Court Watch

Class Action Waivers in Franchise Agreements Are Enforced

Just when everyone has been thinking that franchisors will have a difficult time enforcing class action waiver clauses, two recent cases have indicated that such clauses are alive and well. In a recent California Court of Appeal decision, Gold v. Melt Inc., Cal. Ct. App., 2d Dist., Bus. Franchise Guide (CCH) ' 14,371 (Apr. 16, 2010), certified for non-publication, a three-judge appellate panel affirmed the trial court's determination that a class action waiver contained in a gelato ice-cream franchise was enforceable. (The designation “certified for non-publication” means that the case cannot be cited as authority to any other California state trial or appellate court. However, the case is unofficially published. See, e.g., WL 1951145.)

While the Gold v. Melt decision is officially unpublished, it nonetheless is worthy of discussion as indicative of how a California Court of Appeal is likely to rule in another similar case in the future. The issue was decided on the pleadings and affirmed the trial court's order sustaining a demurrer without leave to amend. No argument was raised regarding the possible impact of California Civil Code S1670.5, which affords a party challenging a provision as unconscionable a “reasonable opportunity to present evidence as to its commercial setting, purpose, and effect to aid the court in making the determination.”

Because of different choice of law clauses in the various franchise agreements in issue, the court concluded that the class action waiver provisions were not unconscionable under California, Florida, or Massachusetts law.

The franchisees first claimed that the trial court had wrongly decided there was no procedural unconscionability because of a five-day “cooling off” period, referencing the provision that required the agreement to be presented to the franchisee at least five days before execution. The appellate court rejected this argument because the trial court did not dispense with the need to consider substantive unconscionability, but simply held that the five-day waiting period reduced the procedural unconscionability to the bare minimum. Nonetheless, franchisors should take note of that argument as a way to reduce procedural unconscionability and require that a plaintiff must show a great degree of substantive unconscionability. While the waiting period certainly undercuts the element of surprise, it still may not do away with the superior bargaining power of the franchisor in assessing procedural unconscionability.

In determining that the class action waiver provision was not substantively unconscionable under California law, the court ruled that Discover Bank v. Superior Court, 30 Cal.Rptr.3d 76 (2005), a leading case that struck down a class action waiver provision in a consumer credit card agreement, should be limited to consumer contracts involving small sums in dispute. The court in Discover Bank held that enforcement of a class action prohibition could be viewed as an unlawful exculpatory clause where it has the effect of allowing the defendant to commit fraud on a large number of people who, because of the small individual recovery, would likely only challenge that conduct in a class action. The Gold court held that franchise agreements do not resemble consumer contracts and pointed to the large amounts of money involved in the dispute.

However, The franchisee's reliance on Postal Instant Press, Inc. v. Sealy, 51 Cal.Rptr.2d 365 (1996), which struck down a franchisor's attempt to collect future royalties on termination, did nothing to shake the court's view that the franchise agreement resembled a consumer contract. While the court cited Independent Association of Mailbox Center Owners, Inc. et al. v. Superior Court, 34 Cal.Rptr.3d 659 (2005) (“Mailboxes“), for general principles pertaining to unconscionability, it did not at all mention that in that case, another court of appeal panel of a different appellate district held that a class action/consolidation waiver provision in a franchise agreement was unconscionable. The basis of the court's ruling in Mailboxes was that franchise agreements have the same characteristics as adhesion contracts in the consumer and employment fields, and enforcement of class action or consolidation waivers would implicate public policy of the franchise-protection statutes.

The result was the same under Florida law. The only Florida cases striking down class action waivers involved consumer contracts, S.D.S. Autos, Inc. v. Chrzanowski, (Fla.App. 1 Dist. 2007) 976 So.2d 600 (auto leasing contract) and Powertel, Inc. v. Bexley, (Fla.App. 1 Dist. 1999) 743 So.2d 570 (cellular phone contracts) and were not applicable to franchise agreements.

For Massachusetts, the plaintiffs principally relied on Skirchak v. Dynamic Research Corp. (1st Cir. 2007) 508 F.3d 49, which struck down a class action waiver in an employment case. The court distinguished Skirchak because of the high degree of procedural unconscionability (the provision was hidden in an e-mail sent to employees two days before Thanksgiving) and because it attempted to waive a statutory right to bring that type of action as a class action. The court noted that franchisees had no statutory right to bring cases as class actions in Massachusetts.

