Who Decides Arbitrability: The Court Or The Arbitrator?

A recent Maryland court decision in a franchise dispute demonstrates the importance of a carefully-drafted arbitration clause

The case, Meena Enterprises, Inc. v. Mail Boxes Etc., Inc., Bus. Franchise Guide (CCH) ¶14,910 (D. Md Oct. 13, 2012), involved a dispute between Mail Boxes Etc. ("MBE"), a franchisor of mailing services businesses.  In March 2001, United Parcel Service purchased MBE.  At the time of the acquisition, UPS announced that MBE franchises would continue to offer choices among delivery services (e.g., UPS, Federal Express, and Airborne Express), but that “the relationships may be altered somewhat” as a result of the purchase.

Plaintiff Meena Enterprises, Inc. (“Meena”) was a franchisee that operated two MBE franchises pursuant to Franchise Agreements that it assumed in August 2001; the Agreements were signed by Mail Boxes Etc. USA, Inc. (an affiliate of MBE) and not MBE itself.  One franchise was located in the University of Maryland Student Union; the other located in College Park.  During the  initial term of the Agreements, MBE and UPS allowed Meena to continue to operate their franchise in the University of Maryland student union as an MBE store because Meena “was required to offer Federal Express shipping services” under its lease with the school.

When it came time to renew the Agreements in 2011, MBE purportedly insisted that the University of Maryland location be converted to a UPS store. Meena advised MBE that conversion was not possible because of the University’s FedEx requirement.  Given MBE's alleged lack of marketing support for the MBE brand, Meena requested that MBE allow it to operate the Student Union location as an independent store after the Franchise Agreement expired. MBE did not respond to this request prior to both Franchise Agreements’ expiration in August 2011. 

Meena sued in January 2012, asserting claims against MBE for breach of contract, fraudulent inducement, and negligent misrepresentation, and sought a declaratory judgment to preclude MBE from enforcing the covenants not to compete that were contained in the Agreements.

Each of the Agreements included an arbitration clause that provides, in relevant part:

Every controversy, claim or dispute arising out of or in connection with the negotiation, performance or non-performance of this Agreement, including, without limitation, any alleged torts and/or claims regarding the validity, scope and enforceability of this Section, shall be solely and finally settled by binding arbitration conducted in the locality in which the franchise is located.

The Agreements also each state that they are “to be construed under and governed by the laws of the State of California except for any provisions which are found to be unenforceable in California.” 

MBE filed a motion to compel arbitration pursuant to the Federal Arbitration Act ("FAA"). In dealing with this Motion, the Court first recognized the rule that, under the FAA, it was required to “engage in a limited review to ensure that the dispute is arbitrable.” Hooters of Am., Inc. v. Phillips, 173 F.3d 933, 938 (4th Cir. 1999).  This would involve two steps: (1) determining who should decide whether the dispute is arbitrable: the arbitrator or the court; and (2) if the court is the proper forum in which to adjudicate arbitrability, deciding whether the dispute is arbitrable. 

Meena contended that because MBE was not a signatory to the Agreements (which were signed by Mail Boxes Etc. USA, Inc.), MBE could not enforce the arbitration clauses. The Court disagreed, finding that Meena agreed to assume all of the predecessor franchisee’s “rights and duties” under the Agreements, and that those “rights and duties” clearly encompass the duty to arbitrate “[e]very controversy, claim or dispute arising out of or in connection with” the Agreements.  The Court also found that Meena was equitably estopped from avoiding the arbitration clause because “each of [Meena’s] claims against MBE makes reference to, and presumes the existence of, the Franchise Agreements. . . in other words, but for the Franchise Agreements, [Meena] would have no basis for recovery on its claims.”

Meena also challenged the arbitration clause as unconscionable. Recognizing the rule that “a challenge to the validity of an arbitration clause is decided by the court,” the Court nonetheless stated that the presumption can be overcome where the parties “clearly and unmistakably” give the arbitrator responsibility for determining “gateway” questions of arbitrability.  The Court found that the above-referenced language “unequivocally delegates to the arbitrator all claims regarding the validity of the arbitration clauses and therefore constitutes a clear and unmistakable delegation provision.” As a result, the Court stayed the action pending a decision by the arbitrator regarding the gateway question of arbitrability. 

If you are a franchisor and you require arbitration of disputes in your franchise agreement, you should be mindful of the Meena decision.  If you want "gateway" issues of arbitrability to be decided  by your arbitrator, and not a court, your arbitration provision needs to clearly address this issue.  While the Mail Boxes Etc. arbitration clause is not a model of clarity on this point, the Meena decision does illustrate the point.     

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