Court Watch

Arbitration Clause in Franchise Agreement Is Enforceable By Nonsignatories

The Eighth Circuit Court of Appeals has ruled that nonsignatories to a franchise agreement were entitled to enforce the agreement's arbitration clause. In CD Partners, LLC v. Grizzle, ___ F.3d ___, 2005 WL 2319132 (8th Cir. Sept. 23, 2005), the court considered whether a franchisor's three principals could compel arbitration of a tort lawsuit brought against them in their individual capacities by the franchisee. The franchisee's lawsuit alleged claims of negligence, negligent misrepresentation, and fraudulent misrepresentation against the three principals. The district court denied the principals' motion to compel arbitration under the arbitration clauses in the franchise agreements on the grounds that the three principals were not signatories to the franchise agreements between the franchisor and franchisee and the tort lawsuit was not covered by the agreements' arbitration clauses.

On appeal, the Eighth Circuit reversed. The court first recognized that there are several circumstances in which a “nonsignatory can enforce an arbitration clause against a signatory to the agreement.” The court noted that one circumstance is when “the relationship between the signatory and nonsignatory defendants is sufficiently close that only by permitting the nonsignatory to invoke arbitration may evisceration of the underlying arbitration agreement between the signatories be avoided,” and another is “when the signatory to a written agreement containing an arbitration clause 'must rely on the terms of the written agreement in asserting [its] claims' against the nonsignatory.” Id. (internal citations omitted). The court found that both of these circumstances were present in CD Partners. First, the court found that the tort allegations against the three principals all arose out of their conduct while acting as officers of the franchisor. Consequently, their relationship to the signatory, the franchisor, was a close one and evisceration of the underlying arbitration agreement would be avoided only by allowing the principals to invoke arbitration. Second, the court found that the franchisee's claims against the three principals relied upon, referred to, and presumed the existence of the written agreement between the two corporations. Therefore, the court held that arbitration was appropriate.

The Eighth Circuit noted in its decision that the “test for determining whether a nonsignatory can force a signatory into arbitration is different from the test for determining whether a signatory can force a nonsignatory into arbitration.” It also noted that the test may differ depending upon whether the agreement at issue is a “one-shot transaction” where, for example, the nonsignatory performed only a single act for the corporate signatory such as signing a purchase agreement, or whether the agreement establishes an “ongoing relationship in which the [signatory's] promises only can be fulfilled by future (unspecified) acts of its employees or agents stretching well into an uncertain future.” (quoting McCarthy v. Azure, 22 F.3d 351 (1st Cir. 1994)). Because CD Partners involved an ongoing relationship where the franchisor's promises could only be fulfilled by the future conduct of its corporate officers, employees, and agents, the court found it appropriate to allow the nonsignatories to enforce the arbitration clause.

The court also found that the arbitration clause in the franchise agreement, which covered “any claim, controversy or dispute arising out of or relating to Franchisee's operation of the Franchised business under the Agreement,” was worded broadly enough to cover the franchisee's tort claims. The court stated that “the tort claims against the three [principals] had their genesis in, arose out of, and related to [the franchisee's] operation of the franchises under the franchise agreements” and therefore were subject to the arbitration clauses.

Would-Be 'Millionaire' Required to Arbitrate Her Claims Against McDonald's

The Seventh Circuit Court of Appeals has affirmed a district court decision that a McDonald's customer who claimed to have received the grand prize winning game card in McDonald's “Who Wants To Be A Millionaire” promotion was required to arbitrate her claims against McDonald's Corporation. In James v. McDonald's Corporation, Bus. Franchise Guide (CCH) ' 13,131 (Aug. 2, 2005), a McDonald's customer, Linda James, filed suit against McDonald's Corporation, Simon Marketing, Inc., and two McDonald's franchisees alleging state law, contract and tort claims after McDonald's rejected her game card as the $1 million grand prize winner in the promotion. McDonald's subsequently filed a motion to compel arbitration relying on an arbitration clause contained in the Official Rules for the game.

In response to McDonald's motion, James asserted that she could not be required to arbitrate because she never saw or read the Official Rules. McDonald's presented evidence, however, that the Official Rules were posted at participating restaurants near the food counter, on the back of in-store tray liners, and near the drive-thru window and that the french fry cartons to which the game cards were affixed had language directing participants to see the Official Rules for details. The district court ruled that James could not avoid the arbitration clause by claiming that she never saw or read the Official Rules and that James' claim that the arbitration clause should not be enforced because McDonald's had fraudulently induced her to participate in the game by misrepresenting the odds of winning was for the arbitrator, rather than for the court, to decide. The court also rejected James' claim that it should not enforce the arbitration clause because the costs of arbitration were prohibitive. When James did not pursue arbitration and, instead, nearly a year later brought a motion for reconsideration, the district court dismissed her case with prejudice for failure to prosecute.

