Courts' Intervention in Arbitration Disputes Keeps Franchises Busy

A Game-Changer

“ATT Mobility v. Concepcion is an absolute game-changer,” said Joseph S. Goode, attorney with Kravit, Hovel & Krawczyk, S.C., in Milwaukee. “The Court said that the Federal Arbitration Act pre-empts states from ' interfering with the Act's fundamental goal of encouraging efficient resolution of conflicts.” Concepcion overturned a body of California case law that previously allowed parties subject to an arbitration provision to proceed as a class, even if the agreement did not allow for such proceedings.

“The Supreme Court is intent on enforcing contracts as written. That's the point of the arbitration decisions ' that the contracts are private agreements enforced on their own terms,” added Karen C. Marchiano, SNR Denton U.S. LLP in Palo Alto, CA. She added that the opinion “repeated over and over that the FAA is designed to streamline proceedings, which the Court supports.”

Taken in combination with the Supreme Court's decision in 2010 in Stolt-Nielsen S.A. v. AnimalFeeds International Corp., 130 S. Ct. 1758, 1768, n.3 (2010), businesses have been given a road map for using class action waivers in arbitration provisions, Goode said. Stolt-Nielsen affirmed that to have a class arbitration, the parties had to specifically consent to it. “If you [franchisor] are looking ahead, you might want to change your franchise agreement to avoid class actions by including an arbitration clause,” he said. “Due to Stolt-Nielsen, don't stay silent about it. Put it in. And make the arbitration clause fair, so that there is no argument that can be made about unconscionability, as was attempted in Concepcion.”

Unconscionability is likely to be the fulcrum around which future arbitration lawsuits will turn, said Marchiano. As an example of how unconscionability can come into play, Marchiano referenced a Ninth Circuit decision, Bridge Fund Capital Corp. v. Fastbucks Franchise Corp., 622 F.3d 996 (9th Cir. 2010), in which a mandatory arbitration clause was not upheld. “Part of the issue was that Bridge Fund Capital chose Texas as its location for arbitration, even though it was a Nevada franchisor with its principal place of business in Texas, and its franchisees were located in California,” she said.

Opposing Mandatory Arbitration

In a paper that accompanied the presentation, the panelists wrote that franchisees will possibly seek to make one of two arguments when opposing mandatory arbitration. First, they might argue that they were presented a contract of adhesion provided on a take-it-or-leave-it basis by a franchisor with more power. Second, they might argue that the contract is substantively unconscionable due to reasons such as: location of arbitration; choice of law at arbitration; arbitration cost allocation; class arbitration waivers; number of arbitrators at arbitration; one-sided carve-outs for disputes not covered by the arbitration clause; discovery limitations; remedy limitations; arbitrator selection mechanisms; contractual limitations periods; lack of mutuality due to one-sided provisions; and confidentiality restrictions.

Franchisees do not necessarily win unconscionability arguments. In Reid v. Supershuttle International, Inc. (No. 08-CV-45854 (JG)(VVP), 2010 WL 1049613 (E.D.N.Y. March 22, 2010)), the Eastern District of New York rejected the franchisees' arguments that the costs of the arbitration made the arbitration clause unconscionable in light of the potential recovery because the franchisees failed to present adequate evidence of the costs of litigating the claims. Yet, in two other cases in recent years, IJL Dominicana S.A. v. It's Just Lunch International, LLC (No. 08-5417-VAP (OPx), 2009 WL 305187 (C.D. Cal. Feb. 6, 2009)) and Bencharsky v. Cottman Transmission Systems, LLC, 625 F. Supp. 2d 872 (N.D. Cal. 2008), courts sided with franchisees who argued that the limitations on remedies, in the forms of a one-year statute of limitations and bans on punitive damages, made the arbitration provisions unconscionable.

