Discovery in Arbitration Proceedings

The result? The franchise agreement dealt with arbitration in one sentence, stating only that “franchisor and franchisee shall arbitrate any disputes arising out of or relating to their agreement.” The agreement was silent on the “details.”

Pupdog Limited now believes that its franchisee has breached the franchise agreement. The franchisee's three franchise stores are always dirty, the merchandise is not well-displayed, and the lights are so dim that the puppies look sickly. Plus, the employees know nothing about dogs. In addition, the franchisee has not paid his franchise fees for three months. The kicker: According to two former employees, the franchisee has siphoned his profits into a secret bank account and, therefore, his monthly franchise reports are shams.

Under the one-sentence governing arbitration clause, Pupdog Limited must arbitrate its claims against the franchisee. No matter, thinks the franchisor. The arbitration will reduce costs and speed up resolution of the dispute. That is what the attorney said, right?

At the pre-hearing conference with the arbitrator, the franchisor's counsel said he wanted to depose the two former out-of-state employees whose testimony not only will demonstrate how the franchisee's fraudulent scheme has operated, but also how much money he has diverted from his franchise stores to his personal accounts. “This is critical testimony for proving liability and for calculating damages,” the attorney told the arbitrator.

The franchisee's lawyer objected to the franchisor's attempt to “introduce litigation tactics into arbitration.” Pointing out that “arbitration is cheaper and faster than litigation” ' echoing what counsel told the franchisor ' the franchisee's lawyer insisted there should be no depositions. “My client bargained for arbitration to avoid the costs, expenses and delays of litigation. Why is counsel seeking to undermine the very purpose of the arbitration provision that he drafted?”

The arbitrator agreed with the franchisee. “No depositions,” said the one-sentence order, which was even shorter than the arbitration provision that the franchisor's lawyer had drafted.

The lawyer now must tell the franchisor that the arbitration will be a lot cheaper and faster than litigation. That is the good news. However, the bad news is very bad indeed: The franchisor's inability to depose these two former employees probably will prevent Pupdog Limited from getting to the bottom of the franchisee's fraudulent scheme.

Preserving a Franchisor's Rights to Take Discovery in Arbitration

Where did the franchisor's counsel go wrong? Should Pupdog Limited have refused to insert an arbitration clause into the franchise agreement? Could Pupdog Limited have preserved the right to arbitrate and take depositions?

Drafters of arbitration provisions sometimes forget that arbitration is a matter of agreement. The parties can tailor all aspects of the arbitration clause, including the discovery process, to fit their anticipated needs and budgets. They can agree to lots of discovery, no discovery or limited discovery. Or, as the franchisor's attorney did, they can ignore the issue and hope they get the discovery they need when they need it.

However, “hoping” is not a reliable strategy when it comes to dispute resolution. As an incredulous franchisor screamed before slamming her attorney's office door, “Pupdog may have to walk away from a claim worth millions because it is not allowed to take depositions?”

In drafting arbitration agreements, parties and their lawyers must consider the type and amount of discovery they will need if a dispute ever arises. Parties can enter into broad arbitration discovery clauses (“to engage in any discovery permitted by the Federal Rules of Civil Procedure”). They can agree to narrow discovery clauses (“the parties shall not be permitted to take any pre-hearing discovery whatsoever”). Or they can enter into something in between that balances the need for discovery with the goal of minimizing the cost of dispute resolution.

At the time of drafting, parties cannot foresee the various disputes that may arise down the road. How would Pupdog Limited have known, two years ago, that it would now be involved in a seven-figure dispute with its franchisee?

However, parties and their counsel should resist the temptation to insert a one-size-fits-all discovery clause that permits lots of discovery. Why? Because a broad discovery clause might undermine the it-will-reduce-your-legal-fees rationale for choosing arbitration in the first place. Would Pupdog Limited now be happy with a broad arbitration clause, permitting many depositions, if the amount in controversy were less than $25,000?

The fatal mistake of the franchisor's attorney stemmed from his failure to consider these issues. He did not anticipate potential
disputes, and he did not figure out how to draft an arbitration clause that sought to achieve Pupdog Limited's objectives. He surely did not respond to his client's needs.

