Sep 23, 2015 - Franchise Articles by |

Arbitration Clause in Subway Franchise Agreement Booted by Court of Appeals  9/24/15

By: Jeffrey M. Goldstein

Goldstein Law Firm, PLLC

202 293-3947

Doctor’s Associates Inc. v. Jose Luis Carbonell, et al., New Mexico, 2015 WL 4380284 (June 29, 2015), addressing an arbitration clause in a Subway franchise agreement. 

My view is that Arbitration clauses in franchise agreements are on balance more helpful than not to franchisees and dealers, and this position has remained consistent throughout my career representing exclusively franchisees and dealers as a franchise lawyer. That is not to say, however, that during my frequent, ongoing and methodical reassessments of the benefit of Arbitration clauses I have always reached the same net value on the balancing scale. To the contrary; over time, my positive assessments have been veering downward.

Is it possible to explain this notable downhill secular trend against the benefits of Arbitrations for franchisees and dealers? Yes. The unadorned answer is that large franchisors, especially those with forum selection clauses in their franchise agreements, have over time become increasingly adept at obtaining biased Arbitrators during the Arbitrator selection process. This obviously does not mean that every arbitrator is intentionally biased. Nor does it mean that every arbitration association despises franchisees. It does mean, though, that the arbitrator selection process itself is inherently biased. 

Understandably, this observation will be attacked by many who regularly serve and make money as ‘Arbitrators.’ Despite their anticipated sincere objections, these critics cannot show that they are immune from the forces of human nature that lead enlightened individuals to seek their ‘self- interest.’ Arbitrators, who are profit-seeking lawyers full-time (and Arbitrators part-time), rightly see Arbitration jobs as quick, easy and profitable engagements. As a general proposition, unless an Arbitrator rules in favor of large franchisors that appear in front of him or her the first time, it is almost a certainty that these scorned franchisors will subsequently always strike the Arbitrator’s name from all Arbitration panels in the future. Again, this is a tendency, not an absolute historical fact. This tendency is a formidable unstated obstruction in the path of justice for franchisee lawyers and their clients.

Augmenting this inherent pro-franchisor bias in Arbitrations is the overwhelming trend in franchise law to find that almost every conceivable dispute between a franchisor and franchisee falls within the scope of the applicable Arbitration clause, thereby foreclosing franchisees’ and dealers’ ability to have a judge hear their disputes. But, every rule has its exceptions. In a recent case in New Mexico, the franchisee was successful in preventing its franchisor from forcing it to try its case before an Arbitrator. This franchise Arbitration case found its way to the state Court of Appeals of New Mexico following a trial court’s having rejected Appellant Doctor’s Associates, Inc.’s (DAI or Subway) motion to compel the franchisee to arbitrate the dispute.

In this case, DAI and Jose Luis Carbonell and Victoria Carbonell were parties to a franchise agreement under which DAI granted the Carbonells the right to operate a Subway restaurant in Silver City, New Mexico. The parties’ rights and responsibilities were regulated in part by a franchise agreement, which included an Arbitration clause. The Arbitration clause provided that “any dispute, controversy or claim arising out of or relating to this agreement or the breach thereof shall be settled by Arbitration.”

After a dispute arose, Subway, following the procedures in the franchise agreement, filed an Arbitration case. Promptly thereafter, before a hearing was held, the parties entered into a stipulated award, and the Arbitration was dismissed. In the agreed-upon final settlement award, the Carbonells admitted to violating the franchise agreement by deviating from certain operations manual standards. Further, under the stipulated award, the franchisees agreed to “transfer the restaurant in accordance with the standard transfer procedures established by [DAI] to a buyer approved by [DAI] within ninety (90) days.” The stipulated award also contained the following provision: “The parties agree and understand that this Stipulated Award contains the entire understanding of the parties.”

