Arbitration Agreements and the Franchise Dispute: the Likely, the Unlikely and the Imponderable
Although arbitration clauses are increasingly common in franchise agreements, they continue to be viewed by drafters as mere boilerplate confined to the back pages of the franchise agreement. Few agreements spell out the basic procedural rules needed to govern an actual dispute, or specify which disputes are exempted from the ambit of the arbitration. As David Sterns writes in this article, most disputes over franchise arbitration clauses are as costly and frustrating as they are preventable so long as proper care is taken at the drafting stage.
Arbitration agreements are an increasing fact of life in franchise relationships[1]. But even as Canadian franchisors and franchisees amass greater experience with arbitration as a means of dispute resolution, arbitration clauses are still too often viewed as "boilerplate". From the drafter's standpoint, the desire to draft a compendious franchise agreement means that arbitration clauses are kept to the bare minimum and are relegated to the "Miscellaneous" section of the franchise agreement. As a result, few agreements carefully define which disputes are subject to or exempt from arbitration, and even fewer speak to the manner in which arbitrators are selected. Once the relationship sours, it is surprising to find just how costly and frustrating a deficient arbitration agreement can be to all parties. A poorly drawn arbitration agreement can actually render arbitration a more costly and less timely process than traditional litigation.
Advantages of Arbitration Clauses in Franchise Agreements
Conventional wisdom holds that it is generally in a franchisor's interest to insist on an arbitration clause in a franchise agreement. While there can be little doubt that arbitration offers many advantages over conventional litigation, the decision of whether or not to include an arbitration clause, and how it should be drafted, should proceed from a careful analysis of the pros and cons. The most obvious advantage which arbitration offers over traditional litigation is its relative speed. If the arbitration agreement specifies a method of appointment, an arbitrator can be appointed within days and a hearing convened long before a trial date would otherwise be available. The ability to tailor the proceeding to the nature of the dispute means that the length of a hearing can be restricted so that it bears some proportion to the amount in dispute. The arbitrator can also be compelled to render an award within a fixed period of time, thus avoiding the long periods of reserve which can slow down the litigation process. In addition, the parties can choose to render any decision of the arbitrator final thereby eliminating appeal delays from the process.
Another welcome feature of most arbitration Rules is that they generally require arbitrations to be conducted in private, away from the prying eyes of media, the general public and other franchisees.[2] The arbitral decision itself can be rendered confidential so long as neither side appeals the decision to the courts. In this way, an adverse arbitration award which is not appealed will generally have little or no precedential value for other franchisees in the system and will therefore not adversely affect the franchisor's relations with its other franchisees.
Arbitrations also tend to be less procedure-driven than traditional litigation. Parties can agree to any number of procedural shortcuts. In appropriate cases, an arbitrator can be directed to summarily decide the dispute based solely on a written record, or place strict limits on the duration of oral evidence. Pre-arbitration hearings and motions are typically conducted by phone without the need for lengthy affidavits and facta. Discovery rights and obligations are also less expansive than under the rules of civil procedure. All of this amounts to substantial cost savings for both sides. Because of its more relaxed rules and faster timelines, arbitration is generally considered the forum of choice when parties are engaged in an ongoing relationship and must deal with each other every day. Arbitration places the focus on the substantive issues and resumption of normal business relations rather than on costly procedural wrangling.
A further benefit of arbitration agreements to franchisors is that they may in some cases prevent franchisees from bringing a class action.[3] While this consideration might not have been a factor when many franchise agreements currently in circulation were drafted, class actions have evolved considerably within the past few years. The rise of class actions in Canada may give rise to a renewed interest in arbitration agreements as a potential shield for the franchisor.[4]
While the advantages of speed and efficiency apply equally to the franchisee, many practitioners believe that arbitration does not favour the franchisee to nearly the same extent as it favours the franchisor. Many franchisees, for instance, instinctively feel that litigation conducted in the public eye is preferable to arbitration conducted behind closed doors. The public forum offers the franchisee the possibility to counter the franchisor's superior financial resources with adverse publicity or the prospect of a bad legal precedent. Franchisees also quickly become aware that courts are taxpayer-funded while the costs of an arbitrator must be paid upfront by the parties.
