Court Watch

Arbitration Forum Selection Clause Upheld By Federal Court

In a case spanning the width of the country, a Seattle-based franchisor had to defend its arbitration forum selection clause from attack by a former franchisee. Gill v. World Inspection Network International, Inc., 2006 WL 2166821 (E.D.N.Y. July 31, 2006).

Timothy Gill operated a World Inspection Network ('WIN') franchise in New York for 5 years. In the process of becoming a franchisee, Gill received a fairly typical array of documents from WIN, including a Uniform Fran-chise Offering Circular and a proposed franchise agreement. The franchise agreement said that all disputes (with limited exceptions not relevant to the court's decision) regarding the franchise relationship were to be resolved by arbitration. The arbitration clause in the franchise agreement specifically identified as arbitrable disputes any disagreement over the validity of any portion of the franchise agreement itself. The franchise agreement specified that the arbitration would take place in King County, WA.

When the 5-year term of the franchise agreement ended, Gill elected not to renew. WIN believed that Gill was violating his post termination non-compete agreement and commenced arbitration in King County. Gill brought an action in New York state court seeking to avoid the arbitration clause in favor of that litigation or to have the arbitration held in New York. WIN removed the action to federal court and resisted Gill's motion for a preliminary injunction.

Gill faced the hurdle that under the Federal Arbitration Act, the agreement to arbitrate was presumptively valid and irrevocable. Gill admitted he had agreed to arbitrate, but claimed the forum selection clause should not be enforced because it was unconscionable. Gill claimed the sentence regarding venue was at the end of a 'long and convoluted' paragraph. Gill also claimed it would be a financial hardship for him to arbitrate in Washington, and that it would be more appropriate to conduct an arbitration in New York, where most of the witnesses were located. Gill also said the provision was inequitable, and contravened New York public policy.

The court first examined whether the enforceability of the arbitration clause was a question for the court or for the arbitrator. The court noted that the question of whether the parties have agreed to submit a particular dispute to arbitration ' the question of arbitrability ' is typically for the judiciary, unless the parties have clearly agreed to the contrary. The court said the 'question of arbitrability' was not so broad as to encompass every dispute over an arbitration agreement. The court distinguished between so-called 'gateway' issues and procedural issues. A gateway question is whether the parties have agreed to arbitrate, and if so, whether the particular dispute is within the scope of their agreement to arbitrate. A procedural issue is one that grows out of the particular dispute and bears on its final disposition. The former is presumptively an issue for the court; the latter for the arbitrator. The court stated that Gill was not likely to prevail on his claim that the arbitration clause was a gateway issue.

The court observed that a number of courts had held that the validity or interpretation of a forum selection clause was not a gateway issue and was for the arbitrator to decide. The court stated that even if Gill could convince it that the issue was a substantive 'question of arbitrability,' the language of the arbitration clause demonstrated that the parties clearly contracted to have that issue resolved by arbitration.

The clause stated that any controversy or claim ' including a claim that any part of the agreement was 'invalid, illegal or otherwise voidable or void' ' must be submitted to arbitration. The court found that was a clear agreement that Gill's challenge to the enforceability of the venue clause was to be resolved by the arbitrator. In the face of the parties' clear agreement, even though the issue might otherwise be appropriate for judicial determination, the court held the issue must go to the arbitrator.

Despite that holding, the court then went on to discuss the merits of Gill's challenge to the forum selection clause. The court examined Gill's claim that the clause was unconscionable. Examining both New York and Washington law, the court found that both states recognized both substantive and procedural unconscionability. Substantive unconscionability means contract terms that are unreasonably one-sided or overly harsh ' those that 'shock the conscience.' Procedural unconscionability means clauses that involve a 'lack of meaningful choice,' and considers all of the circumstances surrounding the contract, such as whether the parties had a reasonable opportunity to understand the terms, the use of fine print, whether deceptive tactics were used, and disparities in bargaining power. Both states usually invalidate a contract provision based on both substantive and procedural unconscionability, but both also permit the substantive test alone to invalidate a clause.

The court said the forum selection clause was not per se substantively unconscionable. Gill argued, however, that the significant financial burden to him was enough to invalidate the clause. The court cited Second Circuit precedent that in the context of franchisor/franchisee, high costs associated with out-of-state arbitration were not enough to prove substantive unconscionability. It distinguished Gill's authority, which was based on consumer relationships.

The court viewed a portion of Gill's argument as directed to procedural unconscionability, specifically his allegation of 'hidden' language. It found that the venue clause was unambiguous, was set forth in the same, reasonably sized font, and was repeated in the UFOC chart that summarized the terms of the franchise agreement. The court also felt the business nature of a franchise relationship argued against any claim of vulnerability or unequal bargaining power on the part of Gill.

Gill next argued that a court in New Jersey had refused to enforce the exact same clause in another WIN franchise relationship, and had re-quired the arbitration to take place in New Jersey. The court noted that while the New Jersey court had cited no authority for its decision, it was likely based on a New Jersey Supreme Court decision that had presumptively invalidated forum selection clauses for litigation. The court in Gill noted that the Second Circuit had explicitly rejected that holding as applied to arbitration forum selection clauses.

Lastly, the court rejected Gill's argument that the forum selection clause should be invalidated as being against New York public policy. It denied Gill's request for a preliminary injunction, and granted WIN's motion to stay the litigation pending completion of the King County arbitration.

Right to Terminate Without Cause Upheld

What do you have to say in a termination letter? In Elliot & Frantz, Inc. v. Ingersoll-Rand Co., 457 F.3d 312 (3rd Cir. 2006), the court was faced with an argument that by failing to recite the specific contractual provision on which the termination was based, the manufacturer had waived its right to terminate the agreement without cause.

Elliott & Frantz was a distributor of Ingersoll-Rand's industrial construction equipment pursuant to a written distributor agreement. The agreement contained a section on termination, which had subsections regarding termination with and without cause. The latter provision stated that the agreement would 'continue in full force and effect until terminated by either party, without cause, on sixty (60) days written notice … to the other party.' The 'with cause' subsection allowed Ingersoll-Rand to terminate the agreement on 30 days written notice if Elliot & Frantz failed to satisfy the sales objectives prescribed in the agreement. The agreement was to be governed by New Jersey law.

Ingersoll-Rand initially notified Elliot & Frantz that it was dissatisfied with what it believed was Elliott & Frantz's declining performance under the agreement. About 10 months later, Ingersoll-Rand sent a letter to Elliott & Frantz terminating its distributorships. The termination letter cited the general section of the agreement allowing for termination, and gave the greater amount of notice required prior to termination without cause. The letter also referenced 'the continued unacceptable performance of Elliott & Frantz and the significant decline in its overall sales and market share with respect to [Ingersoll-Rand] products in 2002.'

Elliott & Frantz sued, alleging breach of contract and breach of the duty of good faith and fair dealing. During discovery, Elliot & Frantz asked Ingersoll-Rand for the factual support for the decision to terminate. In its answers, Ingersoll-Rand said that it based its decision to terminate on Elliott & Frantz's unacceptable performance and the decline in sales and market share.

Ingersoll-Rand moved for summary judgment on Elliott & Frantz's claims for breach of contract and breach of the implied covenant of good faith and fair dealing, arguing that it had an absolute right to terminate the agreement without cause. Elliott & Frantz opposed the motion, arguing in part that Ingersoll-Rand had waived its right to terminate the agreement without cause by failing to raise that right as an affirmative defense, by failing to allege that right in discovery responses, and by failing to state in the termination letter that the termination was being done without cause.

The district court granted Ingersoll-Rand's summary judgment motion. On review, the court of appeals agreed that the failure to reference the right to terminate without cause in the termination letter was not a waiver of that right. The court noted that the agreement itself did not require any particular form of notice of termination. Although the termination letter did not cite the specific subsection (13.A) of the agreement that allowed termination without cause, Ingersoll-Rand did cite the full Section 13 by stating that 'pursuant to Section 13 of the Agreement' the Pennsylvania distributorship would 'terminate sixty (60) days from receipt of [the] letter.' The court felt the reference to 60-days was significant because that provision was only in the 'without cause' termination provision in Section 13.A. The court said that Ingersoll-Rand's reference to both 'Section 13' and the 60-day notice requirement of Section 13.A unequivocally alerted Elliott & Frantz that Ingersoll-Rand was relying upon Section 13.A.

