Ventures. He is a co-founder and member of TMH Ventures. Brown is also allegedly a " control" person of MHF under § 691(3) of the NYFSA.

Miller was another principal of the Meat House, but has since declared bankruptcy. The Plaintiffs are pursuing their claims against Miller in an adversarial bankruptcy proceeding.

B. Factual History

Beginning in early 2010, the Defendants allegedly pursued Schwartz, the sole investor in Schwartzco, to induce him to invest in acquisition rights to franchise and develop The Meat House stores in Westchester, New York; New York City; and Long Island.

The Defendants allegedly targeted Schwartz through his nephew, Cary Tober, a low-level employee in the Meat House franchise system. The Plaintiffs ultimately invested more than $2 million in The Meat House franchise system.

According to the Plaintiffs, the Defendants made " material false misrepresentations (and/or omissions)" verbally and in writing to the Plaintiffs; " used false, inflated, and misleading cherry-picked information, and generated numerous fraudulent financial spreadsheets and financial statements about the Meat House's current

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business and profitability (including false earnings claims), and what Plaintiffs could expect to generate in New York, with [the] Defendants operating the business." (Proposed Amended Compl. [" Amended Compl." ], at ¶ 4.). The Plaintiffs also assert that the Defendants violated the federal franchise disclosure law, including 16 C.F.R. 436 et seq. (the " FTC Act" ), and the NYFSA by failing to provide sufficient disclosures.

The Plaintiffs point to the individual defendants, including Brown, as " active participants" " independent of the [Defendant] entities" in the fraudulent scheme. (Id. at ¶ 11.)

The Plaintiffs contend that, as a result of the Defendants' fraudulent scheme, they entered into various agreements with certain of the Defendants and opened an area development entity and ultimately one franchised location, TMH-NY, in Roslyn, New York.

Despite the fact that TMY-NY was fully funded by Schwartzo, TMH Ventures reserved a 5% ownership interest for itself and the Defendants appointed TMH Management as its sole " manager." In this way, the Defendants retained equity and control over TMH-NY without bearing any financial risk. The Defendants allegedly abused their fiduciary responsibilities and funneled Schwartz's money towards opening TMH-NY as an expensive " show piece" location unable to operate at a profit.

According to the Plaintiffs, Brown and Rosberg were " directly responsible" for feeding Tober with much of the data that was utilized in misrepresentations to Schwartz, including financial information regarding operational expenses, profits, and build-out costs, in order to create a false and overly favorable impression of The Meat House franchise system. (Id. at ¶ 70.) As stated in the proposed amended complaint,

Brown, Rosberg, and Parent allegedly had access to complete information regarding how each of the franchise and company-owned units were performing, as well as the costs associated with opening and operating a franchise unit. With regard to Brown, he allegedly knew what the true profit and loss information, as well as the true cost of building-out and operating a unit was. He also knew what was permissible under the FTC Act, and the NYFSA, with respect to prohibited " earnings claims," and the requirement for adequate disclosure before offering to sell or selling a franchise (or at least should have known, although ignorance of the law is no excuse). Defendant Brown personally, repeatedly and directly presented Plaintiffs with fraudulent information in order to induce Plaintiffs into entering a joint venture with Defendants, entering into an Area Development Agreement, and multiple Franchise Agreements. Mr. Brown also omitted information from in-person and e-mail discussions with Plaintiffs that rendered the information presented to Plaintiffs materially misleading. Specifically, this information included profit and loss figures, revenue figures, profit margins for specific Meat House locations, anticipated costs including opening and " build out" costs for a new Meat House location, and the profitability and viability of the business as a whole. Mr. Brown was directly involved in providing (or failing to properly provide) Plaintiffs with the required Franchise Disclosure Documents (FDDs) - documents that contained materially false or inaccurate information which he knew to be false. Mr. Brown was involved in the mismanagement of the joint venture (e.g. hired an incompetent manager a full year before it was appropriate

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to do so; involved himself in daily operations and planning of the joint venture under the Operating Agreement.

(Id. at ¶ 74.)

The Defendants further allegedly extrapolated " averages" from cherry-picked store locations and periods of time; annualized those amounts to create highly inflated revenues and profits; and grossly underestimated costs of opening units in expensive markets by utilizing average rents from locations that were not indicative of what it would cost to operate a franchise in more expensive markets. (Id. at ¶ 76.)

On or about Wednesday, June 16, 2010, Schwartz attended a presentation with approximately ten employees and principals of The Meat House franchise system, including Rosberg, Brown, and Parent. The presentation included representations that the Meat House locations currently in operation generated in excess of three million dollars in sales per year. Parent, Brown, and Rosberg repeated the statement, alleged to be false, that The Meat House locations had a return on investment (" ROI" ) of 12% to 20%. Rosberg, Brown, and Parent also " touted a model for multiple units in a given area, suggesting that not only were 10 or 20 units viable in a geographical area (including, Long Island, Mr. Schwartz's then potential " territory" ), but that each unit opened, with a ROI of 12 to 20%, would fund the opening of successive units." (Id. at ¶ 90.) The Plaintiffs maintain that Brown " was the individual who orchestrated the meeting and he led a great deal of the discussion that took place," (Id. at ¶ 92.) although they fail to provide significant, if any, detail in this respect.