In reality though, the primary drawback of arbitration for franchisees is that it offers more limited rights of discovery than traditional litigation. Broad discovery is of greater concern to the franchisee than the franchisor since the franchisor usually possesses the information which the franchisee needs to establish liability. For the franchisee, the ability to access a judge and seek sanctions if the franchisor is not complying with its discovery obligations is critical to its ability to prove its case. A franchisee will likely be dissuaded from advancing an ambitious counterclaim in response to a Notice of Arbitration if it knows that its discovery rights will be severely curtailed.
Drawbacks of Arbitration to Franchisors
Not all disputes should be arbitrated
Despite these advantages to franchisors, drafters of franchise agreements should not automatically require every dispute arising during the course of the franchise relationship to be arbitrated. It is necessary in each case to consider restricting the ambit of the arbitration clause or dispensing with arbitration altogether. Deciding whether or not to include an arbitration clause in a franchise agreement requires the drafter and the franchisor-client to consider what types of disputes are most likely to arise in the course of the relationship. If the franchisor is unlikely to be a plaintiff, then a broadly drafted arbitration agreement covering all disputes between the parties may serve its purpose by limiting the franchisee's access to the courts and corresponding discovery rights.
On the other hand, if the franchise agreement incorporates by reference other agreements, such as real estate leases, security agreements or promissory notes then care must be taken to ensure that the arbitration agreement does not inadvertently restrict the franchisor's ability to exercise self-help remedies. Consider for example the case of a franchisor which subleases to the franchisee and wishes to terminate the sublease due to the franchisee's failure to pay rent. An arbitration clause requiring the parties to submit "all disputes between the franchisor and the franchisee" to arbitration could be seen to make arbitration a condition precedent to re-entry. In this case, the arbitration agreement would have the unintended result of preventing the franchisor from exercising the self-help option which would otherwise be available. The franchisee could compel arbitration of a lease dispute simply to prevent or delay the termination of the lease.
Necessity of recourse to the courts
The primary purpose of arbitration is to avoid the costs and delays inherent in the court process. In an ideal setting, arbitration would never require court intervention. In order to achieve this ideal setting both parties must, to a certain extent, "buy into" the process. The existence of an arbitration agreement does not guarantee that the franchisee will cooperate in bringing the dispute forward before a privately-retained arbitrator. Unlike conventional litigation, arbitration does not offer the "Damocles sword" of default judgment for uncooperative or non-responsive defendants absent specific wording in the arbitration agreement to that effect.
A franchisee in fact has several opportunities to contest the arbitration process and, when faced with few options, will not be afraid to use them. The most common disputes arise over either the enforceability or the scope of the arbitration agreement. This will often occur where a franchisee alleges undue influence, fraud or unconscionability or wishes to assert a counterclaim based on these grounds. Despite the fact that most arbitration statutes give arbitrators the power to rule on their own jurisdiction[5], a franchisee may still commence an action and force the franchisor to seek a ruling from the court on whether these issues fit within the scope of the arbitration agreement. Given the amount of jurisprudence on the subject, these disputes arise with considerable regularity in the franchise context.[6]
A franchisee can also dispute the franchisor's choice of arbitrator. Unless the agreement provides a mechanism for choosing an arbitrator or arbitration panel, a franchisee can dispute the appointment of the arbitrator and require the franchisor to bring an application under section 10 of the Arbitration Act (or similar legislation in other provinces) to confirm the appointment. These applications tend to be straightforward, but can result in several months of delays.
A third opportunity to dispute the process is after the arbitrator has rendered his or her Award. In order for the Award to be enforced in the same manner as a court judgment, the successful party must bring an application to the court, on notice to the opposite party[7]. This procedure affords the franchisee another, albeit slim, opportunity to dispute the legitimacy of the arbitration process and the arbitrator's jurisdiction.