The court then approached the same question from the other side: Did Ingersoll-Rand do anything to indicate it was trying to terminate for cause? Although Ingersoll-Rand did indicate the termination was because of the declining sales and market share, Ingersoll-Rand did not then avail itself of the right to terminate on only 30 days notice. By failing to utilize the 30-day provision, the court felt it was clear Ingersoll-Rand was using the 'without cause' section. This analysis also can account for the discovery responses. Simply by stating there was a reason to terminate does not mean the termination then must be for cause. In fact, the court said it would be 'quite surprising' if Ingersoll-Rand had terminated without having good cause to do so, as businesses ordinarily do not make decisions for 'whimsical reasons.'

The court then examined whether by stating reasons for termination in the letter, Ingersoll-Rand waived its right to terminate without cause. The court found it incredible to believe a party would be obligated to withhold the actual reason for its action from the other party, simply to maintain its rights to terminate their contract without cause, especially when the parties have had a long-term relationship. The court explained what it saw as the dilemma in the argument: By not giving a reason, the party could terminate without cause, but by explaining its actions, the party surrendered that right. The court simply found that argument to exceed reason, and affirmed the grant of summary judgment.

The court also rejected a waiver argument based on the pleadings. The court examined Ingersoll-Rand's answer and found it clearly indicated Ingersoll-Rand was preserving its right to terminate without cause. The court then ruled that the contractual right to terminate without cause was not an affirmative defense and did not have to be pled as such.

The court did reverse and remand the matter to the district court on Elliot & Frantz's claim that Ingersoll-Rand breached the agreement by failing to provide certain services and support. On all issues related to the notice of termination, the court found the termination letter adequate.

Jon Swierzewski is an attorney with Larkin Hoffman Daly & Lindgren Ltd., in Minneapolis. He can be reached by phone at 952-835-3800 or by e-mail at [email protected].

Arbitration Forum Selection Clause Upheld By Federal Court

In a case spanning the width of the country, a Seattle-based franchisor had to defend its arbitration forum selection clause from attack by a former franchisee. Gill v. World Inspection Network International, Inc., 2006 WL 2166821 (E.D.N.Y. July 31, 2006).

Timothy Gill operated a World Inspection Network ('WIN') franchise in New York for 5 years. In the process of becoming a franchisee, Gill received a fairly typical array of documents from WIN, including a Uniform Fran-chise Offering Circular and a proposed franchise agreement. The franchise agreement said that all disputes (with limited exceptions not relevant to the court's decision) regarding the franchise relationship were to be resolved by arbitration. The arbitration clause in the franchise agreement specifically identified as arbitrable disputes any disagreement over the validity of any portion of the franchise agreement itself. The franchise agreement specified that the arbitration would take place in King County, WA.

When the 5-year term of the franchise agreement ended, Gill elected not to renew. WIN believed that Gill was violating his post termination non-compete agreement and commenced arbitration in King County. Gill brought an action in New York state court seeking to avoid the arbitration clause in favor of that litigation or to have the arbitration held in New York. WIN removed the action to federal court and resisted Gill's motion for a preliminary injunction.

Gill faced the hurdle that under the Federal Arbitration Act, the agreement to arbitrate was presumptively valid and irrevocable. Gill admitted he had agreed to arbitrate, but claimed the forum selection clause should not be enforced because it was unconscionable. Gill claimed the sentence regarding venue was at the end of a 'long and convoluted' paragraph. Gill also claimed it would be a financial hardship for him to arbitrate in Washington, and that it would be more appropriate to conduct an arbitration in New York, where most of the witnesses were located. Gill also said the provision was inequitable, and contravened New York public policy.

