Court Watch

Sleepy's received reports that Select Comfort salespeople were disparaging Sleepy's as well as the Personal Preference line, and therefore Sleepy's hired secret shoppers to investigate Select Comfort on at least 12 occasions. All but once ( see discussion of secret shopper Deborah Zaffron below) the secret shoppers encouraged Select Comfort salespeople to discuss Sleepy's by being the first to mention it. The secret shoppers were allegedly told by salespeople that the foundation of the Personal Preference beds was inferior to that of the Core beds, that beds sold by Sleepy's were stored in a way that attracted allergens and dust mites, and that Sleepy's offered inferior sales terms and deceitfully refused to honor its warranties.

On one occasion, a secret shopper, Deborah Zaffron, said that she had bought a bed at Sleepy's but that it had become lumpy and that she wished to replace it. The salesperson responded that he had previously worked for Sleepy's and that Sleepy's would not honor its warranty on the bed. Instead, the salesperson said Sleepy's would “send somebody out to your house, they'll inspect the bed, [and] they'll say there's nothing wrong with it. Happens daily.”

Sleepy's brought suit against Select Comfort alleging a variety of claims, including slander. The case proceeded to trial. Near the close of Sleepy's case, Select Comfort moved for judgment on partial findings pursuant to Fed. R. Civ. P. 52(c). Applying New York law, the district court granted the motion. As to those 11 occasions where the secret shopper mentioned Sleepy's first, the district court concluded that Sleepy's had consented to the defamatory comments and therefore could not recover for slander. The district court also denied recovery based upon the statements allegedly made to Zaffron, concluding they were mere sales talk and were not defamatory. The Second Circuit reversed.

In concluding that the district court erred in holding that Sleepy's necessarily consented to publication of defamatory material by having secret shoppers initially mention Sleepy's, the Court of Appeals recognized the general rule that in some circumstances, a person may be prevented from recovering for defamation where they intentionally elicit the defamatory material. However, the circuit court distinguished between those occasions where a person conducts an honest inquiry to determine whether defamatory statements have been made and a situation where a person conducts an investigation with the intention of drawing the speaker into a lawsuit. In the former circumstance, recovery is allowed; in the latter circumstance, it is not. The court also determined that an investigator's degree of certainty a defamatory statement will be made is significant: a high degree of certainty weighs in favor of recovery being denied, as it tends to show the investigation is for the purpose of setting up a lawsuit. As the district court failed to consider Sleepy's intent in conducting the investigation or its certainty that defamatory statements would be made, this part of the district court's ruling was reversed and remanded.

Interestingly, the circuit court suggested that whether Sleepy's had consented to the individual slanders may be inconsequential on the merit of Sleepy's defamation claims, as Sleepy's may be able to show Select Comfort salespeople had engaged in a pattern and practice of defaming Sleepy's. By proving a pattern and practice, Sleepy's may show “that Select Comfort had committed numerous additional similar slanders that were not solicited by Sleepy's.” (In other words, Sleepy's may be able to recover for slanders that presumably it would be unable to prove independently.)

As for the statements allegedly made to Zaffron, the circuit court disagreed that the statements were mere sales talk. To the contrary, it determined that the salesperson had made a defamatory comment and that the statement was one of fact, i.e., Sleepy's regularly refuses to honor its warranty, and instead avoids the warranty by falsely claiming that the product is not defective. Thus, the district court's holding as to these statements was also reversed and remanded for further consideration.

Investigations similar to the one conducted in Sleepy's are now commonplace. Manufacturers must be particularly diligent in training company sales staff not to make defamatory statements about product lines sold by their dealers, as such statements may open the door for the dealer to assert a wide variety of claims (e.g., defamation, breach of contract, breach of the covenant of good faith and fair dealing, etc.). Sales staff are generally given wide discretion to state their opinions about products or the business practices of other companies in the industry, but they must be careful about making statements of fact that may be held defamatory. While there are defenses to defamation liability (e.g., proving the truth of the statement), establishing the entitlement to a defense can be difficult, costly, and time-consuming, such that it is likely more sensible to avoid making the defamatory statement in the first place.