On appeal, James argued that she never agreed, and thus should not be forced, to arbitrate her claims. She asserted that she was not aware of the Official Rules and that “customers cannot be expected to read every container of food they purchase in order to know that they are entering a contract.” In rejecting her position, the Seventh Circuit found that James had agreed to follow the Official Rules by participating in the game. The court stated that “[a]s a general rule, a participant in a prize-winning contest must comply with the terms of the contest's rules in order to form a valid and binding contract with the contest promoter” and that it was “axiomatic that a contest normally has rules regarding eligibility to win the promised prize.” The court found it inconsistent for James to claim, on the one hand, that a valid contract obligated McDonald's to redeem her prize and, on the other hand, that no contract bound her to the contest's rules: “A contest participant cannot pick and choose among the terms and conditions of the contest; the rules stand or fall in their entirety.”

The Eighth Circuit also rejected James' argument that she should not be bound by the arbitration clause because the high upfront costs of arbitration were prohibitive. The court noted that the American Arbitration Association had a fee waiver procedure pursuant to which it might waive fees depending upon a claimant's financial situation. Because James had not submitted evidence indicating how her financial situation would be factored into an assessment of the costs of arbitration or how the costs of litigating her claims would compare with the costs of arbitrating, the court found that she had not shown that the costs of arbitration would be prohibitive.

Finally, the court rejected James' argument that the arbitration clause was unenforceable because it was part of McDonald's alleged scheme to defraud. Relying on Supreme Court precedent, the Eighth Circuit noted that, under the Federal Arbitration Act, the district court could consider a claim that a contracting party was fraudulently induced to include an arbitration provision in the agreement but not claims that the entire contract was the product of fraud. Because James' allegations of fraud did not relate uniquely to the arbitration provision but rather to her participation in the “Who Wants To Be A Millionaire” game as a whole, her claims were for an arbitrator to decide, not the court.

Baked Goods Distributors Not Entitled to Summary Judgment on Claims for Violation of Washington's Franchise Investment Protection Act

The U.S. District Court for the Eastern District of Washington has ruled that two baked goods distributorships are not entitled to summary judgment on their claims for violations of Washington's Franchise Investment Protection Act (“WFIPA”). The case involved two separate actions brought by distributors against defendant Pepperidge Farm, Inc. (“PFI”) seeking rescission and damages for breach of contract, misrepresentation, and violations of the WFIPA.

In the first case, the plaintiff Gilroy responded to an advertisement placed by the owner of a PFI distributorship advertising the sale of his exclusive distributorship of PFI food products. Plaintiff Gilroy initially spoke with the owner of the distributorship and then was referred to representatives of PFI to discuss the sale. In the second case, the plaintiff Atchley responded to an advertisement placed by PFI advertising the sale of an exclusive distributorship of PFI food products that had been abandoned by its former owner. PFI was offering this distributorship for sale on behalf of its former owner.

Both plaintiffs purchased the distributorships and entered into separate Consignment Agreements with PFI, which granted them the “exclusive right to distribute [PFI] Consigned Products to retail stores” within their respective territories and the right to use PFI's trade name, trademark, and distinguishing colors in connection with their businesses. Plaintiff Atchley paid a $25,000 down payment and financed the remainder of the purchase amount. His check was made payable directly to PFI. Plaintiff Gilroy paid 10% down for his distributorship and financed the remainder of the purchase amount. He issued three separate checks. The first was made payable jointly to the former owner of the distributorship and PFI, and a portion of the funds from this check went to pay off the former owner's bank loan, which PFI had guaranteed. The second check was made payable and paid directly to the former owner of the distributorship. The remainder of the purchase price was paid to the former owner after reconciling the various sums he owed to PFI.

The plaintiffs sought partial summary judgment on their claims for violation of the WFIPA, arguing that their distributorships constituted franchises, and it was undisputed that PFI failed to register with the Washington State Securities Division of the Department of Financial Institutions. PFI acknowledged that it did not register, but contended that it was not obligated to do so because the WFIPA was not applicable. The court held that there were genuine issues of material fact on the issue of whether the distributors had paid PFI a franchise fee within the meaning of the act and therefore denied the distributors' motion.

The plaintiffs argued that the amounts they paid to PFI to purchase their distributorships were franchise fees because they paid for the “right to enter into business” with PFI. The court recognized that both the Washington statute and case law suggested that a “franchise fee” could include fees for goods or services. It denied their motion, however, because PFI submitted evidence showing that plaintiffs had purchased their distributorships from the previous owners of those distributorships, not PFI. The court found that plaintiffs had not refuted this evidence, had not shown that there were any hidden fees in their purchase prices nor that PFI had retained any of the money paid for the distributorships, and had not shown that they made any unrecoverable investment in PFI.

Arbitration Clause in Franchise Agreement Is Enforceable By Nonsignatories

The Eighth Circuit Court of Appeals has ruled that nonsignatories to a franchise agreement were entitled to enforce the agreement's arbitration clause. In CD Partners, LLC v. Grizzle , ___ F.3d ___, 2005 WL 2319132 (8th Cir. Sept. 23, 2005), the court considered whether a franchisor's three principals could compel arbitration of a tort lawsuit brought against them in their individual capacities by the franchisee. The franchisee's lawsuit alleged claims of negligence, negligent misrepresentation, and fraudulent misrepresentation against the three principals. The district court denied the principals' motion to compel arbitration under the arbitration clauses in the franchise agreements on the grounds that the three principals were not signatories to the franchise agreements between the franchisor and franchisee and the tort lawsuit was not covered by the agreements' arbitration clauses.

On appeal, the Eighth Circuit reversed. The court first recognized that there are several circumstances in which a “nonsignatory can enforce an arbitration clause against a signatory to the agreement.” The court noted that one circumstance is when “the relationship between the signatory and nonsignatory defendants is sufficiently close that only by permitting the nonsignatory to invoke arbitration may evisceration of the underlying arbitration agreement between the signatories be avoided,” and another is “when the signatory to a written agreement containing an arbitration clause 'must rely on the terms of the written agreement in asserting [its] claims' against the nonsignatory.” Id. (internal citations omitted). The court found that both of these circumstances were present in CD Partners. First, the court found that the tort allegations against the three principals all arose out of their conduct while acting as officers of the franchisor. Consequently, their relationship to the signatory, the franchisor, was a close one and evisceration of the underlying arbitration agreement would be avoided only by allowing the principals to invoke arbitration. Second, the court found that the franchisee's claims against the three principals relied upon, referred to, and presumed the existence of the written agreement between the two corporations. Therefore, the court held that arbitration was appropriate.

The Eighth Circuit noted in its decision that the “test for determining whether a nonsignatory can force a signatory into arbitration is different from the test for determining whether a signatory can force a nonsignatory into arbitration.” It also noted that the test may differ depending upon whether the agreement at issue is a “one-shot transaction” where, for example, the nonsignatory performed only a single act for the corporate signatory such as signing a purchase agreement, or whether the agreement establishes an “ongoing relationship in which the [signatory's] promises only can be fulfilled by future (unspecified) acts of its employees or agents stretching well into an uncertain future.” (quoting McCarthy v. Azure , 22 F.3d 351 (1st Cir. 1994)). Because CD Partners involved an ongoing relationship where the franchisor's promises could only be fulfilled by the future conduct of its corporate officers, employees, and agents, the court found it appropriate to allow the nonsignatories to enforce the arbitration clause.

The court also found that the arbitration clause in the franchise agreement, which covered “any claim, controversy or dispute arising out of or relating to Franchisee's operation of the Franchised business under the Agreement,” was worded broadly enough to cover the franchisee's tort claims. The court stated that “the tort claims against the three [principals] had their genesis in, arose out of, and related to [the franchisee's] operation of the franchises under the franchise agreements” and therefore were subject to the arbitration clauses.

Would-Be 'Millionaire' Required to Arbitrate Her Claims Against McDonald's

The Seventh Circuit Court of Appeals has affirmed a district court decision that a McDonald's customer who claimed to have received the grand prize winning game card in McDonald's “Who Wants To Be A Millionaire” promotion was required to arbitrate her claims against McDonald's Corporation. In James v. McDonald's Corporation, Bus. Franchise Guide (CCH) ' 13,131 (Aug. 2, 2005), a McDonald's customer, Linda James, filed suit against McDonald's Corporation, Simon Marketing, Inc., and two McDonald's franchisees alleging state law, contract and tort claims after McDonald's rejected her game card as the $1 million grand prize winner in the promotion. McDonald's subsequently filed a motion to compel arbitration relying on an arbitration clause contained in the Official Rules for the game.

In response to McDonald's motion, James asserted that she could not be required to arbitrate because she never saw or read the Official Rules. McDonald's presented evidence, however, that the Official Rules were posted at participating restaurants near the food counter, on the back of in-store tray liners, and near the drive-thru window and that the french fry cartons to which the game cards were affixed had language directing participants to see the Official Rules for details. The district court ruled that James could not avoid the arbitration clause by claiming that she never saw or read the Official Rules and that James' claim that the arbitration clause should not be enforced because McDonald's had fraudulently induced her to participate in the game by misrepresenting the odds of winning was for the arbitrator, rather than for the court, to decide. The court also rejected James' claim that it should not enforce the arbitration clause because the costs of arbitration were prohibitive. When James did not pursue arbitration and, instead, nearly a year later brought a motion for reconsideration, the district court dismissed her case with prejudice for failure to prosecute.

