Asymmetry and Invalid Arbitration Clauses

In the world of franchising, mandatory arbitration contract provisions have become de rigueur. In principle, agreements to arbitrate favor neither party; as a practical matter, however, franchisors and franchisees have quickly learned about the real-life advantages and disadvantages of including an arbitration clause in a franchise contract. Generally, these clauses are included in franchise contracts because they tend to favor the franchisor ' the party that, in most cases, usually has the bargaining power to impose terms and conditions on the weaker party, the franchisee. There are very few, if any, reported cases in which a franchisee challenging the validity of an arbitration clause has been shown to have requested or demanded that an arbitration clause be included in the franchise agreement.

In the wake of the recent blizzard of U.S. Supreme Court decisions unequivocally solicitous of arbitration clauses, courts have generally been loath to invalidate arbitration agreements between private parties. Indeed, in most cases, guided by the principle of “rigorous enforcement,” courts faced with mandatory arbitration provisions generally do little more than act as rubber stamps, sending case after case directly to arbitration. To most courts, the mere existence of a mandatory arbitration clause in a contract evinces an intent by the parties (who were often presumed to be sophisticated parties with bargaining power) to arbitrate; the terms in the franchise agreement are held to be conclusive as the final, fully integrated expression of the parties' intent. Although the Federal Arbitration Act (“FAA”) itself provides exceptions to the policy of enforcement, few courts historically have seriously considered invalidating an agreement to arbitrate. Against this strong sentiment, a franchisee seeking to litigate his or her case in court in the face of a mandatory arbitration clause has historically had little hope.

The few courts that have ventured out of the mainstream and invalidated an arbitration clause have done so based on one of two general theories. First, some courts have ruled that a franchisee was not bound by an arbitration clause since the arbitration clause did not itself, or through its language, apply to the underlying dispute. For instance, one court vacated an order compelling arbitration when the written agreement containing the arbitration requirement had expired before the underlying dispute arose. Second, some courts have held that an arbitration clause is void based on unconscionability, one of the traditional bases of challenging the formation of a contract.

By their very nature, arbitration clauses falling in the first category – those that are not applicable to the dispute by virtue of the specific language or terms of the arbitration clause – are very few. It is a simple matter of contract interpretation to determine whether a particular dispute (eg, termination) is covered by the language of an arbitration clause. Further, because franchisors usually themselves draft the voluminous franchise agreements, almost every claim that a franchisee might acquire during, before, and after execution of a franchise agreement is explicitly covered by the scope of the arbitration clause.

Accordingly, only arbitration clauses falling in the second category ' those arising out of faulty contract formation ' offer any hope to franchisees attempting to extricate themselves from the clutches of an arbitration clause. The FAA supports this latter rationale when it states that arbitration clauses may be invalidated “upon such grounds as exist at law or in equity for the revocation of any contract.”

When Are Mandatory Arbitration Clauses Unconscionable?

In the recent past, franchisees have had some limited success challenging arbitration clauses based on unconscionability. Although almost all courts will not hesitate to quickly reject a franchisee's broad allegations that an arbitration clause is by its very nature unfair, some courts have recently shown that they will consider a franchisee's more specific contention that an arbitration agreement is invalid because it fails to impose mutuality of remedy on both parties. For instance, arbitration clauses that provide to one party, and not the other, the choice of whether to arbitrate at all are subject to attack as unconscionable due to lack of mutuality.

Under traditional principles of unconscionability, a franchisee seeking to set aside an arbitration clause must show that the clause is both substantively and procedurally unconscionable. With regard to the latter, many courts have held that since a franchise agreement is a contract of adhesion, the franchisee need not present any further evidence of procedural unconscionability. And, regarding substantive unconscionability, as demonstrated by a recent decision by the Superior Court for the State of California, Byerrum v. RE/MAX of California and Hawaii, Inc., Bus. Franchise Guide (CCH) par. 12,743 (Cal. Super. 2004), courts have shown an increased receptiveness to a franchisee's argument that asymmetrical obligations to arbitrate are sufficient to show unconscionability.

In Byerrum, the Superior Court of the State of California for the County of Los Angeles held that the arbitration clause contained in a franchise agreement RE/MAX of California and Hawaii, Inc. (“RE/MAX”) allegedly entered into with Byerrum was procedurally and substantively unconscionable, and was, therefore, unenforceable.

The plaintiff in that case, Richard Byerrum, purchased a RE/MAX real estate franchise in Roseville, CA in 1986. Over a 17-year period, Byerrum renewed his franchise with RE/MAX three times ' which he was required to do by RE/MAX to continue operating. Each time Byerrum's RE/MAX franchise was nearing the renewal date, RE/MAX offered to Byerrum a renewal franchise agreement that it drafted and offered to Byerrum for signature without negotiation.

