Courts tackle issues of choice of law and venue

Special to The National Law Journal With the growth of franchising on a national basis, franchisors are no longer anchored to a region, and often negotiate and execute franchise agreements with parties in multiple jurisdictions across the country. The nationalization of franchising raises interesting questions about how to maintain uniformity despite differences in the local environments. Franchisors strive for uniformity in the operation of the franchise from the public’s point of view and, as importantly, in the “backroom” administration of the system. Sophisticated franchisors seek to maintain a relatively uniform system of franchise agreements by implementing a single agreement across the country, making changes as infrequently as possible. There is good reason for such uniformity; administration of multiple versions of the franchise agreement is inefficient and expensive, making the implementation of systemwide changes difficult. Choice-of-venue and choice-of-law provisions are a key part of the franchise agreement from the perspective of both franchisors and franchisees. Indeed, the Uniform Franchise Offering Circular Guidelines promulgated by the North American Securities Administrators Association require that the cover page of such an offering circular disclose in boldface type the choice of law and forum imposed on the franchisee, as well as other significant risk factors. See “Requirements For Preparation Of A Uniform Franchise Offering Circular,” Bus. Franchise Guide (CCH) � 5752. The forum in which the franchisee must litigate usually is important, especially for small franchisees. Indeed, it is not unusual for small franchisees to forgo litigation when required to litigate across the country or in distant venues. Choice-of-law provisions are even more important, often deciding the dispute before the case is even filed. This is particularly true when the choice-of-law provision has the effect of incorporating or avoiding (to the extent possible) state franchise statutes, which often provide elaborate protections and causes of action to franchisees. The quest for a “one size fits all” franchise agreement has resulted in choice-of-venue and law provisions that can bear no relationship to the parties. Thus, when franchisors uniformly designate a particular state for venue and choice-of-law purposes, it can result in the selection of a state to which neither the franchisor nor the franchisee otherwise bears any connection. Because the parties may lack a nexus to the designated state, courts are faced with the task of reconciling the parties’ interest in choosing that venue to hear their franchise dispute with the designated state’s franchise law-the provisions of which are often not waivable, and may not apply if the parties do not reside in the state and none of the events relating to the franchise agreement or dispute has any connection to the state. This issue is particularly difficult because franchisees do not draft these franchise agreements and often do not have much leverage in negotiating the terms of the franchise agreement. Franchisees looking to enforce the terms of a franchise agreement may find themselves in a “foreign” court unable to invoke that state’s franchise law. Protecting local franchisees With the proliferation of franchises and franchise sales abuse, federal regulators and many states passed franchise legislation designed to protect local franchisees. As a result, many states now have well-developed bodies of law on the subject. To invoke a state’s franchise statute, typically the offer or sale of the franchise must have taken place in the state or the franchisee’s outlet must be located in the state. See, e.g., N.Y. Gen. Bus. Law � 681 (McKinney’s 2003). If these criteria are satisfied, franchise agreements usually are not waivable-i.e., franchise agreements may not avoid the statute by selecting a different state’s law. For example, the Illinois Franchise Disclosure Act, which provides, in relevant part, that “[a]ny condition, stipulation, or provision purporting to bind any person acquiring any franchise to waive compliance with any provision of this Act or any other law of this State is void,” has the effect of voiding a choice-of-law provision in a franchise agreement that designates the application of another state’s laws if the Illinois Franchise Disclosure Act would otherwise apply. 815 Ill. Stat. � 705/41 (2004). Maryland and Minnesota, among many other states, have similar statutes. See Md. Bus. Reg. � 14-226 (2004); Minn. Stat. Ann. � 80C.21 (2003). The problem is when the events have taken place wholly outside the jurisdiction and neither party resides in the state. Under such circumstances, an out-of-state franchisee, for example, ordinarily would not get the benefit of the state’s franchise laws. But what if the nonresident parties agreed that the law would apply? In New York, for example, the Franchise Sales Act (N.Y. Gen. Bus. Law �� 680 et seq.) expressly extends to franchise offers made to out-of-state franchisees, but the offer (or circumstances surrounding the offer) must have some connection to New York. The question is: Is a choice-of-law provision selecting New York law enough, without more, to invoke New York’s franchise statute? In the case of Mon-Shore Management Inc. v. Family Media Inc., 584 F. Supp. 186, 193 (S.D.N.Y. 1984), the U.S. District Court for the Southern District of New York said yes. The district court examined the history of the New York Franchise Sales Act and noted that New York has a great interest in protecting prospective franchisees from unscrupulous franchisors. Although certain of the parties in Mon-Shore resided in New York, the court determined that the New York choice-of-law provision, without more, was sufficient for it to apply the New York Franchise Sales Act. Both the 9th U.S. Circuit Court of Appeals and the U.S. District Court for the Western District of Washington have followed Mon-Shore. See Schwartz v. Pillsbury Inc., 969 F.2d 840 (9th Cir. 1992) (citing Mon-Shore, and holding that