OsteoStrong Franchisees Win Over a Hidden Fraud Conviction

Item 3 and Item 4 of a franchise disclosure document are the pages most buyers skim. Litigation. Bankruptcy. OsteoStrong's said there was nothing to report. A federal judge in Houston has ruled that was false, that the company knew it, and that the franchisor therefore can't collect on its contracts.

In findings of fact and conclusions of law entered Sept. 30, the U.S. District Court for the Southern District of Texas found that OsteoStrong Franchising fraudulently induced two couples into franchise and regional developer agreements: Ken and Linda Burbank, who had a franchise in Redding, Calif., and Sean and Charla Simpson, who had three in Albuquerque. The Simpsons first sued in 2019.

The problem was Emanuelle "Manny" Butera, the officer the court describes as OsteoStrong's principal sales officer. He had been convicted of felony bankruptcy fraud, and his bankruptcy history went undisclosed. The Burbanks, one of whom was a police officer, testified they would never have signed had OsteoStrong disclosed that Butera had been convicted just two years earlier.

The court held that the FTC's Franchise Rule required the conviction to appear in Item 3 and the bankruptcy history in Item 4, so the "nothing to disclose" statements were false. It imputed Butera's knowledge, and that of founder and CEO Kyle Zagrodzky, to the company.

OsteoStrong argued the franchisees had acknowledged doing their own investigation. The judge wasn't moved. "There was no evidence that even sophisticated franchisees would, as a matter of course, run a criminal background check on every corporate officer with whom they are considering doing business," the order says.

The result: OsteoStrong's counterclaims for unpaid royalties and missed development schedules were dismissed, and the Burbanks recover $244,242 in out-of-pocket losses. The Simpsons got no damages, because an earlier ruling had dismissed their own fraud claim, but they were excused from performing their agreements.

That is the part franchisors should sit with. Questionnaires and independent-investigation clauses did not save a false FDD, a point The Franchise Memorandum, the Lathrop GPM blog, flagged on Nov. 5. Franchisee fraud claims built on the disclosure document keep finding traction in court, as when an Ohio judge kept a Magnolia Soap franchisee's case at home this month.

OsteoStrong had 205 locations in 14 countries at the time of trial, according to the order. The cheapest fix the case points to costs a few dollars: a background check on every officer named in the FDD.