Opinion
Case #08-30185.
May 5, 2008
For the Debtor:, JEFFREY A. RAHN, ESQ., Springfield, MA.
For JTH Tax, Inc.: ARTHUR L. PRESSMAN, ESQ., LEE HARRINGTON, ESQ., CHRISTOPHER DAVIS, ESQ., Nixon Peabody, LLP, Boston, MA.
Electronic Sound Recording Operator
: Laura Chambers Proceedings Recorded by Electronic Sound Recording Transcript Produced by Certified Transcription Service(At 2:12:23 p.m.)
MR. REYNOLDS: Court is now in session. Case #08-30185. Jonathan Fein. Hearing on the motion of JTH Tax doing business as Liberty Tax Service, for relief from automatic stay. Gentlemen, I'm going to take a roll call on line, and would you please confirm that you're still on the telephone? Attorney Rahn?
MR. RAHN: I am here.
MR. REYNOLDS: Thank you, and Mr. Fein, the debtor? (Unclear, microphone bumped and loud rumbling noise from bumping)
MR. FEIN: I am here.
MR. REYNOLDS: Thank you. Attorney Harrington.
MR. HARRINGTON: Here.
MR. REYNOLDS: Attorney Pressman.
MR. PRESSMAN: Present.
THE COURT: And Attorney Davis.
MR. DAVIS: Here.
MR. REYNOLDS: Thank you. Gentlemen, again, I'm going to remind you. Please identify yourselves by name every time you speak so we can get a clear and accurate record.
THE COURT: All right, this is a continued hearing with respect to the motion to modify automatic stay, filed by Liberty Tax Service. The following constitute my findings of fact and conclusions of law pursuant to Federal Rule of Bankruptcy Procedure 7052 as made applicable to this contested matter by Federal Rule of Bankruptcy Procedure 9014.
Two days of trial were conducted in this matter. I heard from three witnesses: Jonathan Fein, the debtor; and Corey Hughes and Russell Gardner on behalf of the movant, Liberty Tax Service.
This is a motion to modify the automatic stay under Section 362(d)(1) of the Bankruptcy Code, and Local Rules 4001-1 and 13-16.
Before the filing of this bankruptcy case, Liberty Tax had brought a civil action against the debtor in the United States District Court for the Eastern District of Virginia, alleging a breach of the franchise agreement between Liberty Tax as franchisor and the debtor as franchisee. In that action Liberty Tax sought to enforce its rights under the franchise agreement and pursue injunctive remedies.
That action was stayed due to the February 13, 2008 filing of the debtor's Chapter 13 bankruptcy petition, pursuant to Section 362(a) of the Bankruptcy Code, and the motion before the Court under Section 362(d)(1) seeks leave to continue with that suit.
Under Section 362(d)(1), quote:
"On request of a party in interest and after notice and a hearing, the Court shall grant relief from the stay, (1), for cause."
There is no question, for the reasons that I will describe later, that cause exists if the debtor still must comply with the franchise agreement. In his bankruptcy case, the debtor seeks to discharge his franchise obligations, but only claims may be discharged under the Bankruptcy Code.
It follows, therefore, that I must find and rule whether the obligations under the franchise agreement constitute, quote, "claims" end quote, within the meaning of Section 101(5) of the Bankruptcy Code.
Under Section 101(5), a claim is defined as:
"(a), a right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal equitable secured or unsecured; or,
(b), a right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured."
The facts are these: Jonathan Fein is a sophisticated debtor. He holds an MBA degree and has been a self-described tax preparer for the last twenty-six years. Prior to 2002 he worked in both the public and private sectors. He has served as the chair of the Town of Longmeadow Board of Assessors for five years.
At some time prior to November 2002 Mr. Fein decided to strike out on his own and sought to become a franchisee of Liberty Tax. Mr. Fein attended a week-long franchisee training in early December, 2002 in Virginia Beach, Virginia. There, he executed the instant franchise agreement, after, on numerous occasions, being offered an opportunity to review both a standard form agreement and an offering circular.
Mr. Fein contends that he did not read the offering circular or the attached standard form franchise agreements. In this, as in several instances during his testimony, I find that Mr. Fein was not credible.
Mr. Fein opened his first Liberty Tax franchise on January 8th, 2003 on Sumner Avenue in Springfield. Subsequent to opening his first Liberty Tax franchise office, Mr. Fein signed four other Liberty Tax franchise agreements in the years 2004 and 2005 as a director and officer of Springfield Tax Group, for the right to operate additional tax franchises in the Springfield area.
All of the franchise agreements contained non-competition provisions and offering circulars provided to Mr. Fein before signing each of these other agreements.
During the period from January 8, 2003 when the Sumner Avenue office was opened until the termination of the franchise agreement in December 2007, Mr. Fein used the Liberty Tax materials and marketing strategies to attract and direct new clients to his business. At the termination of Mr. Fein's Liberty Tax franchise on Sumner Avenue in early December of 2007 he had grown his clientele from approximately 350 clients to 813 clients at that location alone, and there were approximately 850 clients collectively at the other Liberty Tax locations controlled by Mr. Fein.
