Does Your Franchise Agreement Address Group Arbitration?

A popular contractual tool for franchise systems is a mandatory arbitration provision. Under this type of provision, the parties to a dispute are limited in their ability to seek relief through the courts, and instead must submit all disputes to be heard by one or more third party decisionmakers, known as "neutrals" or "arbitrators."  A neutral is usually (but not always) an attorney who may or may not have prior judicial experience. The neutral will, like a judge, hear evidence from both sides and will consider their arguments before rendering a decision that will be binding on both parties. In arbitration, the decisions of neutrals are appealable only under very limited circumstances. Much has been written about the benefits and drawbacks of mandatory arbitration provisions (see, for example, this article ), and I won’t endeavor to address those issues here.

Courts and neutrals will typically look to the language of the agreement to determine whether certain types of disputes must be submitted to arbitration, or whether instead the parties will be permitted to litigate them in court. Unless there is an overriding reason (for example, a statute that prevents enforcement or a question as to whether the contract is valid), both courts and neutrals will enforce an arbitration clause as written. As a result, when the parties choose to arbitrate disputes, they must pay careful attention to the wording of the contract.

During the past several years, the issue of class/group arbitration – where a number of individuals will attempt to arbitrate claims that are common to all of them – has become more prominent. In the franchising world, a number of independent associations of franchisees have attempted to use the group arbitration model to pursue legal claims against their franchisors. From the franchisee’s perspective, group arbitration is an attractive alternative because it enables them to share resources and reduce their individual costs. From the franchisor’s perspective, group arbitration is problematic for a variety of reasons; for example, in the context of a dispute a franchisor typically sees the circumstances of its franchisees as being disparate enough to warrant separate arbitration proceedings for each one of them. As a result, franchisors will usually want to avoid group arbitrations.

A pair of recent decisions involving the Fantastic Sam’s franchise system highlights the importance of careful drafting of arbitration clauses for franchise companies that want to avoid having to arbitrate disputes on a group-wide basis. In FSRO Association Ltd. v. Fantastic Sam’s Franchise Corp., an association of franchisees sought to arbitrate their claims against the franchisor as a group, arguing that the language of the arbitration clause in their contracts was broad enough to permit associational claims. Specifically, the relevant contractual language said:


"Any controversy or claim arising out of or relating in any way to this Agreement or with regard to its formation, interpretation or breach shall be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association."

In spite of this broad language, the franchisor sought a court order prohibiting the group-wide arbitration and compelling each of the franchisees to arbitrate their claims on an individual basis. The U.S. Court of Appeals for the First Circuit held that the arbitrator, and not court, should decide whether the group arbitration was permitted by the franchise agreement. This was because the question of whether group arbitration was permitted was not a "gateway issue" that related to whether the case was arbitrable or not (which ordinarily is decided by courts), but instead was an issue regarding the scope of the arbitration itself. As a result, the Court refused to reach the question of whether group arbitration would be permitted, instead leaving that decision to be made by the arbitrators.

Having the question placed firmly before them, the panel of neutrals selected by the parties noted that the arbitration clause was completely silent on the issue, as it did not use the words "association, group, class, aggregate, or consolidated," and did not limit the arbitration requirement to "all disputes between the parties," or words to that effect. Instead, the panel determined that the language used in the parties' arbitration clause was extremely broad, and its lack of express limitations on group action would be interpreted as permitting such group arbitration. As a result, the franchisee association was permitted to go forward on a group-wide basis.

The Fantastic Sam's decision serves as yet another reminder to franchise companies of the importance of careful drafting in franchise agreements, and in arbitration clauses in particular (I wrote about another arbitration clause-drafting issue in June). If you want to avoid having to arbitrate with a class or group of franchisees, you should have language in your franchise agreement that specifically prohibits group- or class-wide arbitration. This can be done by including language like "any arbitration between the company and the franchisee shall be of the claims related to the franchisee only, and will not be conducted on a class-wide or group basis," or words to that effect. While having that language does not guarantee that a court or neutral(s) will choose to enforce it, it is much more likely that you will be able to avoid mass arbitrations if you have that language in your agreement.

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