although the New York Franchise Act by its terms applies only when a person offers to sell or sells a franchise in New York, the New York Franchise Sales Act was applicable because of the New York choice-of-law clause); McGowan v. Pillsbury Co., 723 F. Supp. 530 (W.D. Wash. 1989) (New York Franchise Sales Act applied because of New York choice-of-law clause). In Schattner-Rosen Constr. Co. v. Union Carbide Marble Care Inc., Bus. Franchise Guide (CCH) � 11, 283 (N.Y. Sup. Ct. 1997), however, a New York state trial court found that in the absence of any connection to New York, a New York choice-of-law clause, without more, is insufficient for the New York Franchise Sales Act to apply. In Schattner, the franchise agreement specified New York as the venue, and the choice-of-law provision provided, in relevant part: “This agreement is to be construed in accordance with the law of the State of New York without recourse to New York Choice of law or conflicts of law principles. If, however, any provision of this Agreement would not be enforceable under the laws of New York, and if the franchised outlet is located outside of New York and such provision would be enforceable under the laws of the state in which the franchised outlet is located, then such provision shall be interpreted under the laws of that state. Nothing in this subsection is intended to invoke the application of any franchise or similar law, rule, or regulation of the State of New York or any other state which would not otherwise apply.” Carve-out provisions The Schattner court noted that to the extent the parties attempted to opt out of the applicability of the New York Franchise Sales Act, such a provision would be void as being against public policy and violating the anti-waiver provision of that act (N.Y. Gen. Bus. Law � 687). In Schattner, however, the parties were not New York residents, and none of the conduct complained of was alleged to have occurred in New York. The court reasoned therefore that the New York Franchise Sales Act did not apply. In reaching its decision, the Schattner court did not directly address or interpret the last clause of the choice-of-law provision-the “carve out” provision that provides “[n]othing in this subsection is intended to invoke the application of any franchise or similar law, rule, or regulation of the State of New York or any other state which would not otherwise apply.” The most reasonable resolution of this apparent split of authority is to afford the parties their expectancy. While franchise statutes generally cannot be waived, parties certainly can choose to include additional protections in their franchise agreement. For example, they can choose to impose any number of substantive requirements on the franchisor or afford the franchisee additional protections. Among these could be the protections afforded by a state franchise statute. In other words, if the parties agree that a state’s franchise statute will apply, there seems to be no legal or policy rationale for refusing to apply that statute, even if it would not otherwise apply in the absence of the agreement. Carve-out language such as that in Schattner is more problematic. Again, the franchise agreement in Schattner provided that New York law, with the exception of its franchise statute, applied to the parties’ dispute. Such provisions seem to be present in an increasing number of franchise agreements. Franchisors in states that are considered to have less favorable statutory and common law-such as California-attempt to select the law of states perceived to be more favorable to large companies and franchisors, such as New York. Franchisors like the one in Schattner seek to select a more favorable state’s laws, yet disclaim aspects of that state’s law-such as franchise statutes-that do not favor the franchisor. On the one hand, interpretation of such a provision is straightforward: The court should apply all of the chosen state’s law except the franchise statute because it reflects the parties’ expectancy. On the other hand, it may be very difficult for a court to apply only portions of a state’s law. State common law necessarily develops in the context of the state’s statutory law. When a statute exists addressing a particular wrong, it seems less likely that courts would develop common law to address that wrong. Thus, when a franchise statute exists, one would expect to find less common law addressing subjects covered by a typical franchise relationship statute. When, however, there is no franchise relationship statute-such as in Florida-common law has developed to address disputes between franchisors and franchisees. It may be difficult for a court to untangle those aspects of a state’s laws that incorporate, reflect or were created because of the franchise statute. In other words, there is a strong argument that state law must be accepted in whole or not at all. In an age of national franchising, courts will be confronted by increasingly complex choice-of-venue and choice-of-law provisions. These provisions are almost always drafted by the franchisor, are rarely negotiated and are often signed by franchisees without a second thought. Accordingly, franchisors appear to be including increasingly complicated choice-of-venue and choice-of-law provisions in their franchise agreements in an attempt to take advantage of favorable law and disclaim the rest. Absent a comprehensive and clear federal private right of action that addresses these issues, the courts will continue to struggle between the sometimes competing interests of the parties’ expectancy, consistency in the law and the important public policy concerns (i.e., protection of franchisees) reflected in state franchise statutes. Dwight J. Davis is a partner in the New York office of Atlanta’s King & Spalding, and Courtland L. Reichman is a partner in the firm’s Atlanta office. They are both litigators with extensive experience advising franchise clients on their dispute resolution and structuring needs. Douglas L. Friedman, an associate in the New York office, is a member of the firm’s business litigation team.