Franchise companies are especially susceptible to class action complaints. The class actions are often brought by consumers buying the franchisor’s branded products and services, and by franchisees claiming systemwide contractual defaults.

Many franchisors seek to thwart class treatment by requiring arbitration of disputes by consumers and franchisees with arbitration clauses that contain waivers of class treatment. Recent U.S. Supreme Court decisions have confirmed this strategy will defeat class treatment for franchisees and consumers where the arbitration clause waives class treatment. (See Stolt-Nielson v. AnimalFeeds International Group (2010) and AT&T Mobility v. Concepcion (2011).) These decisions overrule state law decisions of unconscionability as conflicting with the federal policy encouraging arbitration.

Although not decided in franchise cases, these decisions are a boon for franchisors that desire to eliminate the threat of class treatment.

Special Vulnerabilities of Franchise Companies

Franchise companies are targeted by consumers for class treatment because the strong brand of the franchisor establishes typicality and commonality perfect for class treatment. Franchise companies are targeted by franchisees for class treatment because they have common claims arising from a common franchise agreement or disclosure document.

In reaction to class action complaints filed by these constituencies, franchisors began to require all disputes be resolved by arbitration, which, by definition, is an individualized method of dispute resolution. In response, seeing efficiency in class treatment of arbitrations, some arbitration service providers enacted rules or practices to accommodate or consolidate multiple arbitrations involving common claims. Then the California Supreme Court in Discover Bank v. Superior Court held that contractual provisions prohibiting class treatment violated due process by eliminating effective access to the courts and were otherwise unconscionable. The conflict between the goals of the Federal Arbitration Act (FAA) and California’s rule in Discover Bank caused the U.S. Supreme Court to consider weighing federal policy favoring arbitration against state concerns of unconscionability.

In 2010, the Supreme Court in Stolt-Nielson held that an arbitration provision that was silent on class procedures should not be interpreted as allowing class treatment. Instead, the court would require the arbitrators to determine from the contract and the expectations of the parties whether class treatment would be allowed consistent with the FAA.

For instance, where an arbitration clause was silent on class treatment, but the clause incorporates by reference the rules of JAMS or the AAA allowing class treatment, the arbitrators could find a clause that is facially silent as to class treatment actually allows such treatment. For this reason, arbitration clauses that seek to limit class treatment should require the parties to affirmatively waive class treatment.

The Supremacy of the Federal Arbitration Act

On April 27, the Supreme Court in AT&T Mobility LLC ruled that the FAA pre-empts the Discover Bank rule, which rendered class action waivers in consumer arbitration agreements unconscionable and therefore unenforceable. The high court ruled in a 5-4 decision that the Concepcions, who entered into a contract with AT&T for a free telephone, were not entitled to join an existing class action for false advertising against AT&T when seeking redress for the $30.22 charge for sales tax for their free telephone. The Concepcions were instead required to arbitrate their dispute as required by the contract, a reversal of the 9th U.S. Circuit Court of Appeals decision permitting class treatment. Justice Antonin Scalia, writing for the majority, held: “Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration.”

The court stated that the purpose of the FAA was to ensure private arbitration agreements are to be enforced according to their terms to allow the parties to tailor a streamlined dispute resolution procedure by agreement. The court refused to hold that such class action waivers were unenforceable adhesion contracts, but would allow states to address their concerns over such clauses, perhaps by requiring the highlighting of the anti-waiver provisions. The court was also concerned about the risks of class treatment to the responding party, which is subjected to the possibility of much greater losses in class arbitration proceedings without the same protections of appellate review afforded litigation outcomes.

The minority opinion by Justice Stephen Breyer suggested that without class treatment minor frauds would not be remedied. “What rational lawyer would have signed on to represent the Concepcions in litigation for the possibility of fees stemming from a $30.22 claim?” Breyer wrote. The majority decision rejected this view, but did acknowledge that the arbitration provision in the case had some very consumer favorable provisions, which would treat the Concepcions better in arbitration than in litigation. The majority nevertheless held that “states could not require a procedure that is inconsistent with the FAA, even if desirable for unrelated reasons.”

Recommendations for Franchise Companies

The presence of consumer friendly provisions in the arbitration clause, such as subsidizing the costs of arbitration and granting the prevailing party counsel fees, enhances the ability to compel arbitration of even small claims. One-sided arbitration agreements will still be held unconscionable and therefore unenforceable. Nevertheless, a franchisor that desires to arbitrate may want to add or continue to enforce class action waivers in their agreements. Franchisors that do not have arbitration clauses may desire to add such clauses to take advantage of class action waivers. All arbitration clauses need to be regularly reviewed and updated to comport with changing judicial attitudes toward enforceability and class treatment. •

Craig R. Tractenberg is the chair of the global franchise and distribution practice at Nixon Peabody. He is a former editor of the ABA Franchise Law Journal. Tractenberg can be reached by e-mail at ctractenberg@nixonpeabody.com.