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Awuah v. Coverall: What, If Anything, Does the Dicta Mean for State Regulators?

By Jeffery S. Haff
January 31, 2013

The Awuah v. Coverall North America, Inc. case primarily involves the issue of whether “franchisees” in the Coverall system were, in reality, “employees” under Massachusetts law. In a recent opinion, the First Circuit addressed the issue of an arbitration clause in the parties' franchise agreements and whether it was unenforceable. See Awuah v. Coverall North America, Inc., __ F.3d __, 2012 WL 6699813 (1st Cir. Dec. 27, 2012). The franchisees/employees argued, among other things, that the clause was unenforceable because it was not displayed in a conspicuous manner. The court rejected this argument, stating:

Even if the district court had identified a principle of state law that imposed a special notice requirement before parties such as these could enter into an arbitration agreement, as it did not, such a principle would be preempted by the FAA. Id. at *7 (emphasis added).

This decision and its dicta emphasized above led to an inquiry on the Forum on Franchising Listserv as to whether a state regulator has any power to make a franchisor emphasize, or make conspicuous an arbitration clause in its franchise agreement as a prerequisite to being allowed to sell franchises in a registration state. My opinion was that regulators retained a great deal of power. I was incorrect. What exactly can a state regulator do with respect to arbitration clauses? The answer appears to be, “The regulator cannot do much.”

In State-Federal Battles over Arbitration, States' Laws Almost Always Lose

States have almost never won direct battles with the Federal Arbitration Act. See Southland Corp. v. Keating, 465 U.S. 1 (1984) (California law struck down as contrary to the FAA); Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265 (1995) (Alabama anti-arbitration statute struck down); Doctor's Associates, Inc. v. Casarotto, 571 U.S. 681 (1996) (Montana statute requiring special notice struck down). AT&T Mobility, LLC v. Concepcion, 131 S.Ct. 1740 (2011) (court-imposed general rule struck down). But see Volt Information Sciences, Inc. v. Leland Stanford Junior University, 489 U.S. 468 (1989) (parties' California choice of law incorporated California's state arbitration law; this law was upheld since it was not “hostile” to arbitration). Certainly, a state regulator should be well aware of these decisions when trying to enforce a state regulatory scheme.

Someone supporting the right of a state regulator to take action with respect to arbitration provisions should start with the proposition that the state is not making a determination of whether an arbitration clause to be signed between two parties can make the parties arbitrate a civil dispute. The FAA controls that result ' parties who agree to arbitrate must arbitrate. Instead, the state regulator should focus on the state's ability to control who does business in the state. Anyone seeking to do business in a state is subject to the state's authority to protect its citizens and regulate disclosures made to franchisees.

Unfortunately for regulators, the courts have also been extremely protective of arbitration clauses and have struck down various state efforts to, in some way, regulate the use of these clauses. See Cornhusker Int'l Trucks, Inc. v. Thomas Built Buses, Inc., 637 N.W.2d 876 (Neb. 2002) (Nebraska motor vehicle board could not deny manufacturer right to have termination disputes decided by arbitration); KKW Enterprises, Inc. v. Gloria Jean's Gourmet Coffee Franchising Corp., 184 F.3d 42 (1st Cir. 1999) (and cases cited therein ' Rhode Island could not require arbitration to occur in Rhode Island); Bradley v. Harris Research Inc., 275 F.3d 884 (9th Cir. 2001) (same with respect to California, even if the regulation prohibited all out-of-state dispute resolution); Security Industry Assoc. v. Connolly, 703 F.Supp. 146 (D.Mass. 1988), aff'd, 883 F.2d 1114 (1st Cir. 1989) (Massachusetts could not make security sellers explain arbitration clause to potential investors).

The hostility of federal courts to any efforts to regulate or limit boilerplate arbitration clauses has seemingly emboldened at least one company, in this author's opinion, to ignore even federal regulators. The Financial Industry Regulatory Authority (“FINRA”) has rules that limit arbitration clauses and “no class action” clauses. Specifically, FINRA Rule 2268(d)(3) provides that no predispute arbitration agreement shall include any condition that “limits the ability of a party to file any claim in court permitted to be filed in court under the rules of the forums in which a claim may be filed under the agreement.”

Recently, Charles Schwab & Company inserted an arbitration clause in its contracts that includes a class arbitration waiver. Schwab argued that FINRA Rule 2268(d), properly interpreted, does not prohibit class action waivers and, in the alternative, even if intended to do so, its enforcement would impermissibly violate the FAA. FINRA won the first round in court, on the basis that Schwab had failed to exhaust administrative remedies before bringing suit. See Charles Schwab & Co., Inc. v. Financial Industry Regulatory Authority, Inc., 861 F.Supp.2d 1063 (N.D. Cal. 2012). But when a major entity seemingly ignores federal regulators on the basis of the Federal Arbitration Act, what real chance do state regulators have?

