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New York Bagels Franchise Is the Biggest Franchise Fraud Case For 2024
Written by: Parth Parth
A July 1, 2022 Press Release from the U.S. District Attorney’s Eastern District of Pennsylvania Office reads…
United States Attorney Jacqueline C. Romero and Acting Deputy Assistant Attorney General Stuart M. Goldberg of the Justice Department’s Tax Division announced that Joseph Smith, 57, formerly of Fishkill, New York, was sentenced to three years and six months in prison, three years of supervised release, and ordered to pay $2,100,450 in restitution by Unites States District Court Judge Gerald J. Pappert for his scheme to defraud New York Bagels prospective franchisees of more than $2.1 million, collectively.
So, what happened here? What exactly was the fraud all about? Was there any prior action taken? And how did unassuming franchisees fall for the scam? We will cover all that and much more in this article.
What happened here? Who got scammed and by whom?
Two franchisors, Joseph Smith and Dennis Mason, started promoting “NY Bagel Cafe & Deli” in 2007 which was called the “NYC Bagel and Sandwich Shop” more recently. The pair slowly learned that in the franchising business there is not a lot of oversight. They realized that they were free to do or say whatever they wanted to do with regard to their franchise without any regard for civil or criminal penalties. What the duo started doing was that they started providing prospective franchisees with forged franchise disclosure documents that stated they have never had a store closed (when they’ve had dozens), never had a lawsuit or civil judgment (they have a long list of those), and that they’ve never had a state franchise agency issue an enforcement order for fraudulent sales practices (they’ve had 3).
The franchisors promised a full refund of the franchise fee if the franchisee failed to get financing but never gave one. They have been selling franchises in multiple states without ever registering them with any authorities.
From 2014 through 2016, Smith deposited more than $1.3 million in franchise fees into New York Bagel bank accounts which he controlled. The defendant spent these funds on personal items unrelated to the business, including rent for his home, travel, car payments for personal vehicles, and living expenses. Smith did not file corporate or individual income taxes for these three years or pay the taxes he owed to the IRS.
Was any legal action taken?
It seems like the fraudsters learned that even if legal action is taken, it means nothing. Some years ago, they believed, like most of us, that lawsuits meant something and court judgments must be paid. They fought their first lawsuit conventionally, lost, and made monthly payments to the franchisee they had defrauded.
However, the next time they were served, they decided to not respond. They did not ask for a postponement or showed up to plead their case. The default ruling was given in favor of the franchisee. But nothing happened after that. The system wasn’t able to get the money from them. Joe and Dennis continued to defraud prospective franchisees and disregard franchise laws. They received threatening legal letters, refund demands, and lawsuit filings which they ignored. They learned that the weary victims will eventually storm off, angrily waving the worthless judgments that they had no way of collecting.
All this led to was emboldening Joe and Dennis to start charging franchise fees to more people by providing prospective franchisees with fictitious and forged. They would make whatever promises they needed to get the initial franchise fees between $19,500 and $29,500. The so-called disclosure documents stated that NY Bagel was a fresh new franchise chain that had never had a closed store or any form of litigation. The disclosures contained no mention of Dennis Mason or his bankruptcies, no mentions of the long list of civil lawsuits and judgments against Dennis and Joe Smith, no mention of the dozens of franchises that had opened and closed, and no mention of the dozens of franchisees who had paid franchise fees but never opened a store.
What did the Franchise Regulators do?
Joe and Dennis sold and promoted their franchise in multiple states without registering. Some of those include New York, California, Maryland, and Virginia.
The Maryland Attorney General opened an investigation and contacted Joe Smith but he did not respond. The Maryland AG determined that Joe and Dennis violated Maryland franchise law in selling an unregistered franchise and issued a cease & desist order. However, that was the extent of his authority. He could not order them to repay the franchisee.
Virginia investigated the sale of multiple unregistered franchises to VA residents by NY Bagel. Joe Smith did not respond. Virginia determined that Dennis & Joe had violated Virginia franchise law and issued fines that could be reduced if they repaid the franchise fees to the VA victims.
Was the SBA providing financing for these franchises?
Unfortunately, the scam was so big that it was almost legitimate. NYC Bagel was listed in the Entrepreneur’s Franchise 500 list in 2017. New York Bagel Sandwich Shop & Deli is listed as “Active” on the Franchise Registry, which helps fast-track SBA loans for 8,000 lenders. According to loan data acquired from the SBA, an SBA-guaranteed loan for $190,000 was approved on 9/25/2017 and disbursed by Centric Bank for a NY Bagel Cafe franchise in Harrisburg.
What is the conclusion?
To some respite, Joe was sentenced to 3.5 years in prison and ordered to pay $2,100,450 in restitution by Unites States District Court Judge Gerald J. Pappert for his scheme to defraud prospective franchisees of more than $2.1 million, collectively.