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Developers of Dagwood's Sandwich sue for fraud

A lawsuit filed by a pair of Dagwood's Sandwich Shoppe developers begins with a three-and-a-half pageintroduction that starts with the following sentence: "This case concerns the repeated, intentional and naked fraud of a franchisor, Dagwood's Sandwich Shoppe."

It goes downhill from there.

Filed in federal court in March, the complaint alleges that Dagwood's founders engineered a broad-based conspiracy to commit fraud and make off with "millions of dollars" from numerous franchise developers, known by the company as "market partners." The allegations say the conspiracy began with the company's co-founders, including Dean Young, the son of "Blondie" comic strip creator Chic Young.

Dagwood's Sandwich Shoppe founders are accused of going through the motions of franchising before filing for bankruptcy protection in April.

"Unlike other cases, where franchisor fraud arises out of specific misrepresentations made to specific franchisees by a few unscrupulous franchise salesmen, this case involves the conspiracy designed by the very founders of Dagwood's to commit wholesale unrestrained and continuous fraud on unsuspecting investors," the lawsuit states, adding "Fraud was the dominant trait for Dagwood's from the moment it was conceived."

Regardless, it appears that Dagwood's Sandwich Shoppe burst onto the franchising scene only to flame out quickly. The company, created in 2005, at one point appeared to be on the verge of becoming a fast-growing major franchise, having secured development deals worth more than 1,000 units. It managed to open 14 franchises–with another six to be open this year–before filing for bankruptcy protection in April.

Many of those units remain open, but the chain's developers–who paid as much as $450,000 to develop the brand in their territory–may be left out in the cold, depending on what happens with the bankruptcy.

"Most fraud cases play off an offering circular or a salesman's puffing or lies," said Jeff Goldstein, an attorney for the franchisees. "This fraud is different. We're alleging that there was no product, no franchise that existed that was viable which would enable franchisees to even have a chance to survive."

Efforts to reach company officials were unsuccessful.

Dean Young and Lamar Berry started the chain with the license to use the Dagwood Bumstead character in the 75-year-old comic strip, playing off his famous love of sandwiches. The company's Web site proclaims that "unlike other QSRs" named after people, Dagwood is actually involved with the sandwich shop. It says, "When guests walk into Dagwood's Sandwich Shoppes they will feel, smell and taste Dagwood's passion for sandwiches."

The franchisor opened a corporate unit and began selling area development rights to market partners. By last fall the company had sold 27 territories worth 1,354 units, a number that would propel the company into major franchisor status. An individual store would cost as much as $346,000 to open and franchisees would be required to pay a 6.5 percent royalty and a sizable 4.5 percent to an ad fund. Yet even free from the royalty and ad fund the corporate store in Palm Harbor, Florida, struggled and ultimately closed. That store is at the center of many of the lawsuit's allegations, because market partners believe they were lured to the company by its financial performance.

The company "manipulated" that store's financials to make it seem more profitable, the lawsuit alleges. Dagwood's used corporate employees to staff the restaurant and reduce apparent labor costs. The lawsuit also says the company used supplies from its test kitchen to supplement the store's food without making the proper inventory allocations, thus reducing food costs. In addition, the lawsuit alleges the company inflated the store's revenues by
having workers buy food at the store using corporate funds.

By the middle of last year, the chain apparently couldn't hide the Palm Harbor store's problems, according to the lawsuit. Sales fell by 20 percent between May and July, causing one employee to call for an "emergency project" to improve labor, sales and food costs at the store so sales do not appear "embarrassingly and alarmingly reversed," according to the lawsuit. The company later labeled the store's problems a "predictable summer sales decline."

"A profitable Dagwood's restaurant has never existed," the lawsuit claims. "Not even the prototype restaurant built and operated by Dagwood's itself operated profitably."

The lawsuit also alleges that the company did little in terms of franchise support. It didn't have promised prototype architectural drawings for new stores, the lawsuit says, which caused delays and cost overruns. And it didn't provide franchisees with a promised template to help with marketing their stores.

In addition, the company and its sales staff made several sales and marketing boasts, with one company official apparently promising at one point that two stores would open every week in 2007. Meanwhile, once stores did open the costs owners had to pay for supplies was high, according to the lawsuit–a printer cost $796, much more than double the cost of an equivalent printer in the store.

"It appears to me that they just went through the motions," Goldstein said.

"It's as though the system was great in idea and in the marketing program they put together, but it was never effectuated by anyone with profitable results."There are indications that company officials were trying to raise money to keep the franchisor afloat. According to the lawsuit, it offered to sell shares of stock, each worth 1 percent of the company, for $100,000 apiece. The plan was to sell 15 percent of the company to raise a total of $1.5 million.

Updated financial records were not available, but in its 2007 UFOC the company states it lost $5.3 million in 2006.

The most significant allegation in the lawsuit, however, is that the money paid by the market partners appears to have disappeared. "Every penny has made its way into the savings accounts and IRAs of plaintiffs into the coffers of Dagwood's and its officers," the lawsuit alleges.

Goldstein's lawsuit names several individuals, including Young and Berry, and he said he plans on asking for a freeze on their assets. Still, how do these problems qualify as "naked fraud" and not simply a bad, undercapitalized business in a highly competitive market? Goldstein replied that company officials began by misrepresenting the experience they had in the world
of franchising–another allegation in the lawsuit–and then massaged finances when they did get going.

"If they had known about it then, the market partners could have gotten out," Goldstein said. Company officials, he added, continued to paint a successful picture that "kept the market partners in and lured additional market partners when the company should have known" the concept wasn't working.



Franchise Times - May 2008