A 3 a.m.

bankruptcy filing, unpaid millions, and IHOb burgers: Inside the $23 million
battle raging within Applebee's

Kate Taylor Aug. 15, 2018, 8:00 AM

Applebee's parent company is in the middle of a legal battle with one of its largest franchise groups. Hollis Johnson/Business Insider

Applebee's parent company, Dine Brands, and its second-largest franchisee, RMH Holdings, are
battling in court, with Dine Brands attempting to take control of dozens of the franchisee's
restaurants.

RMH controls more than 140 Applebee's locations and filed for bankruptcy in May, blaming Dine
Brands' "ill-advised and value-destroying" decisions for struggling sales and millions of wasted
dollars.

The franchisee filed for bankruptcy at 3:30 a.m. on May 8, hours after Dine Brands' CEO issued an
ultimatum: send $12 million in unpaid royalties by the end of the day, or lose your restaurants.

Dine Brands claims that RMH owes the company more than $23 million in unpaid and lost future
royalties and other fees.

There's a battle raging within Applebee's.

On one side is the chain's parent company, Dine Brands. On the other is Applebee's second-largest franchisee,
RMH Holdings, which filed for bankruptcy earlier this year — at 3:30 a.m. on Tuesday, May 8, to be exact.
The bankruptcy filing came hours after a fateful phone call on Monday afternoon between Dine Brands CEO
Steve Joyce and RMH representatives.

In the phone call, which is said to have lasted less than five minutes, Joyce said that if the franchisee didn't
wire Dine Brands $12 million by the end of the day, dozens of the franchisee's stores would be shut down,
according to three people with knowledge of RMH's thinking on the matter.

RMH said it was a shocking ultimatum, with one source with direct knowledge of the conversation calling it
the equivalent of "having a nuclear bomb dropped on your head." This person asked to remain anonymous to
be able to speak frankly about the situation.

Before filing for bankruptcy, RMH had refused to pay royalties for almost a year. The franchisee additionally
stopped paying advertising fees four months earlier, in January. A court filing by RMH says the franchisee
believes it had every right to stop paying the fees because of what it saw as "ill-advised and value-destroying"
decisions on the part of Dine Brands.

Dine Brands' CEO has said he feels differently.

"They thought they could keep doing what they were doing for a longer period of time," Joyce told Business
Insider in an interview on August 2. "But they were doing it for a long time."

Now, the two sides are facing off in court.

Dine Brands claims in a lawsuit that RMH owes it more than $23 million in unpaid and lost royalties and fees,
and it is demanding the franchisee hand over control of dozens of restaurants because of the termination of its
franchise agreement.

RMH, in a counterclaim, says the agreement was not terminated, and it is demanding Dine Brands reimburse
it for damages linked to what it says was mismanagement on the part of Applebee's parent company. The
counterclaim says those damages could be millions of dollars in total.

Applebee's multimillion-dollar mistakes

Applebee's wood-fired steaks are said to have cost franchisees millions. Applebee's
While many restaurant-chain companies own and operate at least a portion of their locations, Applebee's is
100% franchised — every Applebee's restaurant in the US is owned by one of 34 franchisees. In exchange for
the use of Applebee's branding and national marketing support, franchisees are expected to make monthly
royalty payments, based on a percentage of sales, along with contributions to an advertising fund as part of
their franchise agreement.

When franchisees refuse to pay royalties, the entire business model can be ruined. One doing so is manageable
at a chain with thousands of franchisees, but when one of fewer than 40 franchisees stops paying royalties, it
can seriously affect a company's bottom line.

The problems between Dine Brands and RMH began not long after the franchise group was founded in 2012 as
one of the private-equity firm ACON Investments' portfolio companies. At the time, Dine Brands was called
Dine Equity; it changed its name in February.

Applebee's, famous for its "eating good in the neighborhood" motto and two-for-$20 deals, began a push to
make the chain seem more upscale in 2014. In 2015, Applebee's moved its headquarters from Kansas City to
Glendale, California. That year, it announced plans to make adjustments to 40% of its menu items.

In May 2016, Applebee's executives announced that all 2,000-plus locations across the US would install wood-
fired grills, which the chain said at the time would require an investment of more than $40 million by its
franchisees. RMH said in its counterclaim, filed this June, that the grills and related expenses cost it almost $3
million, including $180,000 it said it spent on steaks that ended up wasted as employees learned how to cut
the meat by hand.

RMH added that Dine Brands' "mismanagement reached its crescendo" with the installation of the wood-fired
grills, saying the initiative proved to be a "colossal failure." Other franchisees also pushed back on the rollout,
calling it a "disaster," RMH said in the counterclaim.

