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INC. v. Hattenhauer Distributing Co.

United States District Court, S.D. Indiana, Indianapolis Division

March 30, 2018

NOBLE ROMAN'S, INC., Plaintiff,
v.
HATTENHAUER DISTRIBUTING COMPANY, Defendant.

          ENTRY ON MOTIONS FOR SUMMARY JUDGMENT.

          Hon. William T. Lawrence, Judge.

         This cause is before the Court on the Plaintiff's motion for partial summary judgment and the Defendant's motion for summary judgment. The motions were briefed in Cause No. 1:14-1734-WTL-DML, and supplemental briefs were filed in this case. All citations to the record in this Entry refer to the record in Cause No. 1:14-1734-WTL-DML unless otherwise noted. The Court, being duly advised, GRANTS IN PART AND DENIES IN PART both motions for the reasons and to the extent set forth below.

         I. APPLICABLE STANDARD

         Federal Rule of Civil Procedure 56(a) provides that summary judgment is appropriate “if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” In ruling on a motion for summary judgment, the admissible evidence presented by the non-moving party must be believed, and all reasonable inferences must be drawn in the non-movant's favor. Zerante v. DeLuca, 555 F.3d 582, 584 (7th Cir. 2009) (“We view the record in the light most favorable to the nonmoving party and draw all reasonable inferences in that party's favor.”). When the Court reviews cross-motions for summary judgment, as is the case here, “we construe all inferences in favor of the party against whom the motion under consideration is made.” Speciale v. Blue Cross & Blue Shield Ass'n, 538 F.3d 615, 621 (7th Cir. 2008) (quotation omitted). “‘[W]e look to the burden of proof that each party would bear on an issue of trial.'” Diaz v. Prudential Ins. Co. of Am., 499 F.3d 640, 643 (7th Cir. 2007) (quoting Santaella v. Metro. Life Ins. Co., 123 F.3d 456, 461 (7th Cir. 1997)). A party who bears the burden of proof on a particular issue may not rest on its pleadings, but must show what evidence it has that there is a genuine issue of material fact that requires trial. Johnson v. Cambridge Indus., Inc., 325 F.3d 892, 901 (7th Cir. 2003). Finally, the non-moving party bears the burden of specifically identifying the relevant evidence of record, and “the court is not required to scour the record in search of evidence to defeat a motion for summary judgment.” Ritchie v. Glidden Co., 242 F.3d 713, 723 (7th Cir. 2001).

         II. BACKGROUND FACTS

         Unless otherwise noted, the following background facts of record are undisputed. Additional facts are included in the Discussion section.

         A. The Franchise Agreements

         Defendant Hattenhauer Distributing Company (“Hattenhauer”) owns and operates 21 gas stations and associated convenience stores. Relevant to this case are two of the stores, one located in Goldendale, Washington, and the other in Biggs Junction, Oregon. In April 2005, Hattenhauer signed a five-year agreement with the Plaintiff, Noble Roman's, Inc., (“Noble Roman's”) to operate a pizza franchise at its Oregon Location. In August 2006, Hattenhauer signed ten-year agreements with Noble Roman's to operate both a pizza franchise and a Tuscano's sub sandwich franchise at its Washington Location. On March 21, 2011, the parties renewed the franchise agreement for the Oregon location. With one exception, discussed below, all of the franchise agreements are identical in all material respects. The Court will refer to them collectively as the “Franchise Agreements.”

         The Franchise Agreements were drafted by Paul Mobley, Noble Roman's Executive Chairman and CFO.

         The Franchise Agreements require Hattenhauer to pay Noble Roman's “a continuing weekly royalty fee (‘Royalty Fee') in the amount of seven percent (7%) of the Gross Sales of the [Noble Roman's or Tuscano's] . . . for all of the franchised locations.” See e.g., Dkt. No. 1-1 at

          4.[1] “Gross Sales” is defined as

the total selling price of all products and services and all income of every other kind and nature related to [the Noble Roman's or Tuscano's franchises], whether for cash or credit and regardless of collection in the case of credit, but expressly excluding sums representing sales taxes collected directly from customer, based upon present or future laws of federal, state or local governments, by [Hattenhauer] in the operation of the [Noble Roman's or Tuscano's franchises], and any other tax, excise or duty which is levied or assessed against [Hattenhauer] by any federal, state, municipal or local authority, based on sales of specific merchandise sold at or from [Noble Roman's or Tuscano's franchises].