Court Denies Franchisee's Motion to Vacate Attorneys' Fees Award

The case of Medicine Shoppe Int'l, Inc. v. Prescription Shoppes, LLC, Bus. Franchise Guide '15,464 (E.D. Mo. March 3, 2015), reminds parties of the limited grounds for vacating an arbitration award in court. In December 2011, Prescription Shoppes, a franchisee in the Medicine Shoppe system, filed a Statement of Claim with United States Arbitration and Mediation, as called for in the arbitration provision of the parties' license agreement. Medicine Shoppe filed an answer and counterclaim.

Two years later, in March 2014, Prescription Shoppes voluntarily dismissed its claims. In response, Medicine Shoppe requested a default award, pursuant to the applicable arbitration rules. The arbitration administrator determined that Prescription Shoppes had an intent not to proceed, and allowed the case to go forward under the default rule. Medicine Shoppe submitted evidence and moved for a default award, which was granted by the arbitrator. The arbitrator noted that the award would be finally issued following receipt of Medicine Shoppes' evidence regarding attorneys' fees and costs.

Medicine Shoppe filed a request for over $150,000 in attorneys' fees and costs. The evidence supporting the fees consisted of a declaration of lead counsel, listing the number of hours billed and the hourly rate charged by each attorney working on the case. In response, Prescription Shoppes twice requested that it be allowed to examine the specific billing records. The arbitrator denied the requests, based on an earlier statement by counsel for Prescription Shoppes that it was consenting to an award on the counterclaims “which included attorneys' fees,” and based on Medicine Shoppe's counsel's excellent reputation. The arbitrator issued an award that reduced the total requested fees and costs by approximately $2,500.

Medicine Shoppe sought to confirm the award in federal court, and Prescription Shoppes sought to vacate the portion awarding attorneys' fees and costs on the grounds of evident partiality or misconduct by the arbitrator or manifest disregard of the law. The court quickly disposed of the manifest disregard of the law argument, explaining that it is not one of the four listed grounds for vacatur under the Federal Arbitration Act, and that recent case law has limited the reasons that a court may rely on to vacate an arbitration award to the four listed in the FAA.

The court found that Prescription Shoppes had waived the argument of evident partiality of the arbitrator because they had not specifically raised it to him. Although they asserted to the arbitrator that his attorneys' fee award was unjustified and unprecedented, they did not mention partiality, and therefore could not raise the issue for the first time on a motion to vacate.

With respect to the argument that the arbitrator committed misconduct, the court found that it had not been waived and was a proper basis to vacate an arbitration award under the FAA. It determined, however, that there was not misconduct in the arbitrator's handling of the fees and costs such that Prescription Shoppes was deprived of a fair hearing ' the standard for a showing of misconduct ' because it was not entitled to be heard on the issue. Once the administrator determined that the case would proceed by default, which was proper under the applicable arbitration rules, it was within the arbitrator's authority to decide the fees and costs without input or briefing from Prescription Shoppes. Thus, Prescription Shoppes' motion to vacate was denied in its entirety, and Medicine Shoppe's motion to confirm the award was granted.

Parties to arbitration and their counsel are reminded to proceed carefully and consider all potential consequences of their strategic and procedural decisions. In this case, the franchisee consented to proceed by default, but did not seem to contemplate the extent of attorneys' fees that would be awarded or that argument on that issue would not be allowed.

Cynthia M. Klaus is a shareholder with Larkin Hoffman and a member of this newsletter's Board of Editors. She can be reached at [email protected]. Bryan Huntington is an attorney with the firm. Reach him at [email protected].

Circuit Court Reinstates Dealer's Defamation Claims Against Manufacturer

In Sleepy's LLC v. Select Comfort Wholesale Corporation, Bus. Franchise Guide '15,466 (2nd Cir. Feb. 27, 2015), the Second Circuit reinstated a dealer's slander claims against a manufacturer. After the dealer had received reports that the manufacturer's sales staff was making defamatory comments about the dealer and its products, it hired secret shoppers to investigate. The manufacturer's sales staff allegedly then made defamatory comments to the secret shoppers during their investigations. Sleepy's serves as a reminder that manufacturers must properly train their sales staff about the risk of defamation liability, including instruction on the difference between what is permissible puffing/sales talk and what is not.