Another key issue is who decides about unconscionability, said Marchiano, with Rent-A-Center, West, Inc. v. Jackson, 130 S. Ct. 2772 (2010)) providing the Supreme Court's most recent thinking. “Can the court decide if an arbitration provision is unconscionable, or can the arbitrator decide?” she asked. “The Supreme Court in Rent-A-Center said that the arbitrator can, unless there's a specific challenge to that specific provision in the arbitration agreement.”

The Arbitration Fairness Act

While the courts wrestle with interpreting arbitration clauses, Congress is looking at arbitration issues, too. In spring 2009, the Arbitration Fairness Act was introduced into the U.S. House and Senate, and drew the attention of the franchise industry because the bills would prohibit mandatory arbitration. Specifically, the bills stated that no pre-dispute arbitration agreement shall be valid or enforceable if it requires arbitration of an “employment,” “consumer,” or “franchise” dispute, or a dispute arising under any statute intended to protect civil rights. The bills also said that courts, not arbitrators, would determine the validity and enforceability of an agreement to arbitrate, “irrespective of whether the party resisting arbitration challenges the arbitration agreement specifically or in conjunction with other terms of the contract containing such agreement.” Moreover, the bills would apply retroactively to arbitration agreements contained in existing contracts.

Not surprisingly, the IFA opposed the Arbitration Fairness Act when it was introduced in 2009 and re-introduced in 2010. Mary McMonagle, general counsel, Certa ProPainters, Ltd., said that the Act “will be dead on arrival” if it is proposed in the current Congress. (Sure enough, U.S. Sens. Al Franken, D-MN, and Richard Blumenthal, D-CT, and Rep. Hank Johnson, D-GA, introduced the Arbitration Fairness Act on May 17, about two weeks after the IFA presentations. The new bill included provisions specifically designed to address Concepcion, but the bill has not moved in its committees.)

Regardless of the stalemate about the Arbitration Fairness Act, McMonagle warned franchisors that they are not out of the woods in terms of federal intervention in arbitration. The Consumer Financial Protection Agency (“CFPA”) has been given the authority to regulate consumer financial products and services, including writing rules about arbitration. For the moment, the CFPA has only committed to study the impact on consumers of mandatory arbitration, and McMonagle predicted that the study will find that mandatory arbitration is harmful to consumers.

Yet, McMonagle told participants to be careful what they wish for in the area of arbitration. “Who in this room who is a franchisor attorney prefers arbitration? I'm really serious about this,” she said to attendees in the room during the IFA Symposium presentation. Only a few hands, representing about one-fifth of the participants, were raised. “You need to ask yourselves and your clients whether it's worth committing to arbitration in order to avoid class actions,” she said.

She and the other panelists noted that there are times when a franchisor may find that a courtroom challenge is a better strategic path, even if the franchise agreement mandates arbitration: for example, when a franchisor wants to send a uniform message to all or a group of franchisees about a particular kind of claim or complaint. As set forth in the panelists' paper: “If, as individual disputes arise, a franchisor ' is consistently preferring litigation over arbitration, the franchisor may want to consider systemic changes to the dispute resolution provisions in future or existing franchise agreements. The franchisor could conduct a franchise-system-specific analysis of the advantages and disadvantages of arbitration over litigation, including costs and strategic considerations. For example, what is the franchisor's views of the state and federal courts where it otherwise may require disputes to be resolved? What are the average costs incurred by the franchisor in litigating a case in court versus those associated with trying a similar dispute in arbitration? Are the types of claims typically raised by franchisees the kind rebuffed by the appellate courts overseeing where a trial would be held?”

Kevin Adler is associate editor of LJN's Franchising Business & Law Alert. He can be contacted at [email protected].

For many years, it's been assumed that when franchisors and franchisees are locked in an unsolvable dispute, franchisors prefer arbitration to courtroom litigation. Mandatory arbitration clauses have become standard-issue in franchise contracts, and, most likely, they have stifled a fair amount of courtroom action. Franchisors, and businesses generally, have found mandatory arbitration in class action litigation to be valuable.