Id. at 5. “Gross Sales” also includes “all proceeds from the sale of coupons, gift certificates or vouchers . . . provided that the retail price thereof may be credited against Gross Sales during the week in which such coupon, gift certificate or voucher is redeemed for the purpose of determining the amount of Gross Sales upon which the Royalty Fee . . . if any, is due.” Id.

The Franchise Agreements require Hattenhauer to
maintain during the term of this Agreement, and shall preserve for at least five (5) years from the dates of their preparation, full, complete, accurate books, records and accounts, including, but not limited to, daily sales records, sales slips, coupons, purchase orders, payroll records, check stubs, bank statements, monthly sales tax records and returns, cash receipts and disbursements, journals and ledgers in accordance with generally accepted accounting principles.

Id. at 16. The Franchise Agreements also provide that “[Noble Roman's] or its designee shall have the right at all reasonable times to review, audit, examine and copy the books and records of [Hattenhauer] as [Noble Roman's] may require at the Noble Roman's Pizza [location].” Id. at 17.

         Pursuant to the Franchise Agreements, “[i]f any required royalty payments to [Noble Roman's] are delinquent, or if an inspection should reveal that such payments have been understated in any report to [Noble Roman's], then [Hattenhauer] shall immediately pay to [Noble Roman's] the amount overdue or understated upon demand with interest determined in accordance with the provisions of Section IV.B. (3).” Id. That section, in turn, provides:

All unpaid obligations under this Agreement shall bear interest from the date due until paid at the lesser of the highest rate allowed by law or a rate that is five (5) percentage points per annum higher than the ‘prime rate' then currently established by the largest bank (determined by total bank assets) headquartered in the state in which the [Noble Roman's and/or Tuscano's] Location is situated.

Id. at 5.

         B. Facts Relating to Use of Non-Conforming Pizza Cheese

         Pursuant to its agreements with Noble Roman's, Hattenhauer was required to use ingredients approved by Noble Roman's in its franchises. This included Noble Roman's proprietary pizza cheese, which is a blend of mozzarella and Muenster cheese and dry oregano. Noble Roman's Food Preparation and Product Specifications states that “Noble Roman's Pizza Cheese is a custom blend and cut of real Mozzarella and real Muenster cheese with dry oregano added. All items used must be Noble Roman's Inc. approved.” Dkt. No. 159-2 at 2 (emphasis in original).

         In 2010, Noble Roman's changed its approved distributer for Hattenhauer's locations to McDonald Wholesale Company (“McDonald”). Between August 2010 and approximately August 2014, Hattenhauer did not purchase Noble Roman's proprietary cheese for its Oregon location, although it continued to purchase Noble Roman's proprietary cheese from McDonald for its Washington location. For its Oregon location, Hattenhauer purchased other types of pizza cheese from McDonald during this time period, including Golden California brand pizza cheese.[2]McDonald sent Noble Roman's monthly reports of the sales it made to Noble Roman's franchisees; the reports indicated that Hattenhauer's Oregon location was purchasing Golden California cheese and was not purchasing Noble Roman's proprietary cheese.

         On August 23, 2012, Noble Roman's sent Greg McPeters, one of its franchise managers, to Hattenhauer's locations for training. Noble Roman's did not create an inspection report for these visits. McPeters did not tell Hattenhauer to stop using cheese other than Noble Roman's propriety cheese. No. Noble Roman's representative has conducted training at or inspected Hattenhauer's franchise locations since 2012.

         In 2014, Noble Roman's conducted an audit of Hattenhauer's locations. The audit revealed that the Oregon Location had not purchased Noble Roman's specified cheese since as early as 2010 and was instead purchasing non-conforming cheese during that time.

         C. Facts Relating to Inspections and Audits by Noble Roman's

         From time to time, Noble Roman's visited Hattenhauer's Locations and completed checklists titled “Unit Evaluations” or “Opportunities Assessments” (“Inspection Reports”) to monitor Hattenhauer's compliance with the Franchise Agreements. Specifically, Inspection Reports were completed for the Oregon location only on September 6, 2006; for the Washington location only on July 12, 2010, and for both locations on July 14, 2007, January 16, 2009, and October 8, 2009. The Inspection Reports state that Hattenhauer reported its sales and royalties accurately. Several of the Inspection Reports noted Hattenhauer's discount pricing and value meals. The September 6, 2006, Inspection Report for the Oregon location noted that Hattenhauer was “[e]xperiencing serious distributor problems” and was “[c]onstantly out of sauce, pizza crust and pastas.” Dkt. No. 162-4 at 4.