Mr. Fein began thinking about ceasing his relationship with Liberty Tax during the summer of 2007, following a dispute over royalty payments. Liberty Tax issued a notice of default to Mr. Fein's franchise for the failure to pay royalty fees. Had Mr. Fein not paid the royalty fee arrearage, the franchise agreement would likely have ended in the summer of 2007. Mr. Fein paid the disputed amount and continued to operate the franchise. However, then, in the summer of 2007, Mr. Fein had already resolved to continue his business as something other than Liberty Tax.
Despite that resolve, on December 3, 2007, Mr. Fein attended a Liberty Tax franchisee meeting with other Springfield area franchisees. At this meeting, the franchisees discussed advertising and strategies for the upcoming tax season. Mr. Fein contributed to the discussions, though at no point did he communicate to others at the meeting that he was intending to discontinue his status as a Liberty Tax franchisee; and by Mr. Fein's own admission, he attended the December franchisee meeting, despite planning to leave Liberty Tax, quote, "for some time," end quote.
On that day he knew that he was not going to be a Liberty Tax franchisee for the upcoming tax season.
The franchise agreement terminated at the end of the five-year term on December 10, 2007. It further provides that:
"Upon termination, the franchisee and its officers and directors," — which in this case include Mr. Fein —
"— shall, (a), remove all Liberty signs from all the offices and other premises;
(b), cease identifying oneself as a Liberty Tax franchisee;
(c), stop using literature received from Liberty Tax or other items with Liberty Tax marks;
(d), pay all outstanding balances owed to Liberty Tax;
(e), transfer telephone numbers, listings, advertisements that were used in relation to the franchise business, and deliver copies of transfer documents;
(f), deliver copies, including electronic copies, of lists and other sources of information that contain names of customers that use the franchise business;
(g), deliver all customer tax returns, files, records, and copies;
(h), deliver the copy of the operations manual and all updates which were provided,"
— and most importantly —
"(i), refrain from competing in a tax preparation industry for two years, and within twenty-five miles from its location."
On December 11, 2007, Mr. Fein removed the Liberty Tax sign from the location in which he had operated that business and put up a sign reading, "American Tax Service." That sign had been ordered prior to the date of termination of the franchise agreement, and Mr. Fein continued operating a tax preparation service from the same location.
At the beginning of January, 2008, Mr. Fein sent out notices to all of his Sumner Avenue location customers from the 2006 tax season to inform them that he was now American Tax Service. The letter was sent to 813 customers. In addition, one of Mr. Fein's managers at the State Street Liberty Tax franchisee location also sent letters to clients in January 2008 encouraging them to redirect their business to American Tax Service at the Sumner Avenue location, and encouraged them to do so as soon as possible. In February, about 75 other select customers were sent similar noticed by managers of Mr. Fein.
The American Tax Service sign is just as prominent as the Liberty Tax sign.
There existed, as of April 9, 2008, an on-line listing of Mr. Fein's Liberty Tax office at the Sumner Avenue location, which included the phone number for that office. The old Liberty Tax franchisee telephone number for the Sumner Avenue location and the new primary number are not the same number; however, although the primary number for the Sumner Avenue location has changed and is now listed in the Yellow Pages under American Tax Service, the telephone programming has been so arranged that if a customer calls the old Liberty Tax number, his recep — the receptionist at American Tax Service answers the call. The old Liberty Tax number can still be found in the phone book under either Liberty Tax, or JLF Tax Group.
Mr. Fein took no steps to disconnect the old Liberty Tax number, nor did he do it when he was informed of that requirement by Liberty Tax. Similarly, there were no steps made to create a message or answering device to direct callers to the closest Liberty Tax location.
Mr. Fein also took no steps to deliver copies of complete Liberty Tax client tax files back to Liberty Tax. He took no steps to return Liberty Tax informational materials. The operations manual was delivered to Liberty Tax only in open court during the trial. In mid-January 2008 there were still Liberty Tax manuals on the desktops of American Tax Service tax preparers, and even Mr. Fein stated that he was not surprised that a customer had seen Liberty Tax materials in the office location in January.
The tax preparers at American Tax were some of the same tax preparers that had worked for Liberty Tax, and the physical configuration of the office had not changed. The Liberty Tax signs at Mr. Fein's other franchise locations have not been removed, even though the locations are closed and not in operation.
The months of January through April are the most important months of the year for professional tax preparers as they are collectively known as, the quote, "tax season," end quote. Had Mr. Fein informed Liberty Tax of his desire to discontinue the business as a Liberty Tax franchisee or allow the franchise agreement to end in the summer of 2007 as a result of the arrearage default, there would have been at least four months for Liberty Tax to establish a new franchise location run by someone other than Mr. Fein in the Springfield area.
Mr. Fein — I'm sorry — Liberty Tax — strike that. Liberty Tax has opened up a company store in the vicinity of Mr. Fein's American Tax location, and it may even be a more desirable business location; however, the opening of a company store rather than a franchise store was the result of the inability to have a local franchisee establish a franchise store in such a short period of time; and more particularly, because of the uncertainty that existed regarding Mr. Fein still doing tax preparation business in the area.
