By Carmen Caruso

Originally published by Dairy Queen Operators’ Association/Dairy Queen Operators’ Cooperative in September 2009.

Currently pending in the United States Congress is an important piece of legislation that all franchisees should enthusiastically support. The Arbitration Fairness Act of 2009 (Bill H.R. 1020 111th Congress 2009) recognizes that many years ago, when Congress initially approved arbitration as a way of resolving civil cases, Congress was assuming that the parties to an arbitration approached the dispute with equal bargaining power, and that both parties reached the same conclusion, i.e. that arbitration (instead of litigation in the courts) was desirable in their particular case.

The Arbitration Fairness Act of 2009 recognizes that in franchising, and in other areas of modern American business, the assumption of equal bargaining power leading to an intelligent, mutual and fair decision to arbitrate is no longer applicable — not where the dominant party seeks to require arbitration of all future disputes as part of its non-negotiable form contract. Thus, this proposed federal law would prohibit franchisors from including provisions that require the mandatory arbitration of all disputes that might later arise during the term of the franchise agreement. In the event a dispute later arises, the franchisor and franchisee would be free to agree to arbitrate, but the franchisee could not be required to agree in advance (when signing the franchise agreement) to arbitrate any and all future disputes that may arise. (The same bill would also outlaw mandatory arbitration clauses in most consumer and employment contracts as well).

As a lawyer who has tried cases both in the courts and in arbitrations, I am qualified to say that it is possible to win in either forum, and that the presence of an arbitration clause in a franchise agreement is not the end of the world, and should never be allowed to discourage a franchisee from bringing a legitimate claim. In fact, there are some times when arbitration might be the better choice. However, the analysis of which type of dispute resolution might be better tailored for a particular dispute is best undertaken after the dispute arises. When we step back and look at the big picture, it is very clear that mandatory pre-dispute arbitration clauses (which the Arbitration Fairness Act of 2009 seeks to outlaw) unfairly tilts the scales of justice in favor of franchisors at the expense of franchisees. Therefore, it is not surprising that the International Franchise Association (which is largely funded by franchisors and their suppliers) is spending a great deal of money trying to defeat the Arbitration Fairness Act of 2009, as are other trade associations that seek to protect the advantages enjoyed by big business over small business, employees, and consumers.

Therefore it is essential that franchisees and dealers across the country educate themselves on this important issue and join this national debate. For franchisees and dealers in every system, starting with Dairy Queen, here are my top ten reasons, some of which overlap, why you should be writing your Congressional Representatives and Senators to strongly support the Arbitration Fairness Act of 2009:

1) Arbitration is arbitrary! In the court system, if the judge rules against a party on a question of law, the party can generally appeal to a higher court. Arbitration, by contrast, is designed to be “one stop” decision-making. If the arbitrator is wrong about the law, it is very difficult (often impossible) to have the incorrect decision reviewed by a court. Of course, no one, not even the smartest arbitrator, will always be right. By design, proponents of arbitration are willing to accept a certain risk of error.

Think about this. Let’s say that over the life of a franchise system, a franchisor might have 100 disputes with various franchisees. In calling for mandatory arbitration of each of those disputes, the franchisor is betting that any uncorrected errors in particular cases will even out, just as the possibility that an umpire may make a bad call on any given play will tend to even out over a long baseball season.

But this rationale plainly does not work from the standpoint of franchisees facing perhaps the one big case of their lives. There is no acceptable risk of error for someone whose business is at risk. Furthermore, even when one focuses on individual cases, the risk of uncorrected error is not fairly distributed, but instead to fall more heavily on the franchisee. In most franchising disputes, the franchisor is relying on the language of the parties’ agreement as allegedly permitting an action that the franchisor has taken (or wishes to take). The franchisee relying upon a legal right created by the common law (such as the duty of good faith and fair dealing) or a statute (such as a state law requiring “good cause” for terminations or the federal law prohibiting unreasonable restraints of trade) in order to persuade the decision-maker that the franchisor cannot do what the agreement might permit. Simply put, the franchisee’s argument is usually a bit more complicated, and often involves the application of a previous case (a precedent) to facts that are never exactly the same. This means that, as a general proposition, the franchisee usually has the greater risk that an arbitrator’s inherently arbitrary decision may be wrong. The arbitrariness of arbitration favors Goliath, not David.

2) Arbitration is expensive. At the courthouse, taxpayers pay the judge’s salary and pay the freight for the courthouse as well. In arbitration, there are fees for the organization that sponsors the arbitration, additional fees for the arbitrators’ professional time, and often even more fees for renting the hearing room. (See the American Arbitration Association’s published fee schedule (www.adr.org) for an example of the administration fees, not counting the professional time of one or more arbitrators). The franchisee must typically pay one-half of these fees upfront before the hearing will begin, under pain of default if the fees are not paid. This burden impacts an individual franchisee more so than it does the franchisor, which has deeper pockets.

3) Arbitration is often in the franchisor’s hometown, where the franchisor may have considerable influence among the pool of potential arbitrators, and where, consciously or not, the arbitrators (and the arbitration organization) may be biased because they desire the franchisor’s repeat business. The franchisee, on the other hand, will have to absorb the expenses of travel, for both itself and often for its witnesses.

4) By agreeing to arbitrate, important statutory protections may be waived. State franchising acts such as the Illinois Franchise Disclosure Act often prohibit the franchisor from requiring a franchisee to agree to venue for a court case outside of the franchisee’s home state. However, in what is arguably an unfortunate legislative oversight, there typically is no corresponding provision to prevent an out-of-state franchisor from requiring an Illinois franchisee to arbitrate in a different state. Many national franchisors therefore use arbitration clauses to obtain for themselves the hometown advantage described above in point three.

5) Discovery is limited. In litigation, a franchisee can usually get access to key documents in the franchisor’s files, and can take the pre-trial depositions of key franchisor personnel and other important witnesses. In arbitration, discovery rights are much more limited, making it more difficult for the franchisee to uncover evidence before the hearing that may make the difference between winning and losing at the hearing. Once again, franchisors insist this is “fair” because the same restriction applies both ways, but once again, the answer is that the franchisee usually needs discovery more than the franchisor needs discovery. As noted, franchise disputes typically arise from written agreements that the franchisor’s attorney drafted. This necessarily means that the franchisor usually starts almost any case with some degree of advantage based on the language of the agreement, which the franchisee must strive to overcome. To agree, in advance, to arbitrate, and thus to waive one’s right to discovery under the Federal Rules of Civil Procedure (or comparable state codes of civil procedure) plays into the franchisor’s hands.

6) Other important legal rights are also usually waived. Many times, a franchisee or dealer will benefit by having his or her case heard along with a similar case brought by another franchisee, or as part of a class action on behalf of all similