Struggling franchisors who violate state franchise disclosure laws should not assume that the filing of bankruptcy by the franchisor will bring relief from the claims of wronged franchisees. A Bankruptcy Court in North Carolina recently ruled that Michael and Kathy Butler, husband and wife owners of PRS Franchise Systems, LLC were personally liable to one its franchisees for $714,000 plus interest.

PRS Franchise was a North Carolina based franchisor offering retail franchises selling promotional and advertising services to small businesses. The franchisee, New York resident John Mangione, bought 12 PR Store franchises in New York in 2007. At the time of the sale, PRS Systems was not registered in New York to sell franchises and did not escrow Mangione’s franchise fees as required by the New York Department of Law when an franchise registration amendment application is pending.

Unhappy with the situation, Mangione demanded rescission of the franchise agreement and subsequently sued PRS Systems in 2009.  Two months later the Butlers dissolved PRS Systems and filed for personal bankruptcy under Chapter 7. The Butlers hoped to discharge any potential personal liability to Mangione by naming him a debtor in the bankruptcy and valuing his claim at $1.00.   Mangione filed an action asking the court to declare the debt non-dischargable under 523(a)(2) and (4) of the United States Bankruptcy Code on the basis of the Butler’s fraud. 

The Bankruptcy court found the owners personally liable under New York law. The court found no merit in the Butler’s argument that each was uninvolved in the sales process. The court decision details the personal interaction between the Butlers and Mangione, and Mangione’s reliance on the owners’ promises and experience in the PR business. In addition, because an FDD was not provided to Mangione, he was not privy to PRS Systems ‘s abysmal financial statements. Testimony also confirmed that the Butler’s intentionally let the franchisor’s New York registration lapse and made only a half-hearted effort to reinstate it when Mangione showed interest in purchasing franchises.

The full text of the opinion can be found here.