In addition to the expense incurred establishing the company store, that store retained only fifteen per cent of the Liberty Tax clients that had previously used Liberty Tax to prepare their tax returns under Mr. Fein. Mr. Fein's last tax season as a Liberty Tax franchisee, on the other hand, saw a customer retention rate of approximately 58 per cent. If Mr. Fein had still been a franchisee, Liberty Tax expects that the retention rate would be approximately four times higher, close to sixty per cent.
There were two decisions in this District that must be weighed in order to reach the proper result here. In IN RE: Ward, 1996 bankruptcy decision in the District of Massachusetts, Bankruptcy Judge James Queenan held that,
"Where a breach of a covenant to compete gives rise to a claim for damages as well as a right to injunctive relief, the franchisor's rights constitute a claim dischargeable in the bankruptcy case."
Two years later, Judge Nathaniel Gorton of the District Court of Massachusetts ruled in Sir Speedy, Inc. v. Morse that,
"The breach of a covenant not to compete did not constitute a dischargeable claim, because a monetary award would not adequately account for the loss of reputation and good will to the claimant."
The District Court made much of the fact that Ward focused primarily on a calculation of lost profits. Sir Speedy emphasized that loss of reputation and good will are not easily calculable; and even if calculable, the monetary damages may not necessarily be adequate. However, the Sir Speedy decision is not clear as to whether there were in that case alternative monetary damages available to the claimant in the case of a violation of the agreement. Equitable relief from the language of the decision appeared the only remedy available under the franchise agreement.
The franchise agreement in Ward stated that,
"The franchisee," quote — "does not —"
— strike that. The franchise agreement in Ward stated that, quote:
"Franchisee does hereby consent that in the event of such violation, franchisor shall, as a matter of right, be entitled to injunctive relief."
End quote. This injunctive relief was in addition to any other remedies to which the franchisor may then be entitled.
In terms of liability in the case of breach, the agreement set forth, quote:
"In the event of any default on the part of either party hereto, in addition to any other remedies of the aggrieved party, the party in default shall pay to the aggrieved party all amounts due, and all damages, costs, and expenses, including reasonable attorneys' fees incurred by the aggrieved party as a result of any such default."
Thus, from the language of the franchise agreement in Ward there was an alternative right to monetary damages, where that right may not have been explicitly stated in the Sir Speedy instance.
In any event here, the Liberty Tax franchisee established a post-petition covenant not to compete in its paragraph 10(b), but at the same time specifically established the monetary value of that breach in paragraph 10(c). Liberty Tax's own language preestimates the liquidated damages and the royalty and advertising loss, and specifically wrote it into the contract, just in case of a franchisee breach. Not only is the amount set forth, but it also describes for how long those payments are to continue.
Though the covenant does state that the parties, quote, "agree," end quote, that the monetary payments in the case of breach do not affect the ability of Liberty to seek injunctive relief, the language of the franchise agreement does not explicitly say that the franchisor will be entitled to injunctive relief, and the language of the franchise agreement clearly states that a breach of performance by the franchisee gives rise to a right of payment in addition to the threat of pursuing equitable remedies. Nowhere does the agreement state or suggest, as it would if there was a right to injunctive relief, that monetary damages would be an insufficient remedy.
Without more, this Court would be inclined to rule that the covenant-not-to-compete obligations constitute a claim, which, if not held to be non-dischargeable for some other reason, would be discharged. But there is more. Mr. Fein did not just open up another facility within twenty-five miles. He opened up a tax preparation service in the same location. He solicited the former Liberty Tax employees. He solicited the former Liberty Tax customers. He secretively intruded on Liberty Tax strategies by attending a strategy session at a time he knew he would no longer be with the company. He manipulated advertising and phone services so that the customers who did not know of the change would be directed to him. And it was all done with the intention to convert the goodwill and the customers of Liberty Tax and demonstrated by the elusive and deceptive answers given by Mr. Fein in his testimony before the Court.
Accordingly, the Liberty Tax Service loss of goodwill is not a passive outcome of the debtor's dischargeable claim. It is a loss occasioned by the debtor's plan to convert the Liberty Tax assets. Such a loss is not calculable, and a claim therefore is not — a claim for money damages therefore is not a sufficient remedy.
Accordingly, I find that the Liberty Tax Service losses do not fall within the definition of a claim under Section 101(5). Because they do not fall within a claim under the Bankruptcy Code, they are not dischargeable. And because they are not dischargeable and there is an ongoing risk of loss to Liberty Tax, there is a cause for relief from the automatic stay under Section 362(d)(1) of the Bankruptcy Code.
The case law could not be more clear that what Congress has provided and what the Supreme Court has confirmed is the debtors are entitled to a fresh start. They are not entitled to a head start.
The motion to modify the automatic stay is granted. Thank you very much.
TELEPHONE ATTORNEYS: Thank you, Your Honor. (End at 2:34:27 p.m.)