Foodmaker in food fight with franchisee

Abstract

Foodmaker International Franchising, Inc., and Foodmex, Inc., its master licensee in Mexico, are in a messy food fight that has splattered into courts on both sides of the border.

Foodmaker International Franchising, Inc., and Foodmex, Inc., its master licensee in Mexico, are in a messy food fight that has splattered into courts on both sides of the border.

Foodmaker International, the wholly owned subsidiary of the San Diego-based Foodmaker, Inc., has been trying to terminate its 7-year agreement with Foodmex since late last year.

That's the day Foodmaker gave Foodmex a formal "cure or termination" notice, outlining what it calls performance deficiencies.

Under its master license agreement (MLA), Foodmex was granted the right to license, develop and operate Jack In The Box restaurants in Mexico and to use the official logo.

In return, Foodmex agreed to pay licensing and royalty fees to Foodmaker International, according to company documents.

Foodmex also was obligated to develop a certain quota of eateries a year; to monitor license compliance with established quality control and operational systems and standards; and "to maintain sufficient solvency and capitalization to insure that Foodmex and its licensees remained economically viable."

According to Foodmaker, an audit 30 days after the notice was issued showed that the problems had not been resolved.

"Foodmex," it said, "was in no better financial condition. Termination of the MLA was warranted and appropriate."

"The bottom line is that in international franchising, picking the right partner is the key to success," Tim Pickwell, corporate counsel for Foodmaker, Inc., and director of Foodmaker International, said in a phone interview.

"In Foodmex, we have the wrong partner. They are undercapitalized and insolvent and they are failing to comply with our operational standards."

But Foodmex decided to fight the termination order, continuing to operate all of its 10 Jack In The Box eateries in Mexico. according to court papers filed in U.S. District Court's Southern District.

A flurry of suits and countersuits between the two parties followed. In March, federal Judge Napoleon A. Jones Jr. ruled in Foodmaker's favor.

In his decision, Jones concluded that Foodmaker had "demonstrated an immediate harm to their goodwill and reputation in light of Foodmex's continued use of the Jack In The Box proprietary marks."

The court denied Foodmex's request for a preliminary injunction against Foodmaker; and ordered Foodmex to comply with the termination order.

But Foodmex has refused to stop its Jack In The Box operations, prompting Foodmaker to go after a contempt of court action.

"We validly terminated our contract with them," Pickwell said. "They are defrauding consumers in Mexico by continuing to have our signs in Mexico and by disobeying a court order."

Foodmaker, he said, had attempted to cover all of the Jack In The Box signs at the 10 Mexican locations, with the support of the Ministry of Industrial Property in Mexico.

Pickwell said the ministry -- an outgrowth of NAFTA -- is empowered to seize counterfeit products and shut down businesses illegally using corporate trademarks in Mexico.

"The ministry acted and its inspector visited the 10 restaurants on April 30 and covered the signs," Pickwell explained. "They also used big hoods to cover pole signs."

But, he added, Foodmex was able to get an injunction in a Tijuana district court against the ministry and had the covers removed.

"Foodmex and its subsidiaries represented that it had valid rights to use Jack In The Box signs, even though we terminated the deal," Pickwell said. "They misrepresented the situation and filed erroneous documents."

Fernando Orvananos, president of Foodmex, denied the charge.

As for the signs, Orvananos said, "My Mexican partners are assuming that in order for them to remove the signs, they need a legal order from a Mexican judge."

He said he recently filed suit against two of his licensees in Mexico to force them to remove the signs.

"I don't want to do this," he said. "These are people I work with. But I have no choice."

Orvananos also said he had asked Foodmaker to agree to have the dispute mediated.

"But I have had no response," he said. Meanwhile, Foodmex is suing Foodmaker International for $30 million in damages, compensatory damages and attorney's fees.

"We're just trying to stay alive," Orvananos said. "We don't think that this is a way of doing business. It's always better to find a solution than to have litigation."

As for the charges that Foodmex hasn't complied with the MLA, Orvananos said that Foodmaker is just using a smokescreen to mask its real motivation for terminating the contract -- a desire to shut down its international operations due to concerns over another possible outbreak of food poisoning like the e. coli virus outbreak that jolted Foodmaker in 1993.

