Persistence Pays in Detecting Underreporting in Franchisees

After three years of investigating inventory shortages in a five-store network, 7-Eleven was able to obtain a preliminary injunction against franchisees accused of underreporting in 7-Eleven v. Khan, 2013 U.S. Dist. LEXIS 146696 (E.D.N.Y). Little direct evidence demonstrated the diversion of cash and inventory, but the overwhelming circumstantial evidence led inescapably to the conclusion that systematic underreporting was occurring and that management was responsible for the losses.

In the 7-Eleven franchise system, the franchisee does not acquire ownership of the retail outlet. Instead, the franchisee’s ownership consists in the net income derived from operations, after deducting operating expenses and 7-Eleven’s 50 percent share of the gross profits. 7-Eleven requires its franchisees use a point-of-sale (POS) register system to record all sales on an electronic journal, accessible in real time by 7-Eleven. Items are typically bar-coded and scanned into the register. If cash payment is tendered by the customer, the register drawer opens and the customer is given change from the register. 7-Eleven can generate reports reflecting the register transactions and can reconcile those reports to cash reports and deposits required to be submitted by the franchisee. 7-Eleven finances the purchase of inventory for its stores and can reconcile the inventory levels to products sold.