Following the meeting, Brown emailed Schwartz, stating as follows:

Arnie,
On behalf of The Meat House crew, thanks very much for taking the trip up and spending time with us. We are highly confident it will prove to be a very worthwhile investment of time and energy.
I will circle back with Cary to make sure you have everything you need for analysis. I believe you do, but if anything else pops up, please do not hesitate to contact me or anyone else on the team. Very much looking forward to the potential of working with you to dominate the NYC/Long Island marketplace..."

(Id. at ¶ 100.)

Schwartz was also encouraged to visit store locations, and he visited one in Avon, Connecticut, which was held out by the Defendants to be a successful store. Brown subsequently emailed Schwartz stating that " Avon's success is certainly indicative of the market opportunity across the board." (Id. at ¶ 96.) Avon has since ceased operations, for reasons unexplained.

In June of 2010, the Defendants forwarded to the Plaintiffs an FDD and then an amended FDD in October of 2010. Item 7 of the 2010 FDD stated that franchisees would be able to open up a franchise location for an investment between $270,000 and $950,000 -- amounts which included the $120,000 franchise fee, and which Parent, Brown and Rosberg allegedly knew were not correct. In this regard, the Defendants ultimately spent more than $1.2 million of the Plaintiffs' money to open up the first franchise location on Long Island.

The Plaintiffs contend that the Defendants violated New York, New Hampshire, and federal law when they solicited the Plaintiffs to invest in the franchise system without first providing the Plaintiffs with a FDD.

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As a result of the Defendants' solicitations, the Plaintiffs entered into a series of agreements, including (1) a January 20, 2011 joint venture Operating Agreement with the franchisor, (2) a January 20, 2011 Area Development Agreement, (3) a January 20, 2011 Franchise Agreement, and (4) an August 3, 2011 Franchise Agreement.

The Operating Agreement contained an arbitration provision. That provision provides, in pertinent part: " In the event that any dispute should arise among the parties hereto with respect to any matter covered by this Agreement, the parties hereto shall resolve such dispute in accordance with the procedure set forth in this Article XII." The arbitration provision further requires arbitration to be held in Nassau County, New York State, administered by the American Arbitration Association (" AAA" ), and held before a single arbitrator.

The Plaintiffs characterize their investment in The Meat House Franchise system as a " financial disaster" for them. (Id. at ¶ 8.) According to the Plaintiffs, the Defendants " drained Plaintiffs of their money, went far 'over-budget,' mismanaged the only unit that opened (in Roslyn, NY), failed to open multiple units as required by their own agreements, and utilized Plaintiffs' money for the purposes of enriching themselves, and creating an unworkable and expensive 'show piece' location to try and sell other 'would-be' franchisees into buying into the system." (Id.).

According to the Plaintiffs, Brown " ultimately made many of the key decisions concerning the Roslyn location, as he selected key employees of the Roslyn location, was involved in the selection of the location itself (and selling it), and was generally heavily involved in its operations, and in his dual role with the joint venture." (Id. at ¶ 139.)

By October 2012, less than ten months after the opening of the Roslyn Store, the parties, through a termination agreement, agreed to remove TMH management as the manager of that store. (Id. at ¶ 181.) Thereafter, Schwartzo operated the Roslyn Store.

On January 5, 2014, the Roslyn Store closed operations permanently. (Id. at ¶ 195.)

C. Procedural History

By letters dated December 20, 2013 and January 6, 2014, the Plaintiffs invoked the dispute resolution provisions of the Operating Agreement and/or other related agreements. The Defendants did not comply.

On February 19, 2014, the Plaintiffs commenced a separate action against TMH Management, TMH Ventures, Meat House Franchising, LLC, Rosberg, and Brown, entitled Schwartzco Enterprises, LLC et al. v. TMH Management, LLC et al., bearing Index No. U.S.D.C., E.D.N.Y., 2:14-cv-1084 (ADS)(GRB). The defendants in that action, save for Brown, are in default.

Also, as noted above, on February 19, 2014, the Plaintiffs commenced this action. In this action, Brown is the only defendant not in default.

As noted above, on July 24, 2014, Brown moved to dismiss the complaint as against him for failure to comply with Fed.R.Civ.P. 9(b).

On August 4, 2014, the Plaintiffs commenced an arbitration against the Defendants, including Brown, before the AAA, entitled Scwhartzco Enterprises, LLC, et al. v. TMH Management, LLC et al., AA Case No. 01-14-0001-1207, based on the same transactions and occurrences as alleged here. Brown has declined to participate

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in that arbitration on the basis that he is a non-signatory to the Operating Agreement. (See Pls' Exh Q, Operating Agreement, Schedule A.)

On August 5, 2014, the Plaintiffs filed a separate action in the Federal District Court for the Eastern District of New York against Parent under the index no. 14-cv-4631. That case was deemed related to this case, and subsequently assigned to this Court.

By letter dated August 7, 2014, in this action, the Plaintiffs asked the Court to hold Brown's motion to dismiss in abeyance until resolution of their anticipated ...


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