RMH estimates that the value of its business had decreased by more than $141 million, comparing the 12
months leading up to April 2018 to the 12 months leading up to April 2016. The investments were expensive,
and customers simply didn't appear to be interested. Comparable sales fell a whopping 5% at Applebee's in
fiscal 2016.
Finally, in late December 2016, a group of franchisees that included RMH requested that Applebee's March
2017 menu not feature the hand-cut steaks at all. Applebee's agreed. By February 2017, Dine Brands announced
that CEO Julia Stewart, who engineered the company's takeover of Applebee's in 2007 and led the push for
hand-cut steaks, had left the company.

Turnarounds and inner turmoil

Applebee's ditched attempts at being upscale and doubled down on deals in 2017. Hollis Johnson/Business Insider

In March 2017, Applebee's announced it had hired John Cywinski to take over as its president and engineer the
chain's turnaround.

Cywinski had worked at Applebee's from 2001 to 2006, a period that Greg Flynn, the CEO of Applebee's largest
franchisee, Flynn Restaurant Group, told Business Insider included the chain's "glory years." Cywinski already
knew some of the longer-term franchisees, including Flynn, and was up front about the mistakes Applebee's
had made.

"Coming in, it was clear to me who we are and what we stood for," Cywinski told Business Insider in a recent
interview for a story about Applebee's turnaround. "Being with the franchisees enlightened me on maybe
some of the missteps we had taken historically."

Cywinski described 2017 as the year in which Applebee's needed to stabilize its business, with the chain
ditching upscale steaks for deals like the $1 margarita. Same-store sales finally turned positive in the fourth
quarter of 2017, and that has continued into the first two quarters of this year.

Still, RMH and several other franchisees were struggling financially, resulting in issues with paying royalties to
Dine Brands and with contributing to the company's advertising fund. Dine Brands hired Trinity Capital
Investment Banking, a firm with experience restructuring chains like Burger King and Taco Bell, in early 2017
to advise franchisees. As of the end of this June, Applebee's had $14 million outstanding in loans to
franchisees.

RMH said it stopped paying its monthly royalties in June 2017, after nine straight quarters of its stores
experiencing declining sales. It stopped paying advertising and other fees in January.

Applebee's also ditched fire-grilled steak for classics. Hollis Johnson/Business Insider
"Despite repeatedly conceding its missteps, the Franchisor never offered help to the franchisee network, such
as reducing royalty rates, providing a royalty vacation, or doing anything else to help offset the financial
damage it had caused the franchise network," RMH said in the June court filing.

A Dine Brands spokeswoman said in an email to Business Insider that the company's turnaround plan was
working for partners and franchisees who had demonstrated an "individual commitment" to it. She added that
Applebee's had invested in the success of its franchisees and that the company was seeing "some of the best
sales and traffic in a decade," with same-store sales growing 5.7% in the most recent quarter.

In a 100% franchised system such as Applebee's, the parent company's revenue depends on royalties.
Executives are incentivized to get the franchisee to start paying again — and fast.

And with Joyce starting as CEO in September 2017, Dine Brands was ready to turn up the heat.

"When a franchisee fails to meet its legal and financial obligations, we are forced to take action to protect the
brand for the benefit of the restaurants and fellow franchisees who are paying their share," the Dine Brands
spokeswoman said.

In September, Dine Brands sent RMH a notice of default, saying the company owed more than $3.4 million in
royalties. While the notice originally said RMH was required to pay in 90 days, the deadline was pushed back
in December to add another 30 days.

More days were added in January, in February, in March, and — one final time — on April 8, at which point
Dine Brands said RMH owed the company at least $12,161,823.

"Your past assurances that RMH and ACON intend to move forward expeditiously appear questionable at this
point," Bryan Adel, Dine Brands' attorney, wrote in an April 16 letter to RMH included in court filings. "We
have no choice but to interpret any further delay as an indication that RMH and ACON do not consider this
matter to be a priority."
While sales were turning around for RMH and its cash flow was increasing, it expressed a desire to pay back
other lenders before playing catch-up with royalty payments to its franchisor, sources familiar with the
franchisee's thinking said.

After the turmoil of the hand-cut steaks, Dine Brands gave several franchisees some leeway on payments. Now
that RMH had as much as $18 million in cash, the franchisee and franchisor clashed on who RMH should pay
back first.

Dine Brands and RMH went back and forth for months, from September to April, with discussions and
proposals about how much RMH should be required to pay and the date that the franchisee needed to pay it,
court filings outline.

According to Dine Brands, RMH's failure to pay the money by April 27 meant that the franchisee had lost its
rights to operate Applebee's locations on that day.

"After numerous attempts to resolve the situation, we had no choice but to take action," the Dine Brands
spokeswoman said.

RMH denies that Dine Brands had terminated the agreement. The lack of formal notice before the franchisee's
bankruptcy filing, RMH's court filing says, means that the agreement is still valid and that the franchisee is
still free to continue running Applebee's locations.

