Shake-up at Shakey's

Feb. 3, 2003

Less than two weeks before the start of a court battle between Shakey's, Inc. and two of its franchisees, the two parties are waging a war of words.

Officials from Shakey's and its Singaporean parent company, Inno-Pacific Holdings Ltd., allege that franchisees John McNulty and Mick Clark want to gain control of Shakey's Pizza and its trademarks. Shakey's also accuses the two franchisees of waging a public relations campaign against the company.

In the nearly identical lawsuits, scheduled to be heard simultaneously in Los Angeles Superior Court beginning May 28, both franchisees accuse Shakey's, Inc. of breach of contract, negligent misrepresentation and fraud. Combined, their claims for damages total nearly $6 million.

Shakey's officials not only deny the allegations, but claim the cost to defend the firm against McNulty and Clark has diverted the company from its plan to revive and expand the legendary brand.

Artist's rendering of one Shakey's Pizza prototype restaurant.

"Instead of allowing me and my team the opportunity to move this company forward ... (McNulty and Clark) are willing to ... cram down your throats their personal agendas," Shakey's president Sean Flynn wrote in a May 1 letter to franchisees. "This is both sad and unfair, especially to you the dealers."

Trademark Battle

In 2001, Shakey's directed consultant Alan Siskind to mediate discussions between McNulty, Clark and Shakey's, Inc., in hopes he could persuade the franchisees to settle out of court.

According to Siskind, Inno-Pacific board member Quek Chek Lan came to the U.S. late that year to join him, Flynn, McNulty and Clark for a meeting. During their lunch, Lan claimed Shakey's could not pay the damages sought by Clark (who filed his suit on behalf of his company, Sterling Foods) and McNulty. He did, however, offer the men a chance to buy a portion of the company.

"That was the first time that any discussion came up over ownership of the trademark," Clark said.

The next morning, Siskind recalled, Lan then met with Randy Hill, president of Jacmar Corp., a franchisor of 19 Shakey's. Over breakfast a similar offer to invest in Shakey's was made to Hill in an effort to ease tensions between Shakey's and Jacmar, the pizza chain's largest franchisee.

Both Clark and Siskind said none of the franchisees gave the idea much consideration, and, according to Siskind, Lan's contact with Shakey's and its franchisees ended shortly after.

"They stripped him of his responsibilities as far as Shakey's goes," said Siskind. "He's still on Inno-Pac's board, though." 

Flynn, however, recalls the discussions differently, as he wrote in his May 1 letter to franchisees. A copy of the document was provided to PizzaMarketplace by McNulty, president of the Shakey's Franchised Dealers Association (SFDA).

"In case it is unclear to anybody, these individuals are aiming to get control of the company and/or its marks," Flynn wrote. "The destruction of the brand and all of our businesses along the way seems to concern them little."

In the May 1 issue of Singapore's Business Times, Lee Koh Sing, secretary of Inno-Pacific, accused McNulty and Clark of attempting to seize control of the company. Sing wrote, "each of the plaintiffs has admitted in deposition testimony as well as in Court that the primary reason for the lawsuits is to take the major assets of the Company or Shakey's, which are its trademarks and trade names as settlement."

Clark denied the allegations.

"We have never been after the assets of the company, but there were discussions regarding the trademark when Shakey's made it clear that they were unable and unwilling to provide any cash for damages," he said. "So any equity discussions began as a function of their bankruptcy talks and as a way to keep them out of bankruptcy and still keep the system moving ahead. Frankly, that would provide them with something rather than nothing, which is what they'll have in bankruptcy."

Sean Flynn, president of Shakey's Pizza.

On May 8, Inno-Pacific chairman Chin Yong Wong sent a fax to Shakey's U.S. franchisees to counter some of McNulty's publicized claims about the company. A copy of the fax was provided to PizzaMarketplace by McNulty the next day.

In the document, Wong called the 2001 pre-trial settlement attempts by Clark and McNulty "daylight robbery," and said the two franchisees and Randy Hill were stirring up a "media campaign" against Shakey's and Inno-Pacific.

Wong's comments left Clark nearly at a loss for words.

"How do you react to a lie?" said Clark, one of five directors on the board of the SFDA, and a franchisee of five Shakey's. "His response is laughable. ...The only crime I'm aware that has actually happened is the neglect and abandonment that has happened in our system."

Wong also accused McNulty of abusing his office as SFDA president by "lying," "perpetuating misinformation" and making "libelous" claims.

McNulty called the accusations "groundless (and) nothing but their spin."

When Words Collide

In his May 1 letter to franchisees, Flynn accused McNulty and Clark of launching "a Public Relations campaign in the press both (in the U.S.) and in Singapore," and that such negative publicity efforts reflected the pair's concerns about the upcoming trial. "We think that there're (sic) right to worry," Flynn added.

McNulty reacted with his own letter to franchisees the next day, denying Flynn's claims and saying he and Clark were eager for their day in court.

Siskind, who originally was hired by Shakey's to develop new products and marketing ideas for the chain, said he understands the frustrations of McNulty and Clark and others throughout the chain. He also believes Shakey's will face a tough test in court. 

"Were I a franchisee ... I'd be apoplectic," said Siskind. "The franchisees for the most part are making money ... but they could make even more if they could get help from the franchisor."

Flynn and Sing have criticized Siskind as well, calling him a "disgruntled consultant" whose contract was allowed to expire in January. In a May 17 e-mail to PizzaMarketplace, Flynn warned that anything Siskind says "must be looked at in that light."

Siskind said he bears no ill feelings toward Flynn or Inno-Pacific, but he's confident that the numbers on both companies' balance sheets will reflect what he, McNulty and Clark are claiming.