However, litigation about whether mandatory arbitration clauses do, indeed, require arbitration seems to be a growth industry. Most recently, the U.S. Supreme Court, in ATT Mobility v. Concepcion , 563 U.S. __ (2011), upheld a mandatory arbitration clause in a consumer class action. The decision was widely viewed as a significant win for the business community.

The decision in ATT Mobility v. Concepcion was announced on April 27, just a few days before a panel of three franchise attorneys presented an update on arbitration trends at the 44th Annual International Franchise Association Legal Symposium. The panelists addressed arbitration in a post-Concepcion world, pointing out both the advantages that accrued to businesses from the Court's decision, yet observing the fluid issues related to mandatory arbitration clauses and the desirability of mandatory arbitration.

A Game-Changer

“ATT Mobility v. Concepcion is an absolute game-changer,” said Joseph S. Goode, attorney with Kravit, Hovel & Krawczyk, S.C., in Milwaukee. “The Court said that the Federal Arbitration Act pre-empts states from ' interfering with the Act's fundamental goal of encouraging efficient resolution of conflicts.” Concepcion overturned a body of California case law that previously allowed parties subject to an arbitration provision to proceed as a class, even if the agreement did not allow for such proceedings.

“The Supreme Court is intent on enforcing contracts as written. That's the point of the arbitration decisions ' that the contracts are private agreements enforced on their own terms,” added Karen C. Marchiano, SNR Denton U.S. LLP in Palo Alto, CA. She added that the opinion “repeated over and over that the FAA is designed to streamline proceedings, which the Court supports.”

Taken in combination with the Supreme Court's decision in 2010 in Stolt-Nielsen S.A. v. AnimalFeeds International Corp. , 130 S. Ct. 1758, 1768, n.3 (2010), businesses have been given a road map for using class action waivers in arbitration provisions, Goode said. Stolt-Nielsen affirmed that to have a class arbitration, the parties had to specifically consent to it. “If you [franchisor] are looking ahead, you might want to change your franchise agreement to avoid class actions by including an arbitration clause,” he said. “Due to Stolt-Nielsen, don't stay silent about it. Put it in. And make the arbitration clause fair, so that there is no argument that can be made about unconscionability, as was attempted in Concepcion.”

Unconscionability is likely to be the fulcrum around which future arbitration lawsuits will turn, said Marchiano. As an example of how unconscionability can come into play, Marchiano referenced a Ninth Circuit decision, Bridge Fund Capital Corp. v. Fastbucks Franchise Corp. , 622 F.3d 996 (9th Cir. 2010), in which a mandatory arbitration clause was not upheld. “Part of the issue was that Bridge Fund Capital chose Texas as its location for arbitration, even though it was a Nevada franchisor with its principal place of business in Texas, and its franchisees were located in California,” she said.

Opposing Mandatory Arbitration

In a paper that accompanied the presentation, the panelists wrote that franchisees will possibly seek to make one of two arguments when opposing mandatory arbitration. First, they might argue that they were presented a contract of adhesion provided on a take-it-or-leave-it basis by a franchisor with more power. Second, they might argue that the contract is substantively unconscionable due to reasons such as: location of arbitration; choice of law at arbitration; arbitration cost allocation; class arbitration waivers; number of arbitrators at arbitration; one-sided carve-outs for disputes not covered by the arbitration clause; discovery limitations; remedy limitations; arbitrator selection mechanisms; contractual limitations periods; lack of mutuality due to one-sided provisions; and confidentiality restrictions.

Franchisees do not necessarily win unconscionability arguments. In Reid v. Supershuttle International, Inc. (No. 08-CV-45854 (JG)(VVP), 2010 WL 1049613 (E.D.N.Y. March 22, 2010)), the Eastern District of New York rejected the franchisees' arguments that the costs of the arbitration made the arbitration clause unconscionable in light of the potential recovery because the franchisees failed to present adequate evidence of the costs of litigating the claims. Yet, in two other cases in recent years, IJL Dominicana S.A. v. It's Just Lunch International, LLC (No. 08-5417-VAP (OPx), 2009 WL 305187 (C.D. Cal. Feb. 6, 2009)) and Bencharsky v. Cottman Transmission Systems, LLC , 625 F. Supp. 2d 872 (N.D. Cal. 2008), courts sided with franchisees who argued that the limitations on remedies, in the forms of a one-year statute of limitations and bans on punitive damages, made the arbitration provisions unconscionable.

