May 7, 2015 - Franchise Articles by |

Arbitration: Fast But Not Necessarily Fair

Fair Arbitration is not always achievable by franchisees. An increasing number of franchise agreements contain arbitration clauses that require disputes to be resolved by binding arbitration instead of in state or federal courts.  While franchisors argue that the purpose of an arbitration clause is to obtain a faster and more efficient way of resolving litigation, it cannot be disputed that several aspects of an Arbitration heavily favor the franchisor over the franchisee.

First, in an Arbitration, a franchisee is denied his right to a jury trial.  This is significant given that most franchise disputes can be viewed as “David and Goliath” situations.  Second, most arbitration clauses require the franchisee to travel many miles from his home to the franchisor’s headquarters for the Arbitration.  Third, the ability of the franchisee to obtain the information and documents through discovery he needs from the franchisor to adequately prepare his claims for trial is severely limited in an Arbitration.  This inherently disadvantages the party (usually the franchisee) attempting to prove fraud or other claims of misrepresentation, which by their nature, involve complex issues of proof.

Fourth, many times an arbitration provision will provide that the franchisee waives any right to punitive damages and sets forth an abnormally short period of time by which the franchisee must assert or lose his claims.  Fifth, and often-times overlooked, is the requirement that a franchisee wishing to assert a counterclaim must “pay” a fee for this right.

Under prevailing law, arbitration clauses are almost impossible to circumvent.  Usually the “decision” whether to arbitrate a dispute is made at the moment the franchise agreement is signed by the franchisee. Nevertheless, as a recent case, described below, makes clear, in a very small minority of cases it may be possible for a franchisee successfully to challenge the enforceability of an arbitration provision and thereby obtain his “day in court.”

In Ticknor v. Choice Hotels, the United States Circuit Court for the Ninth Circuit ruled that a hotel franchisor, which had terminated a franchise agreement, could not force its hotel franchisee to litigate its claims in an Arbitration instead of a federal court.  As discussed below, the federal court held that the arbitration clause in the franchise agreement, which otherwise would have required that the dispute be arbitrated at the hotel franchisor’s headquarter’s building, was unconscionable and therefore unenforceable.

In Ticknor, the franchisee had executed an Econo Lodge Franchise Agreement with Choice Hotels for a hotel located in Bozeman, Montana.  The Franchise Agreement was a pre-printed standard form contract drafted by Choice – a type often referred to in the law as a contract of adhesion or adhesion contract.

The Agreement contained an arbitration clause stating:

[Any claims relating to the franchise agreement] will be sent to final and binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association. The arbitrator will apply the substantive laws of Maryland, without reference to its conflict of laws provision. Any arbitration will be conducted at our [Choice’s] headquarters office in Maryland.

The standard form Agreement also had attached to it two addendums including a modified liquidated damages formula and a product improvement list.

The hotel franchisee, Ticknor, alleged that Choice had reneged on its promises to provide technical and financial support in the renovation of Ticknor’s hotel through the “Signature Exterior Renovation Program.” The franchisee also claimed that Choice had breached the Franchise Agreement by failing to provide sufficient reservations.  In response to Choice’s alleged breaches, Ticknor stopped paying his franchise fees.  In turn, Choice terminated the franchisee for non-payment of franchise fees.

After terminating the franchise, Choice filed a demand for Arbitration under the arbitration clause of the franchise agreement seeking, inter alia, liquidated damages.  Apparently not wishing to submit its dispute to an Arbitration at Choice’s headquarters building many miles from his home, Ticknor requested that a United States federal court in Montana prohibit Choice from forcing Ticknor to submit to Arbitration.

Deciding in favor of the franchisee, the Ninth Circuit first pointed out that the liberal federal policy in favor of upholding arbitration clauses does not rule out consideration of generally applicable contract defenses including fraud, duress or unconscionability.  In this case, Ticknor raised the state law defense that the arbitration clause was unconscionable.

In refusing to use Maryland law as argued by Choice, the federal court determined that application of Maryland law would be contrary to a fundamental public policy of Montana (the franchisee’s home state), since Montana had a very clearly defined public policy of not enforcing an arbitration clause in a contract of adhesion that “lacks mutuality of obligation, is one-sided, and contains terms that are unreasonably favorable to the drafter.”  And, under Montana law, the enforceability of a contractual provision, including an arbitration clause, is decided by asking two questions: first, whether the contract is one of adhesion, and, if so, second, whether enforcement against the weaker party would be unconscionable, oppressive or against public policy.

Looking at the first question, whether the Franchise Agreement was a contract of adhesion, the court concluded that “the Franchise Agreement was a standardized, form agreement that Ticknor was forced to accept or reject without negotiation.”  In reaching this conclusion, the court rejected Choice’s argument that Ticknor negotiated changes in the Franchise Agreement, since Choice presented no evidence to support this claim.

After having concluded that the Franchise Agreement was a contract of adhesion, the court next turned to the second question — whether the contract was unconscionable – stating that the Franchise Agreement “lacked mutuality of obligation, was one-sided, and contained terms that were unreasonably favorable to the drafter.”  In so concluding, the court found persuasive that Choice had the right under the Franchise Agreement to bring a lawsuit against Ticknor in state or federal court, while Ticknor was limited to bringing a lawsuit only in an Arbitration at Choice’s headquarters in Maryland.  “Oppression and a disparity of bargaining power are the indicia of unconscionability.”

In conclusion, although the court ruled in favor of the franchisee, the lesson to be learned from this case is that, as a general rule, arbitration provisions are not in the franchisee’s best interests, and in almost every case, courts will uphold the validity of arbitration clauses so long as the franchisee has signed the franchise agreement.  Accordingly, unless the franchisee negotiates the removal of an arbitration clause before he signs a franchise agreement, it is very likely that any dispute that arises thereafter will be decided in Arbitration.

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