Struggling Papa John's Franchisee Goes Bankrupt

By Jonathan Maze, September 29, 2011

A big Papa John's franchisee went bankrupt this week, and it is pointing the blame squarely at its franchisor. Essential Pizza, which operates 72 Papa John's in Minnesota and Colorado, went bankrupt this week after its secured creditor, GE Capital, appointed a receiver who quickly froze the company's funds.

But the issue runs deeper deeper. In June, Essential Pizza sued Papa John's in a Minnesota court, claiming a litany of issues, including that Papa John's misled Essential Pizza and its principal, Brian Mills, when Papa John's President Bill Van Epps convinced Mills to buy 84 underperforming stores from the owner at the time, Blackstreet Capital Management.

Blackstreet, a private equity fund, bought the struggling 84 units from Papa John's in 2005. The stores kept struggling, and by 2007 Blackstreet wanted to get rid of them. So Van Epps allegedly turned to Mills, convincing him to buy the stores for about $12 million. That deal included financing from GE Capital and a supplemental loan through Papa John's franchise assistance program known as Capital Delivery.

In its lawsuit, Essential Pizza claims that neither Papa John's, nor Blackstreet, disclosed a $1.2 million tax liability and $700,000 in additional expenses. Essential Pizza claimed that the franchisor ultimately agreed to write off $1 million in deferred royalties, but later reneged on the agreement. The lawsuit claims that the liabilities meant that the $12 million price tag for the stores was inflated, and that Essential Pizza may not have purchased the restaurants if it knew about the expenses.

Meanwhile, Essential Pizza claims that Papa John's required the franchisee to buy litigation insurance that didn't cover a growing problem in the pizza delivery business: class action lawsuits from drivers over federal wage laws. Essential Pizza was hit by two such lawsuits, one in Colorado in 2009, another in Minnesota in 2010. The franchisee has to pay for that litigation itself.

As if these complaints weren't enough, Essential Pizza claims that Papa John's sold defective dough that didn't rise as well and wasn't as sweet as typical Papa John's dough, which hurt quality.

In August, Capital Delivery, the franchisor's finance arm, sued Essential and the principals, Mills and Cliff Harris, claiming that more than $1.4 million in loans and interest has gone unpaid. GE Capital, which is owed $7.7 million according to bankruptcy filings, had a receiver appointed this week who froze the assets, so employees were warned this week that they may not be able to cash their paychecks that went out this week, according to media reports. The bankruptcy was filed this week, and the receiver released the hold.

In one bankruptcy filing, Essential Pizza minces no words as to who is to blame for the mess, noting that its financial problems were caused "primarily by the franchisor."