But everything would soon come to a head.

A 'nuclear' phone call and a midnight scramble toward bankruptcy

Hollis Johnson/Business Insider

On May 7, RMH representatives and Joyce got on a phone call.

According to three people with knowledge of the situation, RMH expected the conversation to be a
continuation of the previous months' slow work toward a solution. Representatives from RMH had been in
touch with Applebee's over the prior week, and Dine Brands executives had attended RMH's annual general
manager conference, held from April 30 to May 3.
Per sources with knowledge of RMH's thinking, Daniel Jinich, a managing partner at ACON, the private-equity
firm that owns the franchisee, had set up the phone call to discuss a potential meeting among RMH, Dine
Brands representatives, and other lenders to the franchisee.

Instead, RMH claims in its court filing, Jinich and Robert Hersch, a senior managing director at the financial
adviser Mastodon Ventures, faced an ambush.

On the call, Joyce said it was "too late" for RMH to attempt to work toward a solution, a source with direct
knowledge of the situation said. Dine Brands had apparently already made a decision — the next day, RMH
would receive a letter terminating the chain's franchise agreement to operate 41 restaurants in Arizona and
Texas.

The only way to prevent the takeover, Joyce said, was if RMH sent Dine Brands $12 million by the end of the
day, RMH's filing says. Then, sources say, Joyce said there was nothing else to discuss. The call ended.

RMH had expected there would be a ratcheting up of tensions before Dine Brands issued such a demand. The
franchisee felt it experienced the equivalent of "having a nuclear bomb dropped on your head," the source
familiar with RMH's thinking said.

Dine Brands disagrees with RMH's characterization of the call, describing it in an email to Business Insider as
"a courtesy notice following the repeated written notices and emails pursuant to our Franchise agreement that
the franchisee chose to ignore for over nine months."

Joyce said RMH's shocked reaction, as documented in court filings, was an insincere response.

"Whatever their intent was, I don't know," Joyce told Business Insider. "They were hurting the system, hurting
the franchisees, hurting the ad fund. And it's my job to protect that."

As Jinich and Hersch spoke with people at ACON and legal counsel, including bankruptcy lawyers, it became
clear that the only way to prevent Dine Brands from taking over the Arizona and Texas restaurants would be to
file for bankruptcy before RMH received the letter that terminated the agreement, sources say. So the
franchisee began an all-night mission to do just that.
At 3:30 a.m., RMH filed for Chapter 11 bankruptcy protection. At 5:59 a.m., Hersch emailed Applebee's and
Dine Brands executives, informing them of the filing.

At 8:02 a.m., Dine Brands had a letter hand-delivered to RMH saying the company's franchise agreement for 41
restaurants in Arizona and Texas had been terminated, effective, retroactively, as of April 27.

The battle continues

Even IHOP's temporary name change to IHOb is being used as evidence against Applebee's. Hollis Johnson/Business Insider

In the wake of the drama in early May, both sides have been trying to stake their claim to RMH's Applebee's
locations — specifically the Arizona and Texas spots.

On the ground, RMH's 146 Applebee's locations are still up and running. The franchisee has closed 13
restaurants in the months following the bankruptcy filing.

On May 25, Dine Brands filed a complaint demanding that RMH surrender the Arizona and Texas restaurants
and stop using Applebee's branding in other restaurants. Dine Brands estimates that the damages suffered by
Applebee's at the hand of RMH exceed $23 million, including more than $12 million in unpaid royalties and
other fees, plus an additional $10 million in lost payments from RMH restaurants that closed without Dine
Brands' permission.

According to Joyce, Dine Brands is now being paid by all franchisees, something he called "a significant
change from a year ago."

RMH filed the counterclaim in June denying that Dine Brands terminated the franchise agreement before the
bankruptcy filing. According to RMH, conversations in late April and early May between representatives from
RMH and Dine Brands, as well as a lack of final notice, prove that.

The franchise group also claimed some new slights against Applebee's. RMH took issue with Applebee's sister
brand IHOP temporarily changing its name to IHOb this summer to promote its new burger line, saying it was
a move that added "insult to the injury" and had the potential to cannibalize Applebee's burger sales.
(Cywinski, Applebee's president, dismissed the concern, citing Applebee's comparable sales growth of 5.7% in
the most recent quarter.)

The two sides are set to face off in court again in late August. According to Joyce, it's too soon to say how things
will play out as the parties search for a solution that "everyone can live with."
"We want a solution that protects the system, because they were hurting the system," Joyce said.

"They had the money to pay us, and they weren't paying us," he continued. "As simple as that."

SEE ALSO: Applebee's is making a comeback by ditching food that people 'can't pronounce' »

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