Gigi’s, Mr Gatti’s bankruptcy filing begs $30-million question

BY BETH EWEN
FRANCHISE TIMES

Beth Ewen
ILLUSTRATION BY JONATHAN HANKIN

Jeffrey Cohen, an attorney representing 18 Gigi’s Cupcakes franchisees in ongoing litigation, is on the hunt for $30 million. That’s the amount borrowed in two loans from Equity Bank last June—$20.2 million by pizza restaurant franchise Mr. Gatti’s and Sovrano, its parent company, and $9.2 million by Gigi’s Cupcakes, the cupcake franchise purchased by KeyCorp and its affiliate FundCorp in 2016.

Both loans are dated June 28, 2018. A bit over six months later, on January 4, 2019, the three debtor firms claimed “a liquidity crisis” in a Chapter 11 bankruptcy filing and petitioned the court to use cash collateral held by Equity Bank. The filings said the companies needed “immediate access to its cash to pay employees and to pay for ordinary operational expenses.”

Cohen, of Cohen Law in Denver, is trying to track down the money. “It’s a term loan, not a line of credit,” he said. “What happened to the cash? I know Gigi’s is losing money, but it’s not losing $1.5 million a month.”

KeyCorp is the venture capital firm that bought Gigi’s in April 2016 via an affiliate called FundCorp, whose principal is Jim Phillips. Sovrano, which bought Mr. Gatti’s in 2015, is also listed as an affiliate of FundCorp. Neither KeyCorp nor FundCorp is listed as a debtor on the January 4 bankruptcy filing.

“I have a feeling, and I’ve brought it up, that the money went upstream to KeyCorp, who is the owner, and Jim Phillips, the major principal,” Cohen alleges. “This $30 million that went upstream—so they sucked the money out of the companies and they put them into bankruptcy?

“That’s what I strongly suspect,” Cohen continues. “It doesn’t seem that Gigi’s is going to borrow $9 million in June and claim it’s insolvent six months later.”

KeyCorp follows Chapter 11 path

On January 25, 2019, another shoe dropped in the case: KeyCorp filed for Chapter 11 bankruptcy protection and asked for an immediate stay to all litigation. Listed as the creditors are 18 entities, the same franchisees Cohen is representing in litigation dating back to late 2017 and claiming fraud by Gigi’s, Gigi’s founder Gina Butler, early Gigi’s investor Alan Thompson and KeyCorp, among others. Absent from the KeyCorp Chapter 11 filing is any mention of FundCorp., the affiliate named as the entity controlling Gigi’s.

“So I don’t know what these guys are up to. It appears, just as a working hypothesis, that they transferred all the assets out of the KeyCorp into FundCorp or somewhere. Who knows? They looted the company altogether,” Cohen alleges.

Facilitating ‘a quick turnaround’

I always try mightily to get all sides of the story to comment, but no one associated with the debtors would reply. Deborah Coldwell of Haynes and Boone, the outside attorney representing KeyCorp. and the related parties, emailed she does not comment on ongoing litigation.

Michael McConnell of Kelly Hart & Hallman, the outside attorney for the debtors in both bankruptcy filings, referred via a spokesperson my request for comment to Jack Strother, general counsel of Mr. Gatti’s Pizza and Gigi’s Cupcakes. Strother did not return phone calls seeking comment.

Documents in the Mr. Gatti’s/Gigi’s Chapter 11 filing say it will “facilitate a quick turnaround and improvement in liquidity in order to create a fiscally stronger enterprise.” The debtors’ filings “are the result of a combination of factors stemming from the acquisition of the Gigi’s brand in 2016, leverage undertaken in connection with acquisition and growth of both brands, and operating losses at certain stores.”

The litigation surrounding Gigi’s shows how an acquisition can go terribly south. KeyCorp touted its purchase of Gigi’s from Butler and Thompson in April 2016. At the
time, Butler herself said in a statement she was “so excited about FundCorp leading the way for Gigi’s Cupcakes. We now have the opportunity to experience tremendous growth.”

By October of 2016, however, KeyCorp sued Gigi’s Holdings, claiming its management, including Butler and Thompson, misrepresented the health of the franchise system. After the purchase, the lawsuit said, KeyCorp learned of 32 locations that had threatened to close or leave the franchise system, “which is six times the number that defendants disclosed.” KeyCorp alleged that damages “exceeded $1.4 million,” and had they known, they “would not have completed the transaction using the same valuation methodology…and very well may not have completed the transaction at all.”

In an interview last June, Butler told me the aftermath of the sale has been difficult. “It’s been really hard. You birth a baby and you put it into someone’s hands and you trust them,” she said. “Your name and your face is on it. The hate mail—and the fan mail—still comes to me,” she said, adding she’ll get a note when a store in Milwaukee, say, runs out of a certain type of cupcake. “I’m still the face” of the brand. Early this year, she sent a mass email about an upcoming celebration at a Gigi’s store.

‘There will be answers’

The lawsuit filed by KeyCorp against Gigi’s et al. settled shortly after it was filed, Cohen said, but Cohen attached it to his complaint filed September 2018 on behalf of the franchisees. “It shows that there was underlying fraud” because that was KeyCorp’s claim against Thompson and Butler. Franchisees were “defrauded as well,” he claims, overstating the earnings and understating the expenses “in a substantial way.”

He will continue pursuing the lawsuit against Butler, Thompson, FundCorp and the others, and is working to schedule depositions in the bankruptcy cases. “We’d like to get Jim Phillips himself, because he’s the guarantor on that $9 million in debt,” Cohen says.

“It’s mysterious,” he says about the hunt for the missing money, but he is resolute. “There will be answers, and I’m sure they won’t be good.”

Beth Ewen is editor-in-chief of Franchise Times, and writes the Continental Franchise Review® column in each issue. Send interesting legal and public policy cases to bewen@franchisetimes.com.

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