Ultimately, the lone remaining remedy for state regulators may be the ability to require a “risk factor” disclosure in the FDD of a franchisor, stating that the franchisor is requiring an arbitration clause and out-of-state arbitration, and that the franchisee may be disadvantaged by those requirements. Since the state regulator has the ability to point out virtually anything in the franchisor's offering that might be a risk factor, pointing out an arbitration clause would not seem particularly “hostile” to arbitration, particularly if no effort is made to state
that the clause is not enforceable.

The Federal Trade Commission's Franchise Rule permits state regulators to require “more extensive disclosures” in an FDD than are required by the FTC Rule. This
includes a “risk factor” page informing the prospective franchisee about risk factors seen by the state regulators, including out-of-state litigation or arbitration. Since there is a specific federal policy favoring such a disclosure, a state regulator might be able to withstand a challenge that forcing disclosure of out-of-state arbitration as a “risk factor” is “hostile” to the federal government's policy favoring arbitration.

Conclusion

My initial thought on this issue was that state regulators have a great deal of power to regulate arbitration clauses, so long as they don't completely invalidate the clauses. The case law, however, indicates that the federal courts' pro-arbitration policy is so strong that virtually any state action related to arbitration clauses will be difficult to justify if the matter is litigated in a federal court.

State regulators seem to be left with three real alternatives: 1) continue to regulate arbitration clauses and hope the law changes; 2) just use risk-factor disclosure to get their point across to prospective franchisees; or 3) try to change the existing case law by statute. On Jan. 18, 2002, the Thomas Built Buses case called into question state regulatory schemes involving auto dealers. Could a manufacturer gut the entire regulatory scheme through an arbitration clause? It appeared so. But auto dealers and state regulatory boards rallied, and by Nov. 2, 2002, President Bush was signing the Motor Vehicle Franchise Contract Arbitration Fairness Act, 15 U.S.C. ' 1226(a)(2), which prohibited pre-dispute arbitration clauses in auto dealer agreements entered into from that date forward. The law also had the effect of saving all state motor vehicle boards nationwide
from extinction.

Ultimately, if state regulators are pushed to the point where they can do virtually nothing to protect their state residents from unfair arbitration provisions, the proper remedy may be to approach Congress and ask for a clarification to the FAA, stating that the FAA does not preclude state regulators from taking certain steps to protect franchisees, so long as the arbitration clause is not fully voided.


Jeffery S. Haff is a partner with Dady & Gardner, P.A., in Minneapolis. He can be reached at 612-359-3514 or [email protected].

The Awuah v. Coverall North America, Inc. case primarily involves the issue of whether “franchisees” in the Coverall system were, in reality, “employees” under Massachusetts law. In a recent opinion, the First Circuit addressed the issue of an arbitration clause in the parties' franchise agreements and whether it was unenforceable. See Awuah v. Coverall North America, Inc. , __ F.3d __, 2012 WL 6699813 (1st Cir. Dec. 27, 2012). The franchisees/employees argued, among other things, that the clause was unenforceable because it was not displayed in a conspicuous manner. The court rejected this argument, stating:

Even if the district court had identified a principle of state law that imposed a special notice requirement before parties such as these could enter into an arbitration agreement, as it did not, such a principle would be preempted by the FAA. Id. at *7 (emphasis added).

This decision and its dicta emphasized above led to an inquiry on the Forum on Franchising Listserv as to whether a state regulator has any power to make a franchisor emphasize, or make conspicuous an arbitration clause in its franchise agreement as a prerequisite to being allowed to sell franchises in a registration state. My opinion was that regulators retained a great deal of power. I was incorrect. What exactly can a state regulator do with respect to arbitration clauses? The answer appears to be, “The regulator cannot do much.”

In State-Federal Battles over Arbitration, States' Laws Almost Always Lose

States have almost never won direct battles with the Federal Arbitration Act. See Southland Corp. v. Keating , 465 U.S. 1 (1984) (California law struck down as contrary to the FAA); Allied-Bruce Terminix Cos. v. Dobson , 513 U.S. 265 (1995) (Alabama anti-arbitration statute struck down); Doctor's Associates, Inc. v. Casarotto , 571 U.S. 681 (1996) (Montana statute requiring special notice struck down). AT&T Mobility, LLC v. Concepcion , 131 S.Ct. 1740 (2011) (court-imposed general rule struck down). But see Volt Information Sciences, Inc. v. Leland Stanford Junior University , 489 U.S. 468 (1989) (parties' California choice of law incorporated California's state arbitration law; this law was upheld since it was not “hostile” to arbitration). Certainly, a state regulator should be well aware of these decisions when trying to enforce a state regulatory scheme.

Someone supporting the right of a state regulator to take action with respect to arbitration provisions should start with the proposition that the state is not making a determination of whether an arbitration clause to be signed between two parties can make the parties arbitrate a civil dispute. The FAA controls that result ' parties who agree to arbitrate must arbitrate. Instead, the state regulator should focus on the state's ability to control who does business in the state. Anyone seeking to do business in a state is subject to the state's authority to protect its citizens and regulate disclosures made to franchisees.