"I believe they think it's difficult for them to control the international, as opposed to their United States operations," he said. "It's just a lack of knowledge of the international market. Other companies are booming."

As evidence of Foodmaker's alleged desire to end its international operations, Orvananos cited pending litigation -- also in federal court in San Diego -- by Foodmaker's Hong Kong licensee, Woisey, Ltd., over its 5-year development agreement with Foodmaker.

Wolsey is seeking $25 million in damages against Foodmaker for breach of contract.

"We have seven units in Hong Kong," Pickwell said, confirming the litigation. "Our relationship has been a little rocky in the past three years."

But, he added, Hong Kong sales are doing well and Foodmaker has no plans to terminate its international end of the business, which, Pickwell said, generates only a small portion of Foodmaker's $1.2 billion revenue.

Asked why Foodmaker retains its international presence, Pickwell said, "It's a crowded market in the United States and there are opportunities in foreign markets if you find the right partners."

But Orvananos isn't convinced. "We are all in court," he said. "Doesn't that make it seem they want to get out of international?" Dennis O'Dorisio, the San Diego-based legal counsel for Wolsey, Ltd., agreed.

"Foodmaker got into the international business in a very contrived fashion. They didn't know what they were doing.

"Now they want to get out and, instead of going to their international developers to work out a solution, they're trying to bludgeon them out of business."

As for Foodmaker's charges that Foodmex failed to expand its locations on schedule and pay its bills on time, Orvananos blamed the Mexican peso crisis that began at the end of 1994.

"We had opened 10, but after the peso crisis, it made no sense to open more restaurants. Nobody was opening restaurants.

"This was a surprise for us," Orvananos said of Foodmaker's action. "For two years, they understood. We had a good relationship."

Foodmex's money problems, Orvananos said, also are tied in with the peso crisis.

"When the crisis came, interest rates jumped 120 percent a year," he said. "It wasn't only us. More than 90 percent of Mexican businesses could not pay on time their interest."

The Mexican government then came in with a plan to restructure all debts of private companies, he said.

"It's just something that happened," he said. "It was the nature of the crisis. But Foodmaker said it you can't pay on time, we can cancel.

"They are pushing us to close down everything. All are doing well. Some may have lower sales than others, but at least all the ones we have in Tijuana and Mexicali do, on average, as well as those in the United States. It doesn't make sense to close them."

But Pickwell said that Foodmex was insolvent long before the peso crisis, owing Foodmaker more than $800,000 in equipment and food purchased through the company, as well as in unpaid royalties and service charges.

"Then the peso devaluation happened and we did try to work with them for a long time," Pickwell said.

"We felt that as long as our standards were being met, this was our best chance to get our money back, hoping that the economy would turn around.

"But on Aug. 9, 1996, they told us they needed to restructure, that they were losing money on eight of their 10 restaurants. They said, 'We need a new deal." We said, 'Enough is enough.'"

As for charges that Foodmex was using unapproved products at its restaurants, Orvananos denied this.

"From day one, we though that all of our products had been approved," he said. "Foodmaker audited all of our restaurants and we received a 93.5 rating on quality, cleanliness, healthiness, food safety."

Pickwell acknowledged that Foodmex received a high rating in some aspects of its operations.

"But they were sourcing food products from vendors that had not been approved by Foodmaker," he said. "We encourage our franchisees in the international market to find alternative suppliers. But they have to be approved."

Foodmex, he said, found an alternative supplier of chicken patties that was found to be deficient by Foodmaker's quality assurance inspector.

But, Pickwell said, Foodmex, despite being notified of the problem, continued to use the supplier "to save a few pennies."

Added Pickwell, "All of our company-owned restaurants and franchise restaurants in the United States and the international market are required to comply with our operating standards. We are adamant. This is not negotiable."

Meanwhile, Orvananos said he is actively looking for buyers for his restaurants.

His options, he said, are limited in the fast-food market in Mexico. The cost of starting over, he added, would be prohibitive.

"It's easier to sell our restaurants than to convert them," Orvananos said. "There is no way we can become a Burger King."