By the time arbitration is invoked, the franchise relationship has usually deteriorated to the point where the parties do not consider that there is much goodwill to be salvaged. Very often the outcome of the arbitration will determine whether the franchisee will succeed or fail, and franchisees therefore feel justified in employing no-holds-barred tactics. Even if the franchisee stands little chance of successfully disputing the enforceability of a broadly worded arbitration agreement[8], such disputes can delay the process for months or years and effectively require the franchisor to litigate both in court and in an arbitration setting.
Crafting the Arbitration Agreement
The best way to avoid a contest over the enforceability of an arbitration agreement is to draft a complete code of procedure or incorporate by reference the rules of a recognized arbitration body such as the American Arbitration Association[9] or the ADR Chambers[10]. If the procedure is drafted within the franchise agreement or an Appendix, it should specify the following elements:
- How will the specific arbitrator be chosen?
- What rules will govern?
- Which disputes are exempted from arbitration, i.e. injunction applications and trademark disputes;
- What recourse is available if the other party does not comply with a Notice of Arbitration or submit a defence to the arbitration: Will the arbitrator be permitted to grant default judgment? If so, under what circumstances?
- Where will the arbitration be held?
- Which province's arbitration legislation will govern?
- Who will bear the cost of the arbitration?
- Will there be any oral discovery prior to the hearing?
- Can the arbitration decision be appealed?
- Whether the arbitration agreement will remain in full force and effect notwithstanding the Agreement's expiration or termination.
The arbitration agreement should also be referenced in any guarantees collateral to the franchise agreement in order to be binding on the guarantors. The arbitration agreement should state that it is made for the benefit of the franchisor, its officers, employees, agents, subsidiaries, affiliates and assigns such that the franchisee cannot attempt to remove the dispute from arbitration by joining parties not privy to the arbitration agreement.[11]
Conclusion
The decision to include an arbitration agreement in a franchise agreement is an important one to be made in consultation with the franchisor-client. Arbitration agreements are often the first target of attack by most franchisees and therefore should be carefully thought through and not considered as mere boilerplate. The arbitration agreement should be tailored to the types of disputes which the franchisor expects to encounter most frequently. Careful consideration should also be given to which disputes are to be excluded from arbitration.
There are many sources for good precedent agreements. Many of the independent arbitral institutes offer detailed Arbitration Rules on their websites which may be incorporated by reference into the arbitration agreement. If the franchisor wishes to draft its own rules, these should be set out in a customized procedure attached as an Appendix to the franchise agreement to allow for sufficient detail. Whatever arbitration procedure is selected, it should be fair and balanced in order to ensure that it will withstand judicial scrutiny, if necessary.
[1] According to a recent article, roughly half of all leading U.S. franchisors' franchise agreements contain arbitration clauses: "Green Tree Financial Corp. v. Bazzle: More for the Arbitrator's Plate" Franchising World, November/December 2003, p. 57
[2] See for example the Rule No. 7 of the ADR Chambers:
7. Privacy and Confidentiality of Arbitration
7(1) All arbitrations held with ADR Chambers are private and confidential. The parties and their representatives shall attend the arbitration. All other persons may only attend with the consent of the parties and the arbitrator(s).
7(2) Unless otherwise agreed by the parties or required by law, all hearings, meetings, and communications shall be private and confidential as between the parties, the arbitrator(s) and ADR Chambers.
7(3) Unless the parties agree to the contrary, or a party to binding dispute resolution appeals to court, all proceedings in ADR Chambers are private and confidential. All documents and exhibits filed are private and confidential.
[3] See Kanitz et al. v. Rogers Cable Inc. (2002), 58 O.R. (3d) 299. Two previous attempts by franchisors to stay a class action commenced in breach of binding arbitration agreements were unsuccessful: Hammer Pizza Ltd. v. Domino's Pizza of Canada Ltd. [1997] A.J. No. 67 (Alta. Q.B.); Rosedale Motors Inc. v. Petro-Canada Inc. (1998), 42 O.R. (3d) 776 (Gen. Div.)
