Rupert Barkoff ()
One of the challenges to all business lawyers is that the law is not static, but often the documents we prepare are. Take, for example, the subject of minimum and maximum vertical price-fixing. When I began practice in the last century, both activities were per se illegal and not governed by the rule of reason. Thus, we would have to tell our clients that they could not fix prices with other companies up or down the distribution chain. But with the advent of Khan1 and Leegin,2 the advice previously given by lawyers on these subjects has been stood on its head. When franchisor clients ask whether they can require their franchisees not to charge more than X for their goods or services, our advice before was a clear “no.” Now, that advice is: “perhaps.” Similarly, lawyers who represent franchisors whose franchisees sell luxury goods now give their clients the same “perhaps” when the franchisor of a luxury item asks if he can keep its franchisees from excessively discounting the system’s high-quality items.
Unfortunately, thinking they were protecting their clients from vertical price-fixing claims, many attorneys years back decided to have their clients’ agreements unequivocally state that the franchisee was an independent contractor and free to set the prices at which it offered goods and services for sale. But franchisee agreements are usually long-term agreements—five to 20 years. Thus, the franchisors whose documents contained pronouncements that franchisees are free to set their own prices have been locked out of the opportunities to take advantage of Khan’s and Leegin’s dramatic changes in the law on vertical price-fixing—for perhaps as long as two decades from the dates these precedents were announced.
Franchise agreements that contain arbitration clauses present a similar challenge to franchisors and their lawyers. Again, going back to the last century, my experience shows that a clear majority of franchise agreements did not then contain arbitration clauses. However, the American Arbitration Association (AAA) strongly suggested at that time that parties consider including in their agreements simple arbitration clauses, like:
Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association in accordance with its [applicable] rules and judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof.3
This would take the parties out of the judicial system when disputes arose and have those disagreements adjudicated in a simpler environment for resolving their disputes—an arbitration proceeding. More and more franchisors, dissatisfied with the U.S. court system, followed the AAA’s suggestion and made arbitration the required method to resolve disputes. I would guess that about half of the franchises now being sold have arbitration clauses in their agreements. The AAA’s argument that arbitration was a quicker and cheaper way to resolve disputes had great appeal to many franchise systems.
But whenever a “better wheel” is invented, there are usually problems that are initially not foreseen, but later surface. Once that happens, they take much of the glitter off of that wheel. Arbitration as a dispute resolution tool in franchise systems is no exception. It was naïve to think that the AAA’s simple language could provide a valuable substitute for the U.S. judicial system with its thousands of precedents and numerous rules, including the Federal Rules of Civil Procedure. But the franchise systems that opted for arbitration are now locked into arbitration for many years. And what we have seen over the last couple of decades is that arbitration has raised a number of issues for the parties. These issues include:
• How many arbitrators should there be?
• Where should the arbitration take place?
•What qualifications should the arbitrators have?
• What level of discovery should be allowed?
• Should there be motion practice?
• How long should arbitrators have to issue their decision?
• Should the arbitrators have to issue reasoned opinions, or may their opinions simply say X or Y wins?
• Must arbitrators follow the law?4
• Should there be any special reasons for arbitration decisions to be appealable, in addition to the very limited reasons set forth in the Federal Arbitration Act?
• How balanced must the arbitration clauses and the arbitration be?
• Can the arbitration proceeding be tipped in favor of the franchisor?
The issues just listed were only the tip of the proverbial iceberg. Franchisors might still have found arbitration overall attractive, but they grew very concerned about arbitrators deciding every issue that might arise in franchise disputes. Issues of particular importance to all franchisors related to trademarks and other intellectual property.5 Some arbitrators are not familiar with trademark law, and franchisors are concerned about those arbitrators issuing incorrect or adverse decisions that are not appealable.
Thus, the simple language proposed by the AAA disappeared and franchisors began to put certain bells and whistles into their arbitration clauses—for the most part reserving issues such as trademark validity for traditional judicial resolution. And with that step, which created dual decision processes for disputes, dispute resolution became more complicated, and often did not lead to quick and cheap decisions. A whole new set of issues came into play when both traditional litigation and arbitration contemporaneously became methods to resolve disputes. Some of the new issues included:
• Who decides what will end up in arbitration and which issues will be steered toward judicial resolution?
• In what order do the proceedings go forward: first the arbitration or first the judicial proceeding? Or do they proceed simultaneously?
• Is this bifurcated process really going to lead to faster and cheaper adjudications?
• In what venues will the proceedings be held?
• Will there be different rules of discovery in the two actions?
• Should class actions be allowed in either form of adjudication and can franchisees band together to bring common claims?
If you examine the published results of cases facing questions such as these, it will make you quickly question all the underlying professed advantages of arbitration.