"Shakey's is dead in the water because it has no capital to feed the engine," he said. "The brand was in desperate straits prior to the filing of those lawsuits."

Recommendation: Bankruptcy

When Siskind couldn't persuade McNulty and Clark to settle in 2001, he gave Sean Flynn some grave advice: move the company into voluntary bankruptcy.

"I believed that was the best method for saving the brand and the mark," Siskind said in a May 8 interview.

If Shakey's were to lose in court, he believed other franchisees would sue. But in bankruptcy, Shakey's could protect itself from further legal action and position itself more favorably to potential investors who might want to grow the chain.

"The Group (Inno-Pacific's subsidiaries, such as Shakey's Inc.) does not have sufficient cash to make repayments due to creditors and to meet daily operational requirements."

Excerpted from an Ernst & Young audit of Inno-Pacific's finances.

"When a company goes into reorganization," Siskind added, "it can still attract outside capital. And any money invested after that cannot be taken by creditors; it's converted into equity in the new company."

When asked why Flynn didn't take his advice, Siskind said, "That's the $64,000 question. ... I know that they owe a considerable amount of money, and under bankruptcy, all it takes is three creditors owed a total of $11,500 to file (an involuntary) bankruptcy request."

Siskind added that bankruptcy in Asia is a shameful last resort for protecting a business, and not the alternative business strategy it has become in the U.S. It would have been a bitter pill to swallow for Inno-Pacific's Asian board members, he said.

Siskind said he believes Shakey's decision to go to trial was made by authorities at Inno-Pacific, not Flynn, Shakey's 13th president. Siskind said that, like the presidents before him, Flynn has endured a consistent lack of support from his bosses in Singapore.

"The parent company in Singapore has sort of pulled the rug out from under Sean," said Siskind. "He hasn't gotten what he's needed."

McNulty and Clark agree, saying Inno-Pacific has expected Shakey's presidents to perform with little to no financial or staff resources. Such mismanagement, said McNulty, has left the one-time pizza empire teetering on the brink of financial ruin.

"We believe that Shakey's, Inc. is insolvent," McNulty wrote in a May 1 e-mail to PizzaMarketplace.

An independent audit of Inno-Pacific conducted by Ernst & Young verifies McNulty's and Siskind's concerns about Shakey's financial viability. On May 15, the accounting firm published its findings on the Singapore Stock Exchange's Web site.

The report read that in 2001, "the Group (Inno-Pacific's subsidiaries Shakey's Inc., in the U.S., and Shakey's International, Ltd., which is the franchisor in the Far East) and the Company" lost S $12.81 million (U.S. $7 million) and S $10.15 million (U.S. $5.6 million) respectively, and that the "current liabilities exceeded current assets by S $2.73 million (U.S. $1.5 million) and S $1.07 million (U.S. $591,000) respectively."

It said Inno-Pacific's subsidiaries are facing "liquidity requirements given the impending need to settle liabilities," and "the Group does not have sufficient cash to make repayments due to creditors and to meet daily operational requirements."

The report paints a bleak picture for Shakey's, Inc., Siskind said, because Ernst & Young's May 15 report covered fiscal 2001, a time when Inno-Pacific still owned Shakey's International. That company's licensing rights were sold in January 2002, leaving Shakey's, Inc. the only member in "the Group" in fiscal 2002.

Gut-wrenching Decline

Mick Clark wasn't yet born when his grandfather became a Shakey's franchisee in 1961. Now 40, Clark has watched the rise and, as he put it, "gut-wrenching decline" of what once was one of the largest pizza chains in the world. Nearly 400 stores strong in the U.S. in the mid-1970s, it now has only 61 domestic stores. Clark's own company has closed five of its 10 Shakey's parlors in the past 15 years.

McNulty, whose one store was started in the '60s by his father, blames Shakey's failing health as a franchise system on Inno-Pacific's refusal to reinvest in the U.S. arm of the chain. Clark agreed, and said Shakey's Pizza's long-term neglect may be irreversible.

"The writing was on the wall that contraction was coming in unless (Inno-Pacific) began to invest in the franchisees instead of sucking out the royalties stream," he said.

A mere 15 percent the size it was 25 years ago, the chain has opened only one new store since 1992. That, plus Shakey's lack of capital, likely won't convince investors the pizza company is positioned to grow as Flynn claims. Shakey's has only one corporate store, in Covina, Calif., which franchisees say badly needs remodeling.

Inno-Pacific's Chin Yong Wong has indicated he believes the decision to reinvest in Shakey's is the company's alone, and that it reserves the right to reap and reinvest the profits from its investments as it chooses.

In his May 8 letter to Shakey's franchisees, Wong wrote, "I was asked if Inno-Pacific would inject further capital and how. I had said that it was my belief (that) Inno-Pacific like any sensible investors will have to consider all the risk-reward factors before making any investment decision. Furthermore, I have told Mr. McNulty that because of the litigation ... Inno-Pacific will have to be more careful about deciding."

Both McNulty and Clark say Wong's remarks are typical of Inno-Pacific's long-term indifference toward Shakey's, Inc.

"There have been so many promises made, and naturally when someone tells you they're going to do something, your first response is to believe what you're being told," Clark said. "It became obvious in December of 2000, (however), that this was all a big farce."

Despite his disappointments, Clark continues to pay his franchisee royalties to Shakey's, Inc., something he said he'll do as long as he's a franchisee. He signed a contract and he believes it's incumbent upon him to live up to his end of the bargain.

"My response is not to break my contract, but to keep doing the right thing and also demand that (Shakey's, Inc.) do the right thing," Clark said. "Two wrongs don't make a right, and I believe I'm operating and handling this matter in the most professional way I can."

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