One solution would have been to write the contract to allow for broad discovery for specified types of claims or for claims where the amount in controversy exceeded a specified amount. This strategy would have ensured that the franchisor would be able to take discovery in big cases, but would have limited discovery in small cases.

Another solution: Kick the can down the road by permitting limited document production and empowering the arbitrator to decide whether the parties can seek additional discovery. This solution does not guarantee the right to take depositions. However, it prevents the other side from saying what the franchisor's adversary said: that nothing in the arbitration agreement allows either side to take depositions. A sample kick-the-can-down-the-road clause could look something like this:

(a) Within ___ days after the filing of the response to the arbitration demand, each party shall provide the other with copies of all documents that are likely to bear significantly on their respective claims and defenses.

(b) The arbitrator may allow the parties to engage in other discovery, including depositions, if the arbitrator determines that the likely benefit of the proposed discovery outweighs the burdens and expenses of the proposed discovery, taking into account the needs of the case, the amount in controversy, the importance of the issues at stake in the arbitration, and the importance of the proposed discovery in resolving the issues.

Pupdog Limited would not be in its present predicament if its counsel had considered these issues two years ago. His failure to do so left the franchisor with the mere hope that it could take depositions ' a hope that fell on the deaf ears of an arbitrator who was unsympathetic to broad arbitration discovery.

Charles F. Forer is a member in the Philadelphia office of Eckert Seamans Cherin & Mellott, LLC, where he practices all types of alternative dispute resolution, both as a neutral and as counsel to parties engaged in ADR. He is a former co-chair of both the Philadelphia Bar Association's Alternative Dispute Resolution Committee and the Fee Disputes Committee. He can be contacted at 215-851-8406 and [email protected].

This article marks the debut of an occasional column that will provide franchise attorneys with practical advice about conducting arbitrations.

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Hypothetical: Two years ago, Pupdog Limited, a franchisor of all things relating to puppies, entered into a franchise agreement. Pupdog Limited's attorney insisted that the franchise agreement contain an arbitration clause. His sage advice to the franchisor, Pupdog's president: “Everyone knows arbitration is cheaper and faster than litigation. There is no downside. And it reduces legal fees.” The franchisor also followed counsel's advice when he told her to “keep it simple.”

The result? The franchise agreement dealt with arbitration in one sentence, stating only that “franchisor and franchisee shall arbitrate any disputes arising out of or relating to their agreement.” The agreement was silent on the “details.”

Pupdog Limited now believes that its franchisee has breached the franchise agreement. The franchisee's three franchise stores are always dirty, the merchandise is not well-displayed, and the lights are so dim that the puppies look sickly. Plus, the employees know nothing about dogs. In addition, the franchisee has not paid his franchise fees for three months. The kicker: According to two former employees, the franchisee has siphoned his profits into a secret bank account and, therefore, his monthly franchise reports are shams.

Under the one-sentence governing arbitration clause, Pupdog Limited must arbitrate its claims against the franchisee. No matter, thinks the franchisor. The arbitration will reduce costs and speed up resolution of the dispute. That is what the attorney said, right?

At the pre-hearing conference with the arbitrator, the franchisor's counsel said he wanted to depose the two former out-of-state employees whose testimony not only will demonstrate how the franchisee's fraudulent scheme has operated, but also how much money he has diverted from his franchise stores to his personal accounts. “This is critical testimony for proving liability and for calculating damages,” the attorney told the arbitrator.

The franchisee's lawyer objected to the franchisor's attempt to “introduce litigation tactics into arbitration.” Pointing out that “arbitration is cheaper and faster than litigation” ' echoing what counsel told the franchisor ' the franchisee's lawyer insisted there should be no depositions. “My client bargained for arbitration to avoid the costs, expenses and delays of litigation. Why is counsel seeking to undermine the very purpose of the arbitration provision that he drafted?”

The arbitrator agreed with the franchisee. “No depositions,” said the one-sentence order, which was even shorter than the arbitration provision that the franchisor's lawyer had drafted.