The franchise agreement, which was drafted by RE/MAX and presented to Byerrum on a “take it or leave it” basis, purportedly required Byerrum to arbitrate “any dispute” arising out of the contract. In drafting the agreement, however, RE/MAX included a provision purporting to allow itself, RE/MAX, to choose between litigation, arbitration, and mediation to resolve “any claims” that it allegedly had against Byerrum. Specifically, Paragraph 14(G) of the franchise agreement stated:

G. RE/MAX Claims Against You. Although you are obligated to arbitrate or mediate[,] RE/MAX is not required to arbitrate or mediate any claims it has against you, including claims relating to the copyrights, Marks or trade secrets of RE/MAX or claims relating to the post-termination obligations set forth in Section 8 of this Agreement. Your obligation to mediate or arbitrate does not prevent RE/MAX from seeking any or all of the remedies under Section 15(E) [relating to specific performance and injunctive relief].

Byerrum filed suit against RE/MAX alleging, inter alia, breach of franchise agreement, violation of California's Unfair Trade Practices Act, breach of implied covenant of good faith and fair dealing, violation of the Franchise Relationship Act, and tortious interference with prospective economic advantage. RE/MAX petitioned the court to compel arbitration based on the mandatory arbitration provision. In response, Byerrum argued that the arbitration provision in the alleged franchise agreement was unenforceable because the language of the arbitration clause, and the circumstances surrounding Byerrum's signing of the agreement, demonstrated both procedural and substantive unconscionability.

Byerrum argued that, under California law, arbitration agreements contained in contracts of adhesion (like the franchise agreement in Byerrum) must contain “a modicum of bilaterality” to be enforceable. Essentially, Byerrum argued that where the party with superior bargaining power (in that case, RE/MAX) attempts to require arbitration by the adhering party (Byerrum) but refuses to accept the obligation to arbitrate at least some of its claims, the arbitration agreement is unconscionable, and therefore is unenforceable against the adhering party.

In general, unconscionability has both a procedural and a substantive element; to succeed on his claim of unconscionability, Byerrum was required to show that both procedural and substantive unconscionability were present in the arbitration provision (although they did not need to be present to the same degree). Essentially, the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to come to the conclusion that the term is unenforceable, and vice versa.

Following recent precedent set by California courts and by the U.S. Court of Appeals for the Ninth Circuit, Byerrum also argued that the arbitration agreement was procedurally unconscionable, as it was part of a contract of adhesion. In Byerrum, the franchise agreement at issue was a renewal of an existing franchise between RE/MAX and Byerrum, was drafted by RE/MAX, and offered to Byerrum on “take it or leave it” terms.

The court held that, particularly since the franchise agreement was offered to Byerrum in the renewal context, it was a contract of adhesion: If Byerrum did not accept RE/MAX's renewal agreement, Byerrum would have been forced to walk away from the business that he had spent countless hours and significant amounts of money developing. The court recognized that essentially, the case was one of “unequal bargaining position,” and that Byerrum had no choice but to renew on the terms offered by RE/MAX. Under applicable case law, the circumstances rendered the franchise agreement a contract of adhesion.

In arguing that the arbitration language in the franchise agreement was substantively unconscionable, Byerrum referred to a recent California Supreme Court decision, Armendariz v. Foundation Health Psych. Servs., Inc., 24 Cal. 4th 83; 99 Cal. Rptr. 2d 745 (2000), striking an arbitration clause in an employment context. Under Armendariz, an agreement to arbitrate will satisfy the general standard for substantive unconscionability if the agreement lacks a “modicum of bilaterality.” Byerrum argued, and the court agreed, that, because the RE/MAX franchise agreement contained a unilateral obligation to arbitrate, it was substantively unconscionable.

While decisions like the one in Byerrum are still the exception rather than the rule, a growing trend leans toward striking arbitration agreements on grounds of unconscionability. For example, in one such case, the U.S. Court of Appeals for the Ninth Circuit recently upheld a Montana District Court's refusal to enforce an arbitration clause in a hotel franchise agreement due to a finding of unconscionability where the provision “lack[ed] mutuality of obligation, [was] one sided, and contain[ed] terms that [were] unreasonably favorable to the drafter.” Ticknor v. Choice Hotels Int'l., Inc., 265 F. 3d 931 (9th Cir. 2001) Because the type of franchise agreements at issue in the Ticknor and Byerrum cases are typical of those used in the industry, those cases may signal the beginning of a new era, wherein the doctrine of unconscionability is considered, and not readily discarded.

In the world of franchising, mandatory arbitration contract provisions have become de rigueur. In principle, agreements to arbitrate favor neither party; as a practical matter, however, franchisors and franchisees have quickly learned about the real-life advantages and disadvantages of including an arbitration clause in a franchise contract. Generally, these clauses are included in franchise contracts because they tend to favor the franchisor ' the party that, in most cases, usually has the bargaining power to impose terms and conditions on the weaker party, the franchisee. There are very few, if any, reported cases in which a franchisee challenging the validity of an arbitration clause has been shown to have requested or demanded that an arbitration clause be included in the franchise agreement.

In the wake of the recent blizzard of U.S. Supreme Court decisions unequivocally solicitous of arbitration clauses, courts have generally been loath to invalidate arbitration agreements between private parties. Indeed, in most cases, guided by the principle of “rigorous enforcement,” courts faced with mandatory arbitration provisions generally do little more than act as rubber stamps, sending case after case directly to arbitration. To most courts, the mere existence of a mandatory arbitration clause in a contract evinces an intent by the parties (who were often presumed to be sophisticated parties with bargaining power) to arbitrate; the terms in the franchise agreement are held to be conclusive as the final, fully integrated expression of the parties' intent. Although the Federal Arbitration Act (“FAA”) itself provides exceptions to the policy of enforcement, few courts historically have seriously considered invalidating an agreement to arbitrate. Against this strong sentiment, a franchisee seeking to litigate his or her case in court in the face of a mandatory arbitration clause has historically had little hope.

The few courts that have ventured out of the mainstream and invalidated an arbitration clause have done so based on one of two general theories. First, some courts have ruled that a franchisee was not bound by an arbitration clause since the arbitration clause did not itself, or through its language, apply to the underlying dispute. For instance, one court vacated an order compelling arbitration when the written agreement containing the arbitration requirement had expired before the underlying dispute arose. Second, some courts have held that an arbitration clause is void based on unconscionability, one of the traditional bases of challenging the formation of a contract.

By their very nature, arbitration clauses falling in the first category – those that are not applicable to the dispute by virtue of the specific language or terms of the arbitration clause – are very few. It is a simple matter of contract interpretation to determine whether a particular dispute (eg, termination) is covered by the language of an arbitration clause. Further, because franchisors usually themselves draft the voluminous franchise agreements, almost every claim that a franchisee might acquire during, before, and after execution of a franchise agreement is explicitly covered by the scope of the arbitration clause.

Accordingly, only arbitration clauses falling in the second category ' those arising out of faulty contract formation ' offer any hope to franchisees attempting to extricate themselves from the clutches of an arbitration clause. The FAA supports this latter rationale when it states that arbitration clauses may be invalidated “upon such grounds as exist at law or in equity for the revocation of any contract.”

When Are Mandatory Arbitration Clauses Unconscionable?

In the recent past, franchisees have had some limited success challenging arbitration clauses based on unconscionability. Although almost all courts will not hesitate to quickly reject a franchisee's broad allegations that an arbitration clause is by its very nature unfair, some courts have recently shown that they will consider a franchisee's more specific contention that an arbitration agreement is invalid because it fails to impose mutuality of remedy on both parties. For instance, arbitration clauses that provide to one party, and not the other, the choice of whether to arbitrate at all are subject to attack as unconscionable due to lack of mutuality.

Under traditional principles of unconscionability, a franchisee seeking to set aside an arbitration clause must show that the clause is both substantively and procedurally unconscionable. With regard to the latter, many courts have held that since a franchise agreement is a contract of adhesion, the franchisee need not present any further evidence of procedural unconscionability. And, regarding substantive unconscionability, as demonstrated by a recent decision by the Superior Court for the State of California, Byerrum v. RE/MAX of California and Hawaii, Inc., Bus. Franchise Guide (CCH) par. 12,743 (Cal. Super. 2004), courts have shown an increased receptiveness to a franchisee's argument that asymmetrical obligations to arbitrate are sufficient to show unconscionability.

In Byerrum, the Superior Court of the State of California for the County of Los Angeles held that the arbitration clause contained in a franchise agreement RE/MAX of California and Hawaii, Inc. (“RE/MAX”) allegedly entered into with Byerrum was procedurally and substantively unconscionable, and was, therefore, unenforceable.

The plaintiff in that case, Richard Byerrum, purchased a RE/MAX real estate franchise in Roseville, CA in 1986. Over a 17-year period, Byerrum renewed his franchise with RE/MAX three times ' which he was required to do by RE/MAX to continue operating. Each time Byerrum's RE/MAX franchise was nearing the renewal date, RE/MAX offered to Byerrum a renewal franchise agreement that it drafted and offered to Byerrum for signature without negotiation.

The franchise agreement, which was drafted by RE/MAX and presented to Byerrum on a “take it or leave it” basis, purportedly required Byerrum to arbitrate “any dispute” arising out of the contract. In drafting the agreement, however, RE/MAX included a provision purporting to allow itself, RE/MAX, to choose between litigation, arbitration, and mediation to resolve “any claims” that it allegedly had against Byerrum. Specifically, Paragraph 14(G) of the franchise agreement stated:

G. RE/MAX Claims Against You. Although you are obligated to arbitrate or mediate[,] RE/MAX is not required to arbitrate or mediate any claims it has against you, including claims relating to the copyrights, Marks or trade secrets of RE/MAX or claims relating to the post-termination obligations set forth in Section 8 of this Agreement. Your obligation to mediate or arbitrate does not prevent RE/MAX from seeking any or all of the remedies under Section 15(E) [relating to specific performance and injunctive relief].

Byerrum filed suit against RE/MAX alleging, inter alia, breach of franchise agreement, violation of California's Unfair Trade Practices Act, breach of implied covenant of good faith and fair dealing, violation of the Franchise Relationship Act, and tortious interference with prospective economic advantage. RE/MAX petitioned the court to compel arbitration based on the mandatory arbitration provision. In response, Byerrum argued that the arbitration provision in the alleged franchise agreement was unenforceable because the language of the arbitration clause, and the circumstances surrounding Byerrum's signing of the agreement, demonstrated both procedural and substantive unconscionability.

Byerrum argued that, under California law, arbitration agreements contained in contracts of adhesion (like the franchise agreement in Byerrum) must contain “a modicum of bilaterality” to be enforceable. Essentially, Byerrum argued that where the party with superior bargaining power (in that case, RE/MAX) attempts to require arbitration by the adhering party (Byerrum) but refuses to accept the obligation to arbitrate at least some of its claims, the arbitration agreement is unconscionable, and therefore is unenforceable against the adhering party.

In general, unconscionability has both a procedural and a substantive element; to succeed on his claim of unconscionability, Byerrum was required to show that both procedural and substantive unconscionability were present in the arbitration provision (although they did not need to be present to the same degree). Essentially, the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to come to the conclusion that the term is unenforceable, and vice versa.

Following recent precedent set by California courts and by the U.S. Court of Appeals for the Ninth Circuit, Byerrum also argued that the arbitration agreement was procedurally unconscionable, as it was part of a contract of adhesion. In Byerrum, the franchise agreement at issue was a renewal of an existing franchise between RE/MAX and Byerrum, was drafted by RE/MAX, and offered to Byerrum on “take it or leave it” terms.

The court held that, particularly since the franchise agreement was offered to Byerrum in the renewal context, it was a contract of adhesion: If Byerrum did not accept RE/MAX's renewal agreement, Byerrum would have been forced to walk away from the business that he had spent countless hours and significant amounts of money developing. The court recognized that essentially, the case was one of “unequal bargaining position,” and that Byerrum had no choice but to renew on the terms offered by RE/MAX. Under applicable case law, the circumstances rendered the franchise agreement a contract of adhesion.

In arguing that the arbitration language in the franchise agreement was substantively unconscionable, Byerrum referred to a recent California Supreme Court decision, Armendariz v. Foundation Health Psych. Servs., Inc., 24 Cal. 4th 83; 99 Cal. Rptr. 2d 745 (2000), striking an arbitration clause in an employment context. Under Armendariz, an agreement to arbitrate will satisfy the general standard for substantive unconscionability if the agreement lacks a “modicum of bilaterality.” Byerrum argued, and the court agreed, that, because the RE/MAX franchise agreement contained a unilateral obligation to arbitrate, it was substantively unconscionable.

While decisions like the one in Byerrum are still the exception rather than the rule, a growing trend leans toward striking arbitration agreements on grounds of unconscionability. For example, in one such case, the U.S. Court of Appeals for the Ninth Circuit recently upheld a Montana District Court's refusal to enforce an arbitration clause in a hotel franchise agreement due to a finding of unconscionability where the provision “lack[ed] mutuality of obligation, [was] one sided, and contain[ed] terms that [were] unreasonably favorable to the drafter.” Ticknor v. Choice Hotels Int'l., Inc., 265 F. 3d 931 (9th Cir. 2001) Because the type of franchise agreements at issue in the Ticknor and Byerrum cases are typical of those used in the industry, those cases may signal the beginning of a new era, wherein the doctrine of unconscionability is considered, and not readily discarded.