Steak ‘n Shake’s push into Denver goes very wrong, very quickly
Just last September, three members of the Baerns family and their company known as Globex were gung-ho about expanding the Steak ‘n Shake franchise in Denver.
They purchased two existing stores from the brand’s only operator in the market, lured by long lines and customers so enthusiastic they’d drive from as far away as New Mexico or Wyoming.
They also scooped up development rights to add up to 13 stores over the next six years. The restaurants throw off so much cash—more than 20 percent of net sales, they say they were told—that their profits could fund a brisk expansion.
Barely 10 months in, and it’s all gone terribly wrong.
First the Baerns hollered about Steak ‘n Shake’s insistence they charge $3.99 for a three-item combo meal, and expand to about 20 the number of items that qualify for that price, claims their attorney, Scott Kannady of Brown & Kannady in Denver.
He says they tried to negotiate with corporate but got only silence. “By making us put in this maximum pricing policy, they’re effectively going to put us out of business because we can’t make a living,” Kannady says.
Then Steak ‘n Shake Enterprises did respond, with the nuclear option: a termination notice filed July 3, which followed a notice of default dated June 18, for cause.
The franchisor had received “numerous customer complaints” about Globex’s “failure and refusal to comply with mandatory promotions run system-wide, including its highly successful $4 menu,” says the Steak ‘n Shake complaint.
The Baerns group shot back with a counterclaim, disputing the grounds for the termination—they did so comply with every aspect of the franchise agreement, they said. Plus they added a fraud charge, claiming executives knowingly made false or misleading claims about store performance.
The counterclaim reaches all the way to the top, referring to Sardar Biglari, chairman and CEO of the chain. According to Christopher Baerns, Biglari said last November that new prototype restaurants “were designed to achieve at least $12 million in annual revenue, and that same-store sales could be increased by 10 percent per year” if franchisees followed the plan.
The two Denver stores, the Baerns say, are grossing far too little to allow for the expansion required in their agreement. They’re vowing to operate on, defying Steak ‘n Shake’s mandate that they cease and desist. Meanwhile Kannady tells the Baerns’ side of the story every time a TV station shows up or a newspaper reporter calls, while Steak ‘n Shake remains silent as per corporate policy.
“It’s a popular place, and my clients want to expand in all of Denver. They want to be part of the brand,” Kannady says. “They just want to be able to make a living.”
Is this any way to expand a franchise?
A sore topic: maximum pricing
Steak ‘n Shake Enterprises, based in Indianapolis, operates 414 company-owned stores in 15 states and 102 franchised stores in 23 states. Ric Cohen, partner at Cheng Cohen in Chicago and the franchisor’s outside attorney, declined to comment on the litigation, citing his client’s “adamant” policy against doing so. He said the franchisor’s position is clearly stated in its complaint, filed in U.S. District Court in Denver.
Cohen did agree to discuss the very sore topic of maximum pricing, those bargain menus—like the famous Subway $5 footlongs—that have been vexing franchisors and franchisees ever since a U.S. Supreme Court ruling in 1997.
Before State Oil Co. vs. Kahn, Cohen explains, arrangements in which a franchisor dictated prices charged by franchisees were presumed illegal under antitrust laws. “This case comes along, and said there are so many good things that could come from maximum pricing that we’re not going to make it illegal,” Cohen says. “Along comes this case and everybody says, OK, great, now we can do it.”
The practice didn’t really get rolling, however, until after the fall of 2008. “Then what happened was the Great Recession, and the importance across QSR and fast food and virtually every segment for value propositions,” Cohen says.
Those dollar menus and 50-cent ice cream cones and $5 footlongs—or $4 Steak ‘n Shake combo meals—have proved enormously popular with consumers, so much so that now they’re expected, and woe to the chain that doesn’t offer a deal. But if franchisees lose money on each item—well, the old joke goes, they can only hope to make it up on volume.
Add the fact that many older franchise agreements don’t discuss maximum pricing, again because before 1997 it was presumed illegal—and you get full-blown litigation, or as Cohen puts it, its milder but equally disruptive counterpart: “heartburn within systems and within franchisee associations over pricing programs.”
‘Allow us some flexibility’
Heartburn, indeed. In addition to the Globex case in Denver, Steak ‘n Shake has three pending federal lawsuits filed in Indiana over the maximum pricing issue. The franchisor lost a big round last fall, in Stuller v. Steak ‘n Shake, decided in the Seventh Circuit Court of Appeals in favor of the franchisee.
A key difference in that case however, is the franchisee had more than 60 years with the brand—and so legal contracts included nothing about maximum pricing.
The Baerns of Denver say they need flexibility from their franchisor in order to adjust to their particular market. A higher minimum wage law went into effect there this winter. Their food costs are higher than those cited at Shake ‘n Steak corporate-owned stores, they say.
Plus they maintain there’s no need for such low prices. Smashburger and Five Guys are packed all over the city, where a burger, fries and a Coke nears 10 bucks. “We’re not competing against McDonald’s,” Kannady says.
What burns the most? Steak ‘n Shake has been flexible with others, the Baerns claim. “The Steak ‘n Shake franchise in Las Vegas, we know for a fact that they charge higher than the maximum pricing policy.” How do they know? “We have his menu. It’s not a secret. Everybody in the system knows that.”
Has this become a clash of egos? A line in the sand? Are the Baerns outrageous and unreasonable? Are they even good operators?
Kannady finds it all frustrating. “That’s what’s most perplexing to me,” he says. “My clients like the brand. Allow us some flexibility because of the economic realities of Denver.” The next step in the case is an evidentiary hearing, which he expects in September.
“They’ll argue the court should close us down pending trial, and we’re going to argue to stay open pending trial. And I think we’re going to win,” he says, but as a long-time franchise attorney who has represented both sides, he doesn’t relish the court battle.“This is just a bad way to handle business.”
Beth Ewen is managing editor of Franchise Times. Send interesting legal cases to firstname.lastname@example.org.