Court Watch

In October 2013, MasterBrand gave notice of its intent to terminate Rogovky's right to sell additional franchises. Rogovsky subsequently brought a 13-count complaint; nine of the counts were claims under various states' franchise acts. MasterBrand moved to dismiss the complaint. The court first considered whether Rogovsky had an “area franchise.” To prove the existence of an area franchise, Rogovsky needed to establish that it sold franchises in the name of, or on behalf of, MasterBrand. Rogovsky could not do so. As the court recognized, Rogovsky's KHI Franchise Disclosure Documents (FDDs) evidenced that Rogovsky was not selling franchises on behalf of MasterBrand. To the contrary, the FDDs never even mentioned MasterBrand by name. Additionally, the fact that KHI franchisees sold a variety of products in addition to MasterBrand cabinets weighed against a finding of an area franchise.

The court noted that a threshold requirement for application of most of the relevant franchise acts was the payment of a franchise fee. Rogovsky argued, among other things, that it satisfied the franchise fee requirement because it spent over $300,000 remodeling and stocking to comply with MasterBrand's requirements. The court recognized that a variety of franchise statutes ' including Minnesota, Illinois, Hawaii and Washington ' specifically state that a franchise fee does not include a purchase at fair market value of supplies or fixtures necessary to enter into the business. The court held that the remodeling costs fell within this statutory exclusion and could not qualify as a franchise fee. Nor could the remodeling cost qualify as a franchise fee in those states that did not have such exclusions, because, among other reasons, the remodeling primarily benefitted Rogovsky, not MasterBrand.

Additionally, the court determined that most states' franchise acts require that the franchised business must be substantially associated with the franchisor's trademark. Rogovsky asserted that a provision in the Agreement that allowed Rogovsky to use Masterbrand's trademarks to advertise MasterBrand's cabinets created such a substantial association. The court was not persuaded. Rogovsky only had the right to use MasterBrand's trademarks to sell cabinets , not to sell KHI franchises . And again, Rogovsky's FDDs made no mention of MasterBrand. For these and other reasons, the court dismissed all nine of Rogovsky's franchise act claims.

In addition to the basic threshold requirements analyzed in Rogovsky Enterprises , various franchise and distribution statutes contain particularized requirements that may bar an alleged franchisee's claims under the acts. Bringing an early dispositive motion may give an alleged franchisor an opportunity to dramatically shift the momentum of a lawsuit and should almost always be seriously considered.

Court Grants Franchisor's Motion to Compel Arbitration

Many franchisors view arbitration as less costly, quicker, and more predictable than litigating in court. Many franchisees, however, argue that arbitration unconscionably deprives them of their statutory and common law rights. Arbitration provisions in franchise agreements sometimes provide franchisors with perceived procedural advantages, particularly since franchisors are usually the ones that draft them. These advantages can include limitations on claims, class action waivers, choice of law, and forum-selection clauses. The recent decision in Meadows v. Dickey's Barbecue Restaurants Inc., 2015 WL 7015396 (N.D. Cal. Nov. 12, 2015), illustrates how franchisees are attempting to avoid arbitration by alleging that the agreement is unclear or inconsistent with existing law regarding its enforcement.

In Meadows, a putative class of franchisees sued a franchisor in federal court in California alleging statutory and common law misrepresentation claims. In response, the franchisor moved to compel arbitration with the American Arbitration Association (AAA) in Texas pursuant to a Texas forum selection clause. The franchisees argued that the arbitration provision was unenforceable and that the court should strike it down. The California court reviewed the pertinent franchise agreements and, as discussed further below, reached different results with respect to whether the court or arbitrator should decide the threshold issue of arbitrability ' which in this case, meant whether the agreement was unconscionable ' for the various franchisees.

The court divided the franchisees into two groups. With respect to the first group of franchisees, the arbitration agreement applied to all disputes “arising out of or relating to this agreement.” The arbitration agreement also required that the “proceedings be conducted in accordance with the current arbitration rules of the area.” With respect to the second group of franchisees, the arbitration agreement applied to all disputes, including those “arising from ' the validity of [the] Agreement.”

The court recognized that arbitrability is generally a matter for the court to decide “unless the parties clearly and unmistakably provide otherwise.” With respect to the second group of franchisees, the court held that the parties had delegated arbitrability to the arbitrator because the parties agreed to arbitrate disputes arising from “the validity of [the] Agreement.” The court cited precedent from the U.S. Court of Appeals for the Ninth Circuit, holding that similar language “clearly and unmistakably indicated [the parties'] intent for the arbitrators to decide the threshold question of arbitrability.”

But the court held otherwise with respect to the first group of franchisees. The court disagreed with the franchisor's argument that the broad scope of the arbitration agreement, applying to all disputes “arising out of or relating to this agreement,” constituted clear and unmistakable evidence that the parties intended to delegate arbitrability. Alternatively, the franchisor argued that the arbitration agreement's incorporation of the AAA rules, which grant arbitrators the authority to decide arbitrability, constituted clear and unmistakable language delegating arbitrability.

The court agreed that “under some circumstances, incorporating the AAA rules into an agreement can evince a 'clear and unmistakable' intent to delegate.” The court cited two Ninth Circuit decisions to that effect, but held that they “specifically left open the question of whether the same rule would apply when fewer than all the parties to an arbitration agreement were sophisticated.” As a result, the court reasoned that a “large corporation” or “sophisticated attorney” might conclude that the incorporation of the AAA rules was intended to delegate arbitrability, while an “inexperienced individual, untrained in the law,” might not.

In the case at hand, the court found that the franchisees “were each far less sophisticated than ' a well-established franchisor corporation” and “asked to sign a complicated, 60-page agreement, drafted by [the franchisor], containing [myriad] legal terms.” The court also found that the franchisees had no “prior experience running a business or owning a franchise,” and there was “no evidence that ' [they] had legal training or experience dealing with complicated contracts.” Finally, the court noted that “other courts frequently treat franchise agreements more like consumer contracts than like commercial ones, owing to the lower sophistication and inferior bargaining position of franchisees.”

The court then went on to address arbitrability for the first group of franchisees. First, however, the court needed to decide whether to enforce the franchise agreement's Texas choice-of-law provision. The franchisees argued that the provision was unenforceable because Texas law was “contrary to a fundamental policy of California.” The court, however, held that “a separate conflict of laws inquiry must be made with respect to each issue in the case,” thus the proper inquiry was “which state's law governs the enforceability of the arbitration provision,” not “what law applies to [the franchisees'] substantive claims.” After holding that “the stricter standards under Texas law in establishing unconscionability [was] not a valid reason to apply California law,” the court applied Texas law and held that the arbitration agreement was not procedurally or substantively unconscionable. Therefore, the first group of franchisees' claims was subject to the arbitration provision.

Meadows is noteworthy because it highlights the importance of drafting an arbitration agreement that is clear and consistent with existing law regarding its enforcement. Franchisors might consult the specific language in Meadows in deciding how to draft their own arbitration agreements that properly delegate arbitrability. Furthermore, Meadows provides instructive precedent outlining how to analyze the effect of a choice-of-law provision in deciding arbitrability.

Bryan Huntington and co-author R. Henry Pfutzenreuter are franchise attorneys with Larkin Hoffman in Minneapolis, MN.' Bryan can be reached at'[email protected]. 'Henry can be reached at'[email protected]. '