[4] It remains to be seen whether the Canadian courts will follow the U.S. Supreme Court in recognizing the possibility of class arbitrations: See Green Tree Financial Corp. v. Bazzle (02-634). The Court in Green Tree held that it is up to the arbitrator to decide whether parties in an arbitration proceeding actually agreed that their dispute could be decided on a class-wide basis. The Court said that a court's role is limited to determining whether the parties have agreed to arbitration; once that determination is made, all further issues of contract interpretation are to be decided by the arbitrator.
[5] For example, section 17(1) of the Arbitration Act, S.O. 1991, c. 17 ("Arbitration Act") states that an arbitral tribunal may rule on the validity of an arbitration clause, and its own jurisdiction.
[6] Cash Converters Canada Inc. v. 1167430 Ontario Inc. [2001] O.J. 5860 (S.C.J.); D.L.T. Holdings Inc. v. Grow Biz International, Inc. (2001), 199 Nfld. & P.E.I.R. 135 (P.E.I.S.C.T.D.); D.L.T. Holdings Inc. v. Grow Biz International, Inc. [2000] P.E.I.J. No. 95 (P.E.I.S.C.T.D.); Ellis v. Subway Franchise Systems of Canada Ltd. (2000), 8 B.L.R. (3d) 55 (S.C.J.); 711447 Alberta Ltd. v. Sarpinos Enterprises (Canada) Ltd. [2000] A.J. No. 1121 (Alta. Q.B.); Hammer Pizza Ltd. v. Domino's Pizza of Canada Ltd. (supra); Bab Systems, Inc. v. McLurg; Bab Systems, Inc. v. McLurg, [1994] O.J. No. 3029 (Ont. Gen. Div.) aff'd [1995] O.J. No. 1344 (Ont. C.A.); 151429 Canada Inc. v. Scaletta [1991] M.J. No. 235 (Man. Q.B. Master); Under the former Arbitrations Act, R.S.O. 1970, c. 25, s. 7: Jussem et al. v. Nissan Automobile Co. (Canada) Ltd. et al. [1973] 1 O.R. 697 (H.C.J.)
[7] Section 50, Arbitration Act
[8] The vast majority of arbitrations agreements are upheld by the courts in Ontario. See for example Kaverit Steel and Crane Ltd. v. Kone Corp., [1992] A.J. No. 40 (Alta. C.A.); Gulf Canada Resources Ltd. v. Arochem International Ltd., [1992] B.C.J. No. 500 (B.C.C.A.); Automatic Systems Inc. v. Bracknell Corp., [1994] O.J. No. 828 (Ont. C.A.); BWV Investments Ltd. v. Saskferco Products Inc., [1994] S.J. No. 629 (Sask. C.A.); Prince George (City) v. McElhanney Engineering Services Ltd., [1995] B.C.J. No. 1474 (B.C.C.A.); Duferco International Investment Holding (Guernsey) Ltd. v. Pan Financial Insurance Co., [1996] O.J. No. 549 (Ont. Gen. Div.); Nutrasweet Kelco Co. v. Royal-Sweet International Technologies Ltd., [1997] B.C.J. No. 332 (B.C.S.C.); NetSys Technology Group AB v. Open Text Corp., [1999] O.J. No. 3134 (Ont. S.C.J.); Turnbridge (c.o.b. Turnbridge & Turnbridge) v. Cansel Survey Equipment (Canada) Ltd., [2000] B.C.J. No. 333 (B.C.S.C.)
[10] See www.adrchambers.com/arbrules
[11] See for example Hammer Pizza v. Domino's (supra) where the franchisor sought to rely on an arbitration agreement while, at the same time, seeking to add parties to the arbitration who had not signed the arbitration agreement.