         In 2009, Noble Roman's conducted an audit of each of Hattenhauer's locations and created “Sales & Purchases Comparison” reports (“SPCs”). Noble Roman's determined that Hattenhauer had underreported its sales by 32.9% at the Oregon Location and by 34.7% at the Washington location. Noble Roman's did not tell Hattenhauer that it had conducted audits for its locations in 2009. The first time Hattenhauer learned about the 2009 audits and resulting SPCs was during discovery in this lawsuit.[3]

         In 2014, Noble Roman's decided to conduct audits of its non-traditional franchisees who paid a royalty fee based on reported sales. This included both of Hattenhauer's locations.

         Noble Roman's audits relied on a review of the records of Hattenhauer's purchases from the approved distributor, McDonald. Noble Roman's describes the process as follows:

In the audit, Noble Roman's reviewed Hattenhauer's purchases, from the distributor's records, of the pizza crusts and other key ingredients, made an allowance for reasonable waste of products, and calculated the amount of sales that would be generated from those purchases. Noble Roman's based its calculations on its operating standards and specifications and decades of experience in the pizza business, [4] then comparing that to the reported sales.

         Dkt. No. 159-1 ¶ 15. Noble Roman's did not review the books and records maintained by Hattenhauer or attempt to verify the accuracy of the information contained in the distributor's reports on which it relied. Noble Roman's methodology calculates an amount of sales that Hattenhauer's locations would be expected to make; in other words, it is an estimate.

         In Noble Roman's opinion, [5] using this methodology is both appropriate and necessary because of the nature of non-traditional franchises:

In convenience stores, products are periodically assembled and baked throughout the day and placed in a multi-tiered warmer surrounded by a Noble Roman's warmer wrap that identifies the brand for a grab-n-go service style. Customers take the pizza and other items that they want to purchase from the warmer, along with anything else in the store they want to buy, to the counter where the sales of all of their purchases are rung up in the same cash register. By the very nature of this system, and location inside a convenience store that sells numerous items, there are a lot of opportunities for errors in tracking sales by specific items. If the items do not all get rung up there are no records of un-rung item sales to audit. Moreover, pizza could be mistakenly rung up as grocery items instead of a Noble Roman's product purchase. Since no records, such as sales tickets or invoices are kept, no records exist to audit for this problem. For these reasons and others, Noble Roman's had to use alternative methods to audit the reported sales for accuracy in locations such as Hattenhauer's.

Dkt. No. 159 at 4-5.

         The methodology used by Noble Roman's does not take into account ingredients that were purchased by Hattenhauer but never used because they were damaged in shipping, handling, or preparation. For example, McDonald's reports reflected credits to Hattenhauer, at least one of which was not accounted for in the audit. Noble Roman's methodology also used a standard “sales mix, ” which is the percentage of various types of products sold (e.g. 60% of pizzas sold have one topping). The sales mix used by Noble Roman's in its audits was not the actual sales mix in Hattenhauer's locations; rather, Noble Roman's used the same sales mix for its audits of all of its non-traditional franchise locations. Similarly, Noble Roman's used waste allowances of 2%, 3%, or 5% for its audits; it did not attempt to determine what Hattenhauer's actual waste was, as Hattenhauer was not required to-and did not-include that information in the weekly sales reports it sent to Noble Roman's.[6] Hattenhauer's locations had a larger amount of waste than the allowances used by Noble Roman's because it kept its warmers stocked with product, as instructed by Noble Roman's, and had to discard product that was not sold after the applicable holding times. The audits did not take into account the inventory Hattenhauer had at the end of the audit period; that is, Noble Roman's calculated how much Hattenhauer should have sold based upon the ingredients purchased by Hattenhauer, but did not consider whether Hattenhauer could have used some of the purchased ingredients for products sold after the audit period. Noble Roman's auditor did not have a complete list of Hattenhauer's menu prices and estimated some of the prices he used for his calculations. Hattenhauer also changed its menu prices over time and sold products for less than full price due to value meals, coupons, frequency cards, specials, and other promotions.

         Noble Roman's methodology assumed a constant menu price for each item. Noble Roman's also considered only one menu item for each “core ingredient.” For example, its methodology assumed that each “Par 7 Dough” purchased by Hattenhauer was used for a small pizza. However, Hattenhauer also used the pizza dough to make Cinnamon Rounds, which were sold for less than small pizzas. Similarly, tortillas were used for both breakfast burritos and chicken wraps, but Noble ...


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