Reconciling Mailboxes with Melt in California may not be that difficult. While franchise agreements are clearly not consumer contracts, as noted in Mailboxes, they still may have the attributes of adhesion contracts. That, however, only allows the court to next consider whether a class action waiver is substantively unconscionable. In order to do so, a court does not only have to find that the provision acts as an exculpatory clause. The other legal theory under which class action waivers can be invalidated is that enunciated by the California Supreme Court in Gentry v. Superior Court, 64 Cal.Rptr.3d 773 (2007). Gentry held that a class action waiver could be struck down in an employment case if the court determined that a class action is a significantly more effective and practical means of vindicating unwaivable statutory rights. Mailboxes preceded Gentry, but its holding is similar to the extent that consolidated or class actions might be the only practical means that franchisees have to assert their rights under the California Franchise Investment Law. To come to that conclusion, of course, a court would have to engage in an extensive factual analysis with regard to the nature of the claims and the viability of bringing them as individual claims. When all is said and done, it may not be enough for a franchise to simply argue that franchise agreements are not consumer contracts in order to uphold class action waivers.

Illustrative of the type of factual showing needed is a recent case from the East Coast, Reid v. Supeshuttle International, Inc., Bus. Franchise Guide (CCH) ' 14,358 (E.D. N.Y. May 22, 2010). There, the franchisees argued that arbitration would be prohibitively expensive unless they were able to seek class relief and would thus allow the defendant to continue its allegedly unlawful practices. The problem with this argument, noted the court, was that it was largely just that ' argument ' without any factual support. In order to prevail on such an argument, the plaintiffs would need to produce expert testimony about the cost of arbitration and show that individual litigation would be cost-prohibitive.

Choice of Law Clause May Not Apply Absent Independent Jurisdictional Elements

In Red Lion Hotels Franchising, Inc. v. MAK, LLC et al., __ F. Supp. 2d __ USDC, BFG ' 14,367 (Eastern District of Washington, March 15, 2010), the plaintiff hotel chain sued a former franchisee for unpaid royalties and liquidated damages after the franchisee's agreement was terminated for not complying with the franchisor's property-improvement requirements. The defendant franchisee counterclaimed, alleging that the termination violated the Washington Franchise Investment Protection Act's (“the Washington FIPA”) relationship law, RCW ' 19.100.180, which in turn constituted a violation of the Washington Consumer Protection Act, RCW ” 19.86.010 et seq.

The plaintiff is located in Spokane, WA. The defendant operated a hotel in Modesto, CA. The franchise agreement specified that Washington law would apply to the agreement except for Washington franchise law, unless that law applied independent of the reference to Washington law in the agreement.

The defendant hoped to apply the Washington relationship law rather than the California Franchise Relations Act (“the CFRA”), Cal. Bus. & Prof. Code ” 20000 et seq., which clearly applies to a California-based franchise, because a violation of the Washington franchise law would permit the recovery of treble damages and attorneys' fees. The only remedy provided by the CFRA is that the franchisor of a wrongfully terminated franchisee must offer to repurchase the franchisee's current resale inventory. The CFRA does not prevent a franchisee from pursuing contract damages for wrongful termination, but common law contract damages would not include treble damages or attorneys' fees absent an attorneys' fees provision in the franchise agreement.

In a motion by the plaintiff seeking a partial summary judgment to dismiss the defendant's Washington-law claims, the defendant franchisee argued that while some of the sections of the Washington FIPA provide that they apply only to activities “in this state,” the relationship provision does not contain such a limitation. As such, argued the defendant, since the plaintiff was based in Washington, and, therefore, the transaction had a substantial relationship with that state, its law should apply as selected.

The court examined the overall statutory scheme of the Washington FIPA to determine whether the Washington legislature intended to confine its reach to franchises operating in that state, or whether it intended the Washington FIPA to have a broader reach. One assumes the franchisee also argued that if the Washington FIPA has extraterritorial reach, it would override the limitation on the application of Washington franchise law in the franchise agreement.

The court concluded that the statute as a whole evinced an intent to apply only to franchises located in Washington, whether or not a specific section referred to “in this state.” As such, a California franchisee whose business is located in California could not benefit from the Washington FIPA, but must rely on the CFRA's more limited remedies and California's general contract remedies. The Washington-law claims were, therefore, dismissed.

The lesson of this case is to use extra care when drafting choice-of-law provisions and to make clear, if the law itself does not do so, under what circumstances the chosen law will or will not apply.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. Charles G. Miller is a shareholder and director of the firm. Hart and Miller can be reached by phone at 415-956-1900.