On appeal, James argued that she never agreed, and thus should not be forced, to arbitrate her claims. She asserted that she was not aware of the Official Rules and that “customers cannot be expected to read every container of food they purchase in order to know that they are entering a contract.” In rejecting her position, the Seventh Circuit found that James had agreed to follow the Official Rules by participating in the game. The court stated that “[a]s a general rule, a participant in a prize-winning contest must comply with the terms of the contest's rules in order to form a valid and binding contract with the contest promoter” and that it was “axiomatic that a contest normally has rules regarding eligibility to win the promised prize.” The court found it inconsistent for James to claim, on the one hand, that a valid contract obligated McDonald's to redeem her prize and, on the other hand, that no contract bound her to the contest's rules: “A contest participant cannot pick and choose among the terms and conditions of the contest; the rules stand or fall in their entirety.”

The Eighth Circuit also rejected James' argument that she should not be bound by the arbitration clause because the high upfront costs of arbitration were prohibitive. The court noted that the American Arbitration Association had a fee waiver procedure pursuant to which it might waive fees depending upon a claimant's financial situation. Because James had not submitted evidence indicating how her financial situation would be factored into an assessment of the costs of arbitration or how the costs of litigating her claims would compare with the costs of arbitrating, the court found that she had not shown that the costs of arbitration would be prohibitive.

Finally, the court rejected James' argument that the arbitration clause was unenforceable because it was part of McDonald's alleged scheme to defraud. Relying on Supreme Court precedent, the Eighth Circuit noted that, under the Federal Arbitration Act, the district court could consider a claim that a contracting party was fraudulently induced to include an arbitration provision in the agreement but not claims that the entire contract was the product of fraud. Because James' allegations of fraud did not relate uniquely to the arbitration provision but rather to her participation in the “Who Wants To Be A Millionaire” game as a whole, her claims were for an arbitrator to decide, not the court.

Baked Goods Distributors Not Entitled to Summary Judgment on Claims for Violation of Washington's Franchise Investment Protection Act

The U.S. District Court for the Eastern District of Washington has ruled that two baked goods distributorships are not entitled to summary judgment on their claims for violations of Washington's Franchise Investment Protection Act (“WFIPA”). The case involved two separate actions brought by distributors against defendant Pepperidge Farm, Inc. (“PFI”) seeking rescission and damages for breach of contract, misrepresentation, and violations of the WFIPA.

In the first case, the plaintiff Gilroy responded to an advertisement placed by the owner of a PFI distributorship advertising the sale of his exclusive distributorship of PFI food products. Plaintiff Gilroy initially spoke with the owner of the distributorship and then was referred to representatives of PFI to discuss the sale. In the second case, the plaintiff Atchley responded to an advertisement placed by PFI advertising the sale of an exclusive distributorship of PFI food products that had been abandoned by its former owner. PFI was offering this distributorship for sale on behalf of its former owner.

Both plaintiffs purchased the distributorships and entered into separate Consignment Agreements with PFI, which granted them the “exclusive right to distribute [PFI] Consigned Products to retail stores” within their respective territories and the right to use PFI's trade name, trademark, and distinguishing colors in connection with their businesses. Plaintiff Atchley paid a $25,000 down payment and financed the remainder of the purchase amount. His check was made payable directly to PFI. Plaintiff Gilroy paid 10% down for his distributorship and financed the remainder of the purchase amount. He issued three separate checks. The first was made payable jointly to the former owner of the distributorship and PFI, and a portion of the funds from this check went to pay off the former owner's bank loan, which PFI had guaranteed. The second check was made payable and paid directly to the former owner of the distributorship. The remainder of the purchase price was paid to the former owner after reconciling the various sums he owed to PFI.

The plaintiffs sought partial summary judgment on their claims for violation of the WFIPA, arguing that their distributorships constituted franchises, and it was undisputed that PFI failed to register with the Washington State Securities Division of the Department of Financial Institutions. PFI acknowledged that it did not register, but contended that it was not obligated to do so because the WFIPA was not applicable. The court held that there were genuine issues of material fact on the issue of whether the distributors had paid PFI a franchise fee within the meaning of the act and therefore denied the distributors' motion.

The plaintiffs argued that the amounts they paid to PFI to purchase their distributorships were franchise fees because they paid for the “right to enter into business” with PFI. The court recognized that both the Washington statute and case law suggested that a “franchise fee” could include fees for goods or services. It denied their motion, however, because PFI submitted evidence showing that plaintiffs had purchased their distributorships from the previous owners of those distributorships, not PFI. The court found that plaintiffs had not refuted this evidence, had not shown that there were any hidden fees in their purchase prices nor that PFI had retained any of the money paid for the distributorships, and had not shown that they made any unrecoverable investment in PFI.