Benefits of Arbitration
However, in recent days, even with the skepticism now expressed about arbitration, as it turns out, there is a new reason for franchisors to go with arbitration for dispute resolution. Being the defendant in a class action proceeding is one constant concern of franchisors. In some jurisdictions, the parties may not, by contract, be able to explicitly exclude franchisee plaintiffs from bringing class actions.6 Recent Supreme Court decisions indicate, however, that an arbitrator does not have the right to turn a simple case into a class action unless the arbitration clause grants him or her power to do so7—something that is highly unlikely.
In fact, the opposite is usually the case. The courts generally adhere to the concept that arbitration provisions are creatures of contracts,8 and within limits, the courts will give parties the right to agree to almost anything they want to agree to, as long as procedural and substantive principles of due process (a topic for another article) are not violated. This includes the right to exclude class arbitration proceedings.
So, let’s return to the beginning. A franchisor client walks into your office and asks whether an arbitration clause will be good or bad for him. The problem the lawyer faces is that his recommendation will be made in a static environment at the time the contract is drafted, but the law may have evolved in an unfavorable direction when the dispute arises several years later.
When you convene a gaggle of franchisor-oriented lawyers, you will find that there is almost always a significant split between them on whether arbitration is better than a court proceeding. In discussions with attorneys whose practices are franchisee oriented, I have seen the results to be similarly split.
I have found myself in this quandary more times than I would like to admit, and my solution is that the lawyer and client must look at the nature of the franchise system and anticipated disputes, the likelihood of disputes developing, the advantages and disadvantages of having precedents on the record that may affect future franchisee behavior, the fear that adverse decisions will be non-appealable, and the monetary amounts that are likely to be involved in a dispute, and then, after carefully analyzing these factors, make a gut decision.
Although I have historically been a fence-sitter on this issue, I have in the past generally preferred the courthouse for franchisors. But if the franchisor has carefully drafted the arbitration provision, he or she gets to make many of the rules on how the proceeding will be handled. This is a significant strategic advantage.
The recent Supreme Court pronouncements that limit franchisees’ ability to go for a class action when the contract is silent on the issue, puts the thumb of justice on the arbitration side of the scale.
Rupert M. Barkoff is a partner and chair of the franchise team at Kilpatrick Townsend & Stockton; he is resident in its Atlanta office.
1. State Oil Co. v. Khan, 522 U.S. 3 (1997).
2. Leegin Creative Leather Prods. v. PSKS, 551 U.S. 877 (2007).
3. See, e.g., Drafting Dispute Resolution Clauses: A Practical Guide, AMERICAN ARBITRATION ASSOCIATION PUBLICATIONS (AAA) GUIDES, 1993 WL 495383 (Jan. 1, 1993).
4. The answer, as is often the case in the legal world, is “It depends.” Unless the arbitration agreement says otherwise, arbitrators are required to follow pertinent law, or at least not manifestly disregard it. See, e.g., George Watts & Son v. Tiffany and Co., 248 F.3d 577, 583 (7th Cir. 2001); see also Shearson/Am. Express v. McMahon, 482 U.S. 220, 232 (1987) (“[T]here is no reason to assume at the outset that arbitrators will not follow the law; although judicial scrutiny of arbitration awards necessarily is limited, such review [under the Federal Arbitration Act] is sufficient to ensure that arbitrators comply with the requirements of the statute.”); Montes v. Shearson Lehman Bros., 128 F.3d 1456, 1459 (11th Cir. 1997).
Counsel should keep in mind, however, that arbitrators do not have to explain their decisions, which makes it “impossible to determine whether they acted with manifest disregard for the law.” Wachovia Sec. v. Gangale, 125 Fed. App’x 671, 679 (6th Cir. 2005). Moreover, an arbitration award “may not be vacated based on errors of law or interpretation.” Aldred v. Avis Rent-A-Car, 247 Fed. App’x 167, 169 (11th Cir. 2007) (citing Scott v. Prudential Sec., 141 F.3d 1007, 1014 (11th Cir. 1998)).
5. See, e.g., Synergistic Int’l, LLC v. Monaghan, No. 12-3299, 2013 WL 5587269 (C.D. Ill. Oct. 9 and 10, 2013) (plaintiff’s claims related to its trademarks, inter alia, were properly before the court; defendants’ motion to compel arbitration or mediation was defeated). The author’s firm represented the plaintiff. The case is ongoing; however, no appeal on the issues discussed in this article have been taken.
6. See, e.g., Bridge Fund Capital Corp. v. Fastbucks Franchise Corp., 622 F.3d 996, 1005 (9th Cir. 2010) (finding waiver of class action in franchise agreement unconscionable and unenforceable); Jones v. DirecTV, 381 Fed. App’x 895 (11th Cir. 2010) (finding waiver of class action in arbitration agreement unenforceable); Skirchak v. Dynamics Research Corp., 508 F.3d 49, 59??(1st Cir. 2007) (applying Massachusetts law to hold that under the particular circumstances of that case, the class action waiver was unconscionable).
7. E.g., Stolt-Nielsen v. AnimalFeeds Int’l, 559 U.S. 662 (2010).
8. Goldberg v. Bear, Stearns & Co., 912 F.2d 1418, 1419–20??(11th Cir. 1990).