Another key issue is who decides about unconscionability, said Marchiano, with Rent-A-Center, West, Inc. v. Jackson , 130 S. Ct. 2772 (2010)) providing the Supreme Court's most recent thinking. “Can the court decide if an arbitration provision is unconscionable, or can the arbitrator decide?” she asked. “The Supreme Court in Rent-A-Center said that the arbitrator can, unless there's a specific challenge to that specific provision in the arbitration agreement.”

The Arbitration Fairness Act

While the courts wrestle with interpreting arbitration clauses, Congress is looking at arbitration issues, too. In spring 2009, the Arbitration Fairness Act was introduced into the U.S. House and Senate, and drew the attention of the franchise industry because the bills would prohibit mandatory arbitration. Specifically, the bills stated that no pre-dispute arbitration agreement shall be valid or enforceable if it requires arbitration of an “employment,” “consumer,” or “franchise” dispute, or a dispute arising under any statute intended to protect civil rights. The bills also said that courts, not arbitrators, would determine the validity and enforceability of an agreement to arbitrate, “irrespective of whether the party resisting arbitration challenges the arbitration agreement specifically or in conjunction with other terms of the contract containing such agreement.” Moreover, the bills would apply retroactively to arbitration agreements contained in existing contracts.

Not surprisingly, the IFA opposed the Arbitration Fairness Act when it was introduced in 2009 and re-introduced in 2010. Mary McMonagle, general counsel, Certa ProPainters, Ltd., said that the Act “will be dead on arrival” if it is proposed in the current Congress. (Sure enough, U.S. Sens. Al Franken, D-MN, and Richard Blumenthal, D-CT, and Rep. Hank Johnson, D-GA, introduced the Arbitration Fairness Act on May 17, about two weeks after the IFA presentations. The new bill included provisions specifically designed to address Concepcion, but the bill has not moved in its committees.)

Regardless of the stalemate about the Arbitration Fairness Act, McMonagle warned franchisors that they are not out of the woods in terms of federal intervention in arbitration. The Consumer Financial Protection Agency (“CFPA”) has been given the authority to regulate consumer financial products and services, including writing rules about arbitration. For the moment, the CFPA has only committed to study the impact on consumers of mandatory arbitration, and McMonagle predicted that the study will find that mandatory arbitration is harmful to consumers.

Yet, McMonagle told participants to be careful what they wish for in the area of arbitration. “Who in this room who is a franchisor attorney prefers arbitration? I'm really serious about this,” she said to attendees in the room during the IFA Symposium presentation. Only a few hands, representing about one-fifth of the participants, were raised. “You need to ask yourselves and your clients whether it's worth committing to arbitration in order to avoid class actions,” she said.

She and the other panelists noted that there are times when a franchisor may find that a courtroom challenge is a better strategic path, even if the franchise agreement mandates arbitration: for example, when a franchisor wants to send a uniform message to all or a group of franchisees about a particular kind of claim or complaint. As set forth in the panelists' paper: “If, as individual disputes arise, a franchisor ' is consistently preferring litigation over arbitration, the franchisor may want to consider systemic changes to the dispute resolution provisions in future or existing franchise agreements. The franchisor could conduct a franchise-system-specific analysis of the advantages and disadvantages of arbitration over litigation, including costs and strategic considerations. For example, what is the franchisor's views of the state and federal courts where it otherwise may require disputes to be resolved? What are the average costs incurred by the franchisor in litigating a case in court versus those associated with trying a similar dispute in arbitration? Are the types of claims typically raised by franchisees the kind rebuffed by the appellate courts overseeing where a trial would be held?”

Kevin Adler is associate editor of LJN's Franchising Business & Law Alert. He can be contacted at [email protected].