In June 2005, Sleepy's and Select Comfort executed a written dealer agreement under which Sleepy's was to sell the Personal Preference line of Sleep Number beds manufactured by Select Comfort. Select Comfort would continue to sell its own Core line beds from its company-owned stores. The Personal Preference and Core lines differed in several significant respects, such as their foundations and the types of controls they used to adjust bed firmness.

Sleepy's received reports that Select Comfort salespeople were disparaging Sleepy's as well as the Personal Preference line, and therefore Sleepy's hired secret shoppers to investigate Select Comfort on at least 12 occasions. All but once ( see discussion of secret shopper Deborah Zaffron below) the secret shoppers encouraged Select Comfort salespeople to discuss Sleepy's by being the first to mention it. The secret shoppers were allegedly told by salespeople that the foundation of the Personal Preference beds was inferior to that of the Core beds, that beds sold by Sleepy's were stored in a way that attracted allergens and dust mites, and that Sleepy's offered inferior sales terms and deceitfully refused to honor its warranties.

On one occasion, a secret shopper, Deborah Zaffron, said that she had bought a bed at Sleepy's but that it had become lumpy and that she wished to replace it. The salesperson responded that he had previously worked for Sleepy's and that Sleepy's would not honor its warranty on the bed. Instead, the salesperson said Sleepy's would “send somebody out to your house, they'll inspect the bed, [and] they'll say there's nothing wrong with it. Happens daily.”

Sleepy's brought suit against Select Comfort alleging a variety of claims, including slander. The case proceeded to trial. Near the close of Sleepy's case, Select Comfort moved for judgment on partial findings pursuant to Fed. R. Civ. P. 52(c). Applying New York law, the district court granted the motion. As to those 11 occasions where the secret shopper mentioned Sleepy's first, the district court concluded that Sleepy's had consented to the defamatory comments and therefore could not recover for slander. The district court also denied recovery based upon the statements allegedly made to Zaffron, concluding they were mere sales talk and were not defamatory. The Second Circuit reversed.

In concluding that the district court erred in holding that Sleepy's necessarily consented to publication of defamatory material by having secret shoppers initially mention Sleepy's, the Court of Appeals recognized the general rule that in some circumstances, a person may be prevented from recovering for defamation where they intentionally elicit the defamatory material. However, the circuit court distinguished between those occasions where a person conducts an honest inquiry to determine whether defamatory statements have been made and a situation where a person conducts an investigation with the intention of drawing the speaker into a lawsuit. In the former circumstance, recovery is allowed; in the latter circumstance, it is not. The court also determined that an investigator's degree of certainty a defamatory statement will be made is significant: a high degree of certainty weighs in favor of recovery being denied, as it tends to show the investigation is for the purpose of setting up a lawsuit. As the district court failed to consider Sleepy's intent in conducting the investigation or its certainty that defamatory statements would be made, this part of the district court's ruling was reversed and remanded.

Interestingly, the circuit court suggested that whether Sleepy's had consented to the individual slanders may be inconsequential on the merit of Sleepy's defamation claims, as Sleepy's may be able to show Select Comfort salespeople had engaged in a pattern and practice of defaming Sleepy's. By proving a pattern and practice, Sleepy's may show “that Select Comfort had committed numerous additional similar slanders that were not solicited by Sleepy's.” (In other words, Sleepy's may be able to recover for slanders that presumably it would be unable to prove independently.)

As for the statements allegedly made to Zaffron, the circuit court disagreed that the statements were mere sales talk. To the contrary, it determined that the salesperson had made a defamatory comment and that the statement was one of fact, i.e., Sleepy's regularly refuses to honor its warranty, and instead avoids the warranty by falsely claiming that the product is not defective. Thus, the district court's holding as to these statements was also reversed and remanded for further consideration.