As happens frequently in similar circumstances, the Carbonells subsequently failed to effectuate a timely sale of the business, and DAI sued them in court requesting that the judge confirm “the Arbitration award as set forth in the stipulated award.” The Carbonells counterclaimed in the court asserting that DAI breached the franchise agreement and had engaged in a civil conspiracy and fraudulent misconduct in connection with the Carbonells’ transfer of the restaurant. In turn, Subway moved the district court to compel Arbitration based on the Arbitration clause of the franchise agreement. The Carbonells opposed the request, and argued that the matter was properly before the district court because their counterclaim did not arise from the franchise agreement, but from the stipulated award that did not contain an Arbitration clause. The trial court agreed with the Carbonells, and concluded that an agreement to arbitrate did not exist because the Carbonells’ claims arose from the stipulated Arbitration award, not from the franchise agreement. Further, the district court found that the stipulated award did not contain language incorporating the Arbitration requirements of the franchise agreement.

The Court of Appeals, in finding against Subway, began its analysis by defining the issue as “whether the Carbonells’ claims are based on the stipulated agreement or the franchise agreement [because] a court cannot compel Arbitration in the absence of an enforceable agreement to arbitrate.”  Although accepting that the parties had a valid, enforceable Arbitration clause in the franchise agreement, and while the initial historical original dispute properly was submitted to Arbitration, the Court stated that “the question before us ….is not as simple. When the parties proceeded to arbitrate the operations dispute, they entered into another agreement: the stipulated award.”

Rejecting Subway’s argument that the subsequent settlement agreement could not trump the franchise agreement, the Court reasoned that “the parties could not vary their relationship such that all consequences of their actions would be controlled by the franchise agreement merely because it was the first agreement between them.” From the Court’s point of view, the stipulated settlement award, which, according to DAI, “could not have arisen in the absence of the parties’ franchise relationship”, varied the parties’ relationship. “It added another express, written agreement between them. We thus must examine the stipulated award in addition to the franchise agreement in order to determine the intent of the parties regarding Arbitration.”  

In turn, the Court observed that, although the stipulated award incorporated provisions of the franchise agreement that were necessary to carry out the terms of the stipulated award, it clearly did not contain a provision requiring Arbitration. Therefore, according to the Court, the parties did not intend the Arbitration clause of the franchise agreement to apply to claims that arose out of the stipulated award.

In so concluding the Court rejected Subway’s three arguments. First, Subway argued that the Arbitration clause of the franchise agreement remained in effect even after entry of the stipulated award because “it would be unnecessary and duplicative to again include the Arbitration provision” in the stipulated award. In this regard, DAI contended that because the stipulated award required continued compliance with the franchise agreement during the time before the contemplated sale of the franchise, this made “clear that the Carbonells were expected to continue to comply with the terms of” the franchise agreement.” The Court, however, came to the opposite conclusion: “We consider these provisions to be inconsistent with an intent that the provisions of the franchise agreement continued in effect without mention in the stipulated award. If the parties made such an assumption, it would not have been necessary to specifically state that the insurance and non-compete provisions had continued effect.”

Second, Subway claimed that the Carbonells’ claims specifically related to the termination and attempted transfer of the franchise agreement, and therefore the court claims were governed by the franchise agreement. Again, however, the Court rejected Subway’s avowal “The Carbonells’ claims pertain to the transfer of the Carbonells’ Silver City restaurant and other restaurants, which was the express subject matter of the stipulated award. Appellants do not otherwise specifically tie the Carbonells’ claims to the franchise agreement. We conclude that the parties did not intend for the Arbitration clause of the franchise agreement to apply to the Carbonells’ claims.”

 Third, Subway argued that the language of the stipulated award “contains the entire understanding of the parties,” and contended that the merger clause in the Arbitration agreement was insufficient to supersede the Arbitration clause of the franchise agreement based on prior case law of the United States Circuit Court for the Tenth Circuit. Expectedly, again, the Court disagreed with Subway’s view, reasoning that even though the Tenth Circuit has expressed the presumption that an Arbitration provision is presumed to survive the expiration of the parties’ contract unless there is some express or implied evidence that the parties intend to override this presumption, in this case such a presumption did not arise since the parties had clearly expressed or implied an intent to repudiate post-expiration arbitrability.

Accordingly, the Court of Appeals affirmed the order of the district court denying Subway’s motion to compel Arbitration. Even though this case is not a watershed in franchise litigation regarding arbitration clauses, it nevertheless is helpful to franchisee lawyers and their clients.



By: Jeffrey M. Goldstein

Goldstein Law Firm, PLLC

202 293-3947

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