The court first examined whether the enforceability of the arbitration clause was a question for the court or for the arbitrator. The court noted that the question of whether the parties have agreed to submit a particular dispute to arbitration ' the question of arbitrability ' is typically for the judiciary, unless the parties have clearly agreed to the contrary. The court said the 'question of arbitrability' was not so broad as to encompass every dispute over an arbitration agreement. The court distinguished between so-called 'gateway' issues and procedural issues. A gateway question is whether the parties have agreed to arbitrate, and if so, whether the particular dispute is within the scope of their agreement to arbitrate. A procedural issue is one that grows out of the particular dispute and bears on its final disposition. The former is presumptively an issue for the court; the latter for the arbitrator. The court stated that Gill was not likely to prevail on his claim that the arbitration clause was a gateway issue.

The court observed that a number of courts had held that the validity or interpretation of a forum selection clause was not a gateway issue and was for the arbitrator to decide. The court stated that even if Gill could convince it that the issue was a substantive 'question of arbitrability,' the language of the arbitration clause demonstrated that the parties clearly contracted to have that issue resolved by arbitration.

The clause stated that any controversy or claim ' including a claim that any part of the agreement was 'invalid, illegal or otherwise voidable or void' ' must be submitted to arbitration. The court found that was a clear agreement that Gill's challenge to the enforceability of the venue clause was to be resolved by the arbitrator. In the face of the parties' clear agreement, even though the issue might otherwise be appropriate for judicial determination, the court held the issue must go to the arbitrator.

Despite that holding, the court then went on to discuss the merits of Gill's challenge to the forum selection clause. The court examined Gill's claim that the clause was unconscionable. Examining both New York and Washington law, the court found that both states recognized both substantive and procedural unconscionability. Substantive unconscionability means contract terms that are unreasonably one-sided or overly harsh ' those that 'shock the conscience.' Procedural unconscionability means clauses that involve a 'lack of meaningful choice,' and considers all of the circumstances surrounding the contract, such as whether the parties had a reasonable opportunity to understand the terms, the use of fine print, whether deceptive tactics were used, and disparities in bargaining power. Both states usually invalidate a contract provision based on both substantive and procedural unconscionability, but both also permit the substantive test alone to invalidate a clause.

The court said the forum selection clause was not per se substantively unconscionable. Gill argued, however, that the significant financial burden to him was enough to invalidate the clause. The court cited Second Circuit precedent that in the context of franchisor/franchisee, high costs associated with out-of-state arbitration were not enough to prove substantive unconscionability. It distinguished Gill's authority, which was based on consumer relationships.

The court viewed a portion of Gill's argument as directed to procedural unconscionability, specifically his allegation of 'hidden' language. It found that the venue clause was unambiguous, was set forth in the same, reasonably sized font, and was repeated in the UFOC chart that summarized the terms of the franchise agreement. The court also felt the business nature of a franchise relationship argued against any claim of vulnerability or unequal bargaining power on the part of Gill.

Gill next argued that a court in New Jersey had refused to enforce the exact same clause in another WIN franchise relationship, and had re-quired the arbitration to take place in New Jersey. The court noted that while the New Jersey court had cited no authority for its decision, it was likely based on a New Jersey Supreme Court decision that had presumptively invalidated forum selection clauses for litigation. The court in Gill noted that the Second Circuit had explicitly rejected that holding as applied to arbitration forum selection clauses.

Lastly, the court rejected Gill's argument that the forum selection clause should be invalidated as being against New York public policy. It denied Gill's request for a preliminary injunction, and granted WIN's motion to stay the litigation pending completion of the King County arbitration.

Right to Terminate Without Cause Upheld

What do you have to say in a termination letter? In Elliot & Frantz, Inc. v. Ingersoll-Rand Co. , 457 F.3d 312 (3rd Cir. 2006), the court was faced with an argument that by failing to recite the specific contractual provision on which the termination was based, the manufacturer had waived its right to terminate the agreement without cause.

Elliott & Frantz was a distributor of Ingersoll-Rand's industrial construction equipment pursuant to a written distributor agreement. The agreement contained a section on termination, which had subsections regarding termination with and without cause. The latter provision stated that the agreement would 'continue in full force and effect until terminated by either party, without cause, on sixty (60) days written notice … to the other party.' The 'with cause' subsection allowed Ingersoll-Rand to terminate the agreement on 30 days written notice if Elliot & Frantz failed to satisfy the sales objectives prescribed in the agreement. The agreement was to be governed by New Jersey law.