The lawyer now must tell the franchisor that the arbitration will be a lot cheaper and faster than litigation. That is the good news. However, the bad news is very bad indeed: The franchisor's inability to depose these two former employees probably will prevent Pupdog Limited from getting to the bottom of the franchisee's fraudulent scheme.

Preserving a Franchisor's Rights to Take Discovery in Arbitration

Where did the franchisor's counsel go wrong? Should Pupdog Limited have refused to insert an arbitration clause into the franchise agreement? Could Pupdog Limited have preserved the right to arbitrate and take depositions?

Drafters of arbitration provisions sometimes forget that arbitration is a matter of agreement. The parties can tailor all aspects of the arbitration clause, including the discovery process, to fit their anticipated needs and budgets. They can agree to lots of discovery, no discovery or limited discovery. Or, as the franchisor's attorney did, they can ignore the issue and hope they get the discovery they need when they need it.

However, “hoping” is not a reliable strategy when it comes to dispute resolution. As an incredulous franchisor screamed before slamming her attorney's office door, “Pupdog may have to walk away from a claim worth millions because it is not allowed to take depositions?”

In drafting arbitration agreements, parties and their lawyers must consider the type and amount of discovery they will need if a dispute ever arises. Parties can enter into broad arbitration discovery clauses (“to engage in any discovery permitted by the Federal Rules of Civil Procedure”). They can agree to narrow discovery clauses (“the parties shall not be permitted to take any pre-hearing discovery whatsoever”). Or they can enter into something in between that balances the need for discovery with the goal of minimizing the cost of dispute resolution.

At the time of drafting, parties cannot foresee the various disputes that may arise down the road. How would Pupdog Limited have known, two years ago, that it would now be involved in a seven-figure dispute with its franchisee?

However, parties and their counsel should resist the temptation to insert a one-size-fits-all discovery clause that permits lots of discovery. Why? Because a broad discovery clause might undermine the it-will-reduce-your-legal-fees rationale for choosing arbitration in the first place. Would Pupdog Limited now be happy with a broad arbitration clause, permitting many depositions, if the amount in controversy were less than $25,000?

The fatal mistake of the franchisor's attorney stemmed from his failure to consider these issues. He did not anticipate potential
disputes, and he did not figure out how to draft an arbitration clause that sought to achieve Pupdog Limited's objectives. He surely did not respond to his client's needs.

One solution would have been to write the contract to allow for broad discovery for specified types of claims or for claims where the amount in controversy exceeded a specified amount. This strategy would have ensured that the franchisor would be able to take discovery in big cases, but would have limited discovery in small cases.

Another solution: Kick the can down the road by permitting limited document production and empowering the arbitrator to decide whether the parties can seek additional discovery. This solution does not guarantee the right to take depositions. However, it prevents the other side from saying what the franchisor's adversary said: that nothing in the arbitration agreement allows either side to take depositions. A sample kick-the-can-down-the-road clause could look something like this:

(a) Within ___ days after the filing of the response to the arbitration demand, each party shall provide the other with copies of all documents that are likely to bear significantly on their respective claims and defenses.

(b) The arbitrator may allow the parties to engage in other discovery, including depositions, if the arbitrator determines that the likely benefit of the proposed discovery outweighs the burdens and expenses of the proposed discovery, taking into account the needs of the case, the amount in controversy, the importance of the issues at stake in the arbitration, and the importance of the proposed discovery in resolving the issues.

Pupdog Limited would not be in its present predicament if its counsel had considered these issues two years ago. His failure to do so left the franchisor with the mere hope that it could take depositions ' a hope that fell on the deaf ears of an arbitrator who was unsympathetic to broad arbitration discovery.

Charles F. Forer is a member in the Philadelphia office of Eckert Seamans Cherin & Mellott, LLC, where he practices all types of alternative dispute resolution, both as a neutral and as counsel to parties engaged in ADR. He is a former co-chair of both the Philadelphia Bar Association's Alternative Dispute Resolution Committee and the Fee Disputes Committee. He can be contacted at 215-851-8406 and [email protected].