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Franchisee sues Steak n Shake over pricing policy after losing money at 9 restaurants

April 9, 2018

A franchisee has filed suit against Indianapolis-based Steak n Shake in an effort to raise its menu prices because it says all nine of its restaurants are losing money.

In a suit filed in federal court Thursday, Steaks of Virginia LLC said Steak n Shake is breaking its franchise and development agreements by not allowing it to set its own menu prices.

“The profitability of Steaks of Virginia’s restaurants is suffering,” the Virginia Beach-based franchisee said in the lawsuit. “As of the end of 2017, all of Steaks of Virginia’s restaurants are losing money.”Steaks of Virginia said it entered into a franchise agreement as well as an area development agreement, or ADA, with Steak n Shake in 2009.

The ADA gave the franchisee the rights to develop 15 restaurants in certain areas of Virginia over a 10-year period.The franchisee said it decided to enter into both agreements based on information provided in Steak n Shake’s franchise disclosure document, also called a uniform franchise offering circular.

Steaks of Virginia said the document clearly states that “Franchisees are free to set consumer prices different from prices on [Steak n Shake]-owned restaurant menus and several do so.”

That information was contained in Item 19 of the offering circular, a section of the document that is expected to contain all of a franchisor’s disclosures related to financial performance representations. The agreement also did not state that Steak n Shake reserved the right to revoke a franchisee’s right to set menu prices.

“If Steak n Shake did not believe that a franchisee’s ability to set its own prices was material to a franchisee’s decision to become a franchisee—or that it was a relevant as a Financial Performance Representation—it simply would not have made any representation at all. Indeed, Steak n Shake was under no legal obligation to do so.”

Steak n Shake put a heavy emphasis on inexpensive food, including $4 meals, after entrepreneur Sardar Biglari gained control of the chain and folded it into his San Antonio-based holding company, Biglari Holdings, in 2008. 

At some point after 2009, Steak n Shake revised its franchising circular. Current franchising documents signed by new franchisees stipulates they must follow the company's pricing.

The value-pricing strategy helped Steak n Shake put together an impressive streak of 29 straight quarters of same-store sales increases at company-owned locations before hitting a rough stretch in 2016 that continues.

Steak n Shake now has reported two consecutive years of same-store sales drops, fueled in part by declines in customer traffic of 1.2 percent in 2016 and 4.4 percent in 2017. The numbers equate to losing 7 million customers over two years. Some franchisees say Biglari's pricing strategy worked for years but now needs to be adjusted. 

Steaks of Virginia said it has priced menu items as directed by Steak n Shake since 2009, but those prices haven’t materially changed over that time.
In June 2017, according to the suit, Steaks of Virginia informed Steak n Shake that it wanted to raise prices on some items because its restaurants were losing money, but that request was rejected. It made additional requests in December and early this year.

Steaks of Virginia said it cannot change the prices of its menu items itself because Steak n Shake controls the point of sale computer system in all restaurants.The franchisee said Steak n Shake eventually relented by giving Steaks of Virginia permission to raise prices at just one restaurant—in Fredericksburg—but not at its other eight restaurants.

Steaks of Virginia said raising prices at just one restaurant is impractical because its nine restaurants are all in close proximity to each other. The one restaurant with higher prices would alienate its customers, the franchisee said.

The suit says Steak n Shake’s refusal to allow Steaks of Virginia to raise prices is preventing the franchisee from meeting rising “threshold sales levels” called for in the area development agreement. The agreement called for the franchisee to average $1.5 million in sales at its restaurants in 2009, but that level has since been raised to about $1.7 million.

Steaks of Virginia said it paid $225,000 for the exclusive right to develop Steak n Shake restaurants in its territory. The franchise said it is not allowed to develop more restaurants and could lose the entire $225,000 fee if it doesn’t meet the threshold sales levels.

“Steaks of Virginia would not have agreed to enter the ADA if Steak n Shake would have informed Steaks of Virginia it would not be able to set its own menu prices,” the lawsuit says.

Steaks of Virginia is seeking unspecified damages for the violations to the franchise agreement and an order rescinding the area development agreement and franchise agreement.

According to Steak n Shake, Steaks of Virginia signed a "Eyes Wide Open Compliance Certification" for eight of its restaurants, agreeing to comply with franchisor's "pricing and promotions in all respects regardless of your particular circumstances."

The document says "failure to comply with menu specifications, including standardized pricing requirements, may result in termination of the Franchise Agreement."

 

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