Class Action Waivers in Franchise Agreements Are Enforced

Just when everyone has been thinking that franchisors will have a difficult time enforcing class action waiver clauses, two recent cases have indicated that such clauses are alive and well. In a recent California Court of Appeal decision, Gold v. Melt Inc., Cal. Ct. App., 2d Dist., Bus. Franchise Guide (CCH) ' 14,371 (Apr. 16, 2010), certified for non-publication, a three-judge appellate panel affirmed the trial court's determination that a class action waiver contained in a gelato ice-cream franchise was enforceable. (The designation “certified for non-publication” means that the case cannot be cited as authority to any other California state trial or appellate court. However, the case is unofficially published. See, e.g., WL 1951145.)

While the Gold v. Melt decision is officially unpublished, it nonetheless is worthy of discussion as indicative of how a California Court of Appeal is likely to rule in another similar case in the future. The issue was decided on the pleadings and affirmed the trial court's order sustaining a demurrer without leave to amend. No argument was raised regarding the possible impact of California Civil Code S1670.5, which affords a party challenging a provision as unconscionable a “reasonable opportunity to present evidence as to its commercial setting, purpose, and effect to aid the court in making the determination.”

Because of different choice of law clauses in the various franchise agreements in issue, the court concluded that the class action waiver provisions were not unconscionable under California, Florida, or Massachusetts law.

The franchisees first claimed that the trial court had wrongly decided there was no procedural unconscionability because of a five-day “cooling off” period, referencing the provision that required the agreement to be presented to the franchisee at least five days before execution. The appellate court rejected this argument because the trial court did not dispense with the need to consider substantive unconscionability, but simply held that the five-day waiting period reduced the procedural unconscionability to the bare minimum. Nonetheless, franchisors should take note of that argument as a way to reduce procedural unconscionability and require that a plaintiff must show a great degree of substantive unconscionability. While the waiting period certainly undercuts the element of surprise, it still may not do away with the superior bargaining power of the franchisor in assessing procedural unconscionability.

In determining that the class action waiver provision was not substantively unconscionable under California law, the court ruled that Discover Bank v. Superior Court, 30 Cal.Rptr.3d 76 (2005), a leading case that struck down a class action waiver provision in a consumer credit card agreement, should be limited to consumer contracts involving small sums in dispute. The court in Discover Bank held that enforcement of a class action prohibition could be viewed as an unlawful exculpatory clause where it has the effect of allowing the defendant to commit fraud on a large number of people who, because of the small individual recovery, would likely only challenge that conduct in a class action. The Gold court held that franchise agreements do not resemble consumer contracts and pointed to the large amounts of money involved in the dispute.

However, The franchisee's reliance on Postal Instant Press, Inc. v. Sealy, 51 Cal.Rptr.2d 365 (1996), which struck down a franchisor's attempt to collect future royalties on termination, did nothing to shake the court's view that the franchise agreement resembled a consumer contract. While the court cited Independent Association of Mailbox Center Owners, Inc. et al. v. Superior Court, 34 Cal.Rptr.3d 659 (2005) (“Mailboxes“), for general principles pertaining to unconscionability, it did not at all mention that in that case, another court of appeal panel of a different appellate district held that a class action/consolidation waiver provision in a franchise agreement was unconscionable. The basis of the court's ruling in Mailboxes was that franchise agreements have the same characteristics as adhesion contracts in the consumer and employment fields, and enforcement of class action or consolidation waivers would implicate public policy of the franchise-protection statutes.

The result was the same under Florida law. The only Florida cases striking down class action waivers involved consumer contracts, S.D.S. Autos, Inc. v. Chrzanowski, (Fla.App. 1 Dist. 2007) 976 So.2d 600 (auto leasing contract) and Powertel, Inc. v. Bexley, (Fla.App. 1 Dist. 1999) 743 So.2d 570 (cellular phone contracts) and were not applicable to franchise agreements.

For Massachusetts, the plaintiffs principally relied on Skirchak v. Dynamic Research Corp. (1st Cir. 2007) 508 F.3d 49, which struck down a class action waiver in an employment case. The court distinguished Skirchak because of the high degree of procedural unconscionability (the provision was hidden in an e-mail sent to employees two days before Thanksgiving) and because it attempted to waive a statutory right to bring that type of action as a class action. The court noted that franchisees had no statutory right to bring cases as class actions in Massachusetts.