Investigations similar to the one conducted in Sleepy's are now commonplace. Manufacturers must be particularly diligent in training company sales staff not to make defamatory statements about product lines sold by their dealers, as such statements may open the door for the dealer to assert a wide variety of claims (e.g., defamation, breach of contract, breach of the covenant of good faith and fair dealing, etc.). Sales staff are generally given wide discretion to state their opinions about products or the business practices of other companies in the industry, but they must be careful about making statements of fact that may be held defamatory. While there are defenses to defamation liability (e.g., proving the truth of the statement), establishing the entitlement to a defense can be difficult, costly, and time-consuming, such that it is likely more sensible to avoid making the defamatory statement in the first place.

Court Denies Franchisee's Motion to Vacate Attorneys' Fees Award

The case of Medicine Shoppe Int'l, Inc. v. Prescription Shoppes, LLC, Bus. Franchise Guide '15,464 (E.D. Mo. March 3, 2015), reminds parties of the limited grounds for vacating an arbitration award in court. In December 2011, Prescription Shoppes, a franchisee in the Medicine Shoppe system, filed a Statement of Claim with United States Arbitration and Mediation, as called for in the arbitration provision of the parties' license agreement. Medicine Shoppe filed an answer and counterclaim.

Two years later, in March 2014, Prescription Shoppes voluntarily dismissed its claims. In response, Medicine Shoppe requested a default award, pursuant to the applicable arbitration rules. The arbitration administrator determined that Prescription Shoppes had an intent not to proceed, and allowed the case to go forward under the default rule. Medicine Shoppe submitted evidence and moved for a default award, which was granted by the arbitrator. The arbitrator noted that the award would be finally issued following receipt of Medicine Shoppes' evidence regarding attorneys' fees and costs.

Medicine Shoppe filed a request for over $150,000 in attorneys' fees and costs. The evidence supporting the fees consisted of a declaration of lead counsel, listing the number of hours billed and the hourly rate charged by each attorney working on the case. In response, Prescription Shoppes twice requested that it be allowed to examine the specific billing records. The arbitrator denied the requests, based on an earlier statement by counsel for Prescription Shoppes that it was consenting to an award on the counterclaims “which included attorneys' fees,” and based on Medicine Shoppe's counsel's excellent reputation. The arbitrator issued an award that reduced the total requested fees and costs by approximately $2,500.

Medicine Shoppe sought to confirm the award in federal court, and Prescription Shoppes sought to vacate the portion awarding attorneys' fees and costs on the grounds of evident partiality or misconduct by the arbitrator or manifest disregard of the law. The court quickly disposed of the manifest disregard of the law argument, explaining that it is not one of the four listed grounds for vacatur under the Federal Arbitration Act, and that recent case law has limited the reasons that a court may rely on to vacate an arbitration award to the four listed in the FAA.

The court found that Prescription Shoppes had waived the argument of evident partiality of the arbitrator because they had not specifically raised it to him. Although they asserted to the arbitrator that his attorneys' fee award was unjustified and unprecedented, they did not mention partiality, and therefore could not raise the issue for the first time on a motion to vacate.

With respect to the argument that the arbitrator committed misconduct, the court found that it had not been waived and was a proper basis to vacate an arbitration award under the FAA. It determined, however, that there was not misconduct in the arbitrator's handling of the fees and costs such that Prescription Shoppes was deprived of a fair hearing ' the standard for a showing of misconduct ' because it was not entitled to be heard on the issue. Once the administrator determined that the case would proceed by default, which was proper under the applicable arbitration rules, it was within the arbitrator's authority to decide the fees and costs without input or briefing from Prescription Shoppes. Thus, Prescription Shoppes' motion to vacate was denied in its entirety, and Medicine Shoppe's motion to confirm the award was granted.

Parties to arbitration and their counsel are reminded to proceed carefully and consider all potential consequences of their strategic and procedural decisions. In this case, the franchisee consented to proceed by default, but did not seem to contemplate the extent of attorneys' fees that would be awarded or that argument on that issue would not be allowed.

Cynthia M. Klaus is a shareholder with Larkin Hoffman and a member of this newsletter's Board of Editors. She can be reached at [email protected]. Bryan Huntington is an attorney with the firm. Reach him at [email protected].