Ingersoll-Rand initially notified Elliot & Frantz that it was dissatisfied with what it believed was Elliott & Frantz's declining performance under the agreement. About 10 months later, Ingersoll-Rand sent a letter to Elliott & Frantz terminating its distributorships. The termination letter cited the general section of the agreement allowing for termination, and gave the greater amount of notice required prior to termination without cause. The letter also referenced 'the continued unacceptable performance of Elliott & Frantz and the significant decline in its overall sales and market share with respect to [Ingersoll-Rand] products in 2002.'

Elliott & Frantz sued, alleging breach of contract and breach of the duty of good faith and fair dealing. During discovery, Elliot & Frantz asked Ingersoll-Rand for the factual support for the decision to terminate. In its answers, Ingersoll-Rand said that it based its decision to terminate on Elliott & Frantz's unacceptable performance and the decline in sales and market share.

Ingersoll-Rand moved for summary judgment on Elliott & Frantz's claims for breach of contract and breach of the implied covenant of good faith and fair dealing, arguing that it had an absolute right to terminate the agreement without cause. Elliott & Frantz opposed the motion, arguing in part that Ingersoll-Rand had waived its right to terminate the agreement without cause by failing to raise that right as an affirmative defense, by failing to allege that right in discovery responses, and by failing to state in the termination letter that the termination was being done without cause.

The district court granted Ingersoll-Rand's summary judgment motion. On review, the court of appeals agreed that the failure to reference the right to terminate without cause in the termination letter was not a waiver of that right. The court noted that the agreement itself did not require any particular form of notice of termination. Although the termination letter did not cite the specific subsection (13.A) of the agreement that allowed termination without cause, Ingersoll-Rand did cite the full Section 13 by stating that 'pursuant to Section 13 of the Agreement' the Pennsylvania distributorship would 'terminate sixty (60) days from receipt of [the] letter.' The court felt the reference to 60-days was significant because that provision was only in the 'without cause' termination provision in Section 13.A. The court said that Ingersoll-Rand's reference to both 'Section 13' and the 60-day notice requirement of Section 13.A unequivocally alerted Elliott & Frantz that Ingersoll-Rand was relying upon Section 13.A.

The court then approached the same question from the other side: Did Ingersoll-Rand do anything to indicate it was trying to terminate for cause? Although Ingersoll-Rand did indicate the termination was because of the declining sales and market share, Ingersoll-Rand did not then avail itself of the right to terminate on only 30 days notice. By failing to utilize the 30-day provision, the court felt it was clear Ingersoll-Rand was using the 'without cause' section. This analysis also can account for the discovery responses. Simply by stating there was a reason to terminate does not mean the termination then must be for cause. In fact, the court said it would be 'quite surprising' if Ingersoll-Rand had terminated without having good cause to do so, as businesses ordinarily do not make decisions for 'whimsical reasons.'

The court then examined whether by stating reasons for termination in the letter, Ingersoll-Rand waived its right to terminate without cause. The court found it incredible to believe a party would be obligated to withhold the actual reason for its action from the other party, simply to maintain its rights to terminate their contract without cause, especially when the parties have had a long-term relationship. The court explained what it saw as the dilemma in the argument: By not giving a reason, the party could terminate without cause, but by explaining its actions, the party surrendered that right. The court simply found that argument to exceed reason, and affirmed the grant of summary judgment.

The court also rejected a waiver argument based on the pleadings. The court examined Ingersoll-Rand's answer and found it clearly indicated Ingersoll-Rand was preserving its right to terminate without cause. The court then ruled that the contractual right to terminate without cause was not an affirmative defense and did not have to be pled as such.

The court did reverse and remand the matter to the district court on Elliot & Frantz's claim that Ingersoll-Rand breached the agreement by failing to provide certain services and support. On all issues related to the notice of termination, the court found the termination letter adequate.

Jon Swierzewski is an attorney with Larkin Hoffman Daly & Lindgren Ltd., in Minneapolis. He can be reached by phone at 952-835-3800 or by e-mail at [email protected].