Reconciling Mailboxes with Melt in California may not be that difficult. While franchise agreements are clearly not consumer contracts, as noted in Mailboxes, they still may have the attributes of adhesion contracts. That, however, only allows the court to next consider whether a class action waiver is substantively unconscionable. In order to do so, a court does not only have to find that the provision acts as an exculpatory clause. The other legal theory under which class action waivers can be invalidated is that enunciated by the California Supreme Court in Gentry v. Superior Court, 64 Cal.Rptr.3d 773 (2007). Gentry held that a class action waiver could be struck down in an employment case if the court determined that a class action is a significantly more effective and practical means of vindicating unwaivable statutory rights. Mailboxes preceded Gentry, but its holding is similar to the extent that consolidated or class actions might be the only practical means that franchisees have to assert their rights under the California Franchise Investment Law. To come to that conclusion, of course, a court would have to engage in an extensive factual analysis with regard to the nature of the claims and the viability of bringing them as individual claims. When all is said and done, it may not be enough for a franchise to simply argue that franchise agreements are not consumer contracts in order to uphold class action waivers.

Illustrative of the type of factual showing needed is a recent case from the East Coast, Reid v. Supeshuttle International, Inc., Bus. Franchise Guide (CCH) ' 14,358 (E.D. N.Y. May 22, 2010). There, the franchisees argued that arbitration would be prohibitively expensive unless they were able to seek class relief and would thus allow the defendant to continue its allegedly unlawful practices. The problem with this argument, noted the court, was that it was largely just that ' argument ' without any factual support. In order to prevail on such an argument, the plaintiffs would need to produce expert testimony about the cost of arbitration and show that individual litigation would be cost-prohibitive.

Choice of Law Clause May Not Apply Absent Independent Jurisdictional Elements

In Red Lion Hotels Franchising, Inc. v. MAK, LLC et al., __ F. Supp. 2d __ USDC, BFG ' 14,367 (Eastern District of Washington, March 15, 2010), the plaintiff hotel chain sued a former franchisee for unpaid royalties and liquidated damages after the franchisee's agreement was terminated for not complying with the franchisor's property-improvement requirements. The defendant franchisee counterclaimed, alleging that the termination violated the Washington Franchise Investment Protection Act's (“the Washington FIPA”) relationship law, RCW ' 19.100.180, which in turn constituted a violation of the Washington Consumer Protection Act, RCW ” 19.86.010 et seq.

The plaintiff is located in Spokane, WA. The defendant operated a hotel in Modesto, CA. The franchise agreement specified that Washington law would apply to the agreement except for Washington franchise law, unless that law applied independent of the reference to Washington law in the agreement.

The defendant hoped to apply the Washington relationship law rather than the California Franchise Relations Act (“the CFRA”), Cal. Bus. & Prof. Code ” 20000 et seq., which clearly applies to a California-based franchise, because a violation of the Washington franchise law would permit the recovery of treble damages and attorneys' fees. The only remedy provided by the CFRA is that the franchisor of a wrongfully terminated franchisee must offer to repurchase the franchisee's current resale inventory. The CFRA does not prevent a franchisee from pursuing contract damages for wrongful termination, but common law contract damages would not include treble damages or attorneys' fees absent an attorneys' fees provision in the franchise agreement.

In a motion by the plaintiff seeking a partial summary judgment to dismiss the defendant's Washington-law claims, the defendant franchisee argued that while some of the sections of the Washington FIPA provide that they apply only to activities “in this state,” the relationship provision does not contain such a limitation. As such, argued the defendant, since the plaintiff was based in Washington, and, therefore, the transaction had a substantial relationship with that state, its law should apply as selected.

The court examined the overall statutory scheme of the Washington FIPA to determine whether the Washington legislature intended to confine its reach to franchises operating in that state, or whether it intended the Washington FIPA to have a broader reach. One assumes the franchisee also argued that if the Washington FIPA has extraterritorial reach, it would override the limitation on the application of Washington franchise law in the franchise agreement.

The court concluded that the statute as a whole evinced an intent to apply only to franchises located in Washington, whether or not a specific section referred to “in this state.” As such, a California franchisee whose business is located in California could not benefit from the Washington FIPA, but must rely on the CFRA's more limited remedies and California's general contract remedies. The Washington-law claims were, therefore, dismissed.

The lesson of this case is to use extra care when drafting choice-of-law provisions and to make clear, if the law itself does not do so, under what circumstances the chosen law will or will not apply.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. Charles G. Miller is a shareholder and director of the firm. Hart and Miller can be reached by phone at 415-956-1900.