Unfortunately for regulators, the courts have also been extremely protective of arbitration clauses and have struck down various state efforts to, in some way, regulate the use of these clauses. See Cornhusker Int'l Trucks, Inc. v. Thomas Built Buses, Inc. , 637 N.W.2d 876 (Neb. 2002) (Nebraska motor vehicle board could not deny manufacturer right to have termination disputes decided by arbitration); KKW Enterprises, Inc. v. Gloria Jean's Gourmet Coffee Franchising Corp. , 184 F.3d 42 (1st Cir. 1999) (and cases cited therein ' Rhode Island could not require arbitration to occur in Rhode Island); Bradley v. Harris Research Inc. , 275 F.3d 884 (9th Cir. 2001) (same with respect to California, even if the regulation prohibited all out-of-state dispute resolution); Security Industry Assoc. v. Connolly , 703 F.Supp. 146 (D.Mass. 1988), aff'd , 883 F.2d 1114 (1st Cir. 1989) (Massachusetts could not make security sellers explain arbitration clause to potential investors).

The hostility of federal courts to any efforts to regulate or limit boilerplate arbitration clauses has seemingly emboldened at least one company, in this author's opinion, to ignore even federal regulators. The Financial Industry Regulatory Authority (“FINRA”) has rules that limit arbitration clauses and “no class action” clauses. Specifically, FINRA Rule 2268(d)(3) provides that no predispute arbitration agreement shall include any condition that “limits the ability of a party to file any claim in court permitted to be filed in court under the rules of the forums in which a claim may be filed under the agreement.”

Recently, Charles Schwab & Company inserted an arbitration clause in its contracts that includes a class arbitration waiver. Schwab argued that FINRA Rule 2268(d), properly interpreted, does not prohibit class action waivers and, in the alternative, even if intended to do so, its enforcement would impermissibly violate the FAA. FINRA won the first round in court, on the basis that Schwab had failed to exhaust administrative remedies before bringing suit. See Charles Schwab & Co., Inc. v. Financial Industry Regulatory Authority, Inc. , 861 F.Supp.2d 1063 (N.D. Cal. 2012). But when a major entity seemingly ignores federal regulators on the basis of the Federal Arbitration Act, what real chance do state regulators have?

Ultimately, the lone remaining remedy for state regulators may be the ability to require a “risk factor” disclosure in the FDD of a franchisor, stating that the franchisor is requiring an arbitration clause and out-of-state arbitration, and that the franchisee may be disadvantaged by those requirements. Since the state regulator has the ability to point out virtually anything in the franchisor's offering that might be a risk factor, pointing out an arbitration clause would not seem particularly “hostile” to arbitration, particularly if no effort is made to state
that the clause is not enforceable.

The Federal Trade Commission's Franchise Rule permits state regulators to require “more extensive disclosures” in an FDD than are required by the FTC Rule. This
includes a “risk factor” page informing the prospective franchisee about risk factors seen by the state regulators, including out-of-state litigation or arbitration. Since there is a specific federal policy favoring such a disclosure, a state regulator might be able to withstand a challenge that forcing disclosure of out-of-state arbitration as a “risk factor” is “hostile” to the federal government's policy favoring arbitration.

Conclusion

My initial thought on this issue was that state regulators have a great deal of power to regulate arbitration clauses, so long as they don't completely invalidate the clauses. The case law, however, indicates that the federal courts' pro-arbitration policy is so strong that virtually any state action related to arbitration clauses will be difficult to justify if the matter is litigated in a federal court.

State regulators seem to be left with three real alternatives: 1) continue to regulate arbitration clauses and hope the law changes; 2) just use risk-factor disclosure to get their point across to prospective franchisees; or 3) try to change the existing case law by statute. On Jan. 18, 2002, the Thomas Built Buses case called into question state regulatory schemes involving auto dealers. Could a manufacturer gut the entire regulatory scheme through an arbitration clause? It appeared so. But auto dealers and state regulatory boards rallied, and by Nov. 2, 2002, President Bush was signing the Motor Vehicle Franchise Contract Arbitration Fairness Act, 15 U.S.C. ' 1226(a)(2), which prohibited pre-dispute arbitration clauses in auto dealer agreements entered into from that date forward. The law also had the effect of saving all state motor vehicle boards nationwide
from extinction.

Ultimately, if state regulators are pushed to the point where they can do virtually nothing to protect their state residents from unfair arbitration provisions, the proper remedy may be to approach Congress and ask for a clarification to the FAA, stating that the FAA does not preclude state regulators from taking certain steps to protect franchisees, so long as the arbitration clause is not fully voided.


Jeffery S. Haff is a partner with Dady & Gardner, P.A., in Minneapolis. He can be reached at 612-359-3514 or [email protected].

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