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The Creditors’ Committee has sued Grant Thornton for alleged auditing failures relating

to the firm’s handling of the pre-petition debtor’s “acquisition” of certain Area Developer

Agreements from NS Associates. Schlotzsky’s2 entered into area developer agreements with

persons or entities who were charged with both recruiting new franchisees and handling some of

the management tasks for existing franchisees within a certain area, in exchange for a portion of

the franchise revenue. One of the largest of these ADA’s involved NS Associates, covering

Dallas, Houston and San Antonio. The agreement was entered into in 1996.

A few years later, Schlotzsky’s initiated a strategy of either re-negotiating the terms of

some of these area developer agreements or buying them out outright, with the goal of obtaining

a new source of financing by securitizing the franchise revenue stream. The reacquisition

transaction with NS Associates forms the basis of this lawsuit, as the committee alleges that

Grant Thornton improperly characterized the debtor’s exercise of the option in the agreement as

an “acquisition of intangible assets,” thereby impermissibly permitting the offset of 100 percent

of the Option price. The Committee maintains that the transaction should have been recorded as

an expense because it was more properly characterized as a contract termination fee. According

to the Committee, accounting for the transaction as did Grant Thornton allegedly caused the

Debtor’s financial statements to falsely show an increase in intangible assets of more than $25

million offsetting the $23 million liability recorded, artificially masking the company’s

insolvency. The Committee also alleges that the assets were worth substantially less than $25

million, evidenced by the major write-down by the Debtor after filing.

Grant Thornton was hired to perform a fiscal year 2002 audit. It was re-engaged for the

following fiscal year as well. The Committee in its complaint charges that Grant Thornton failed


The background facts as set out herein are descriptive only and should not be construed as findings.

2 In this generic description, the reference to Schlotzsky’s is actually a reference to a number of related corporate entities through which business was conducted.


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