Articles

How to Win a Franchise Arbitration

by John M. Brickman

The Supreme Court has expressed a strong federal preference for the rapid and unobstructed enforcement of arbitration agreements. This is good news for most franchisors, who traditionally favor arbitration for resolving disputes with franchisees. Arbitration enjoys the reputation of simplicity and economy. Yet success in arbitration, and in its difficult interplay with litigation, requires substantial experience and sophistication.

Early planning is essential. The time to begin planning for arbitration is early, ideally before parties sign a franchise agreement. Franchisors need to ask themselves the following basic questions:

1. Do we want to arbitrate? If so, you need to put an arbitration provision in your franchise agreement. Fortunately, as noted above, courts are favorably disposed to enforcing arbitration provisions, so absent fraud, you can be fairly confident that a well drafted arbitration provision in your franchise agreement will require your francisees to arbitrate rather than litigate their disputes.

2.If we want to arbitrate, do we want to arbitrate all issues that could possibly arise under our franchise agreement or are there some issues we want to have decided by a court? A few issues, for example, was the agreement to arbitrate procured by fraud, will be decided by the court even in the face of a broad arbitration provision. But virtually all substantive contractual issues can be reserved to the arbitrator with a sufficiently broad arbitration provision.

3. What law do we want to apply? To compel an arbitrator to apply the law of a selected jurisdiction, rather than the proverbial "rough justice," you must say so in the arbitration provision of your franchise agreement. The more specific the language, the better. Again, you must bear in mind that, even with a specific choice of law provision, there is no guarantee that all issues will be decided in strict accordance with the law designated. For example, in cases subject to the Federal Arbitration Act, a provision specifying a choice of New York law (which does not permit arbitrators to award punitive damages) will not necessarily preclude the arbitrator from awarding punitive damages, since federal law allows such an award.

4. Where do we want the arbitration to take place? This is known as forum selection, and your franchise agreement should provide for arbitration in the jurisdiction you think is the most advantageous for you. A forum selection clause may also determine the place in which a party can bring judicial proceedings related to the arbitration. However, franchisors should be wary of franchise laws in certain jurisdictions [e.g., Indiana and Wisconsin], which may invalidate a forum selection clause that requires a franchisee to arbitrate outside that jurisdiction.

In determining a forum for your arbitrations, bear in mind that it is cheaper to arbitrate in or nearby your home city. Producing employee witnesses and documents is less disruptive and less expensive if it does not require travel, and because regular counsel to the company typically is nearby, local arbitration saves legal expense as well. But there may be countervailing considerations. You may have a particular desire to seek punitive damages, or to avoid the possibility of an adverse award of punitive damages. Research the law of any jurisdiction you are considering to be certain its laws are favorable to your concerns.

5. How many arbitrators should we use? Some arbitration agreements prescribe three arbitrators (sometimes all three are neutrals; sometimes each party picks one and the third is a neutral). Others call for one neutral arbitrator. Unless there is compelling reason to the contrary in a particular case, there is little reason to choose three. Scheduling becomes a problem with three; also, hearings with three arbitrators typically stretch longer. Party-appointed arbitrators essentially duplicate the functions of the parties' counsel, so with effective counsel there is no reason for the expense and delay that accompany the party-appointed arbitrator.

6. Who should we pick as an arbitrator? The franchisor who perceives that it has a strong case wants to avoid the arbitrator who would play Solomon or who might be swayed by the equitable position presented by the individual confronting a substantial company in litigation. Our experience suggests that the franchisor in this situation is served best by an arbitrator who is a lawyer, who is likely to apply the law strictly and not be affected by the emotional attractiveness of the franchisee's position. Obvious candidates to be stricken include practitioners who specialize in representing plaintiffs or those who regularly represent franchisees.

7. What if we need immediate relief and can't wait for an arbitration to start? An arbitrating litigant may need immediate injunctive relief pending arbitration. A franchisor may wish to enjoin a terminating franchisee from misusing trade secrets or a protected trademark or trade name, or from violating post-termination restrictions in the parties' agreement. Conversely, the franchisee may seek to stay the franchisor from terminating the franchise of from taking some other adverse action. In such cases, the arbitration tribunal presents one possibility (arbitrators have the right to issue certain forms of relief pending an arbitration award), but the timing may require quicker action than the AAA can provide (the AAA usually takes several weeks to commence administration of an arbitration, including the appointment of an arbitrator), and in any event a litigant may prefer to have court-issued injunctive process, with the immediate power of the contempt sanction, rather than an arbitrator's injunction, which may require confirmation by court action, a potentially uncertain and time-consuming procedure).

In a case where speed is important or the right to emergency relief seems clear as a matter of law, the movant should think first about applying to court rather than the arbitrator. Federal courts have inherent power to grant status quo injunctions in aid of arbitration (literally, to maintain the existing status without derogation of the parties' rights) pending the outcome of the arbitration.This can pose a tremendous advantage to a franchisor, who can force a remote franchisee, typically poorer than the franchisor, to hire local counsel in the franchisor's city on short notice to respond to an application for emergency relief. State courts have similar powers to grant status quo injunctions, sometimes by statute.

Discovery. A litigant in arbitration has no automatic right to discovery. In some jurisdictions, local law allows parties to seek court-mandated discovery, including depositions, but neither the FAA nor case law under it creates a similar right for arbitrations under federal law.

Stenographic Transcript. Federal arbitration rules allow a party to make a stenographic record of the hearing. The party must make independent arrangements with a reporting service (the AAA does not provide "official" reporters), notice must be given to the adversary (which, if it chooses, must be allowed to purchase the transcript), and the AAA must be notified.

Should you order a transcript? Unless the expense becomes an unacceptable burden, why not? Counsel may find the transcript particularly helpful in a complex case, with delays between sessions, to refresh recollections, or to provide the arbitrator with an accurate record of the evidence. Later, if a reviewing court needs to consider a question of arbitral misconduct or another issue affecting the award, the transcript will provide evidence of the proceeding.

Methods of Proof. In arbitration, creativity works. While live witness testimony is usually the best (because the opportunity to cross-examine and ability to judge demeanor allows the arbitrator to give the testimony the greatest weight, other methods of adducing proof also succeed. Federal arbitration rules allow testimony by affidavit, although the weight of the evidence may be diminished ("Ms. Arbitrator, I can't cross-examine a piece of paper!"). Yet proof by affidavit is vastly cheaper than flying in a live body, and may be the only way to present testimony by a recalcitrant witness. Remarkably, lawyers who prepare affidavits for arbitration -- when they have the opportunity, in effect, to put words in the mouths of their witnesses, and thus to cast testimony in the most favorable light -- simply fail to take advantage of this enormous opportunity, within the boundaries of the truth and their ethical obligations.

Nothing in the Rules bars testimony by telephone, although an arbitrator may decline to take it. Nothing bars proof by letter either. In either case, you must decide whether the benefit to be gained outweighs the risk that your adversary (who surely will be allowed to adduce proof by the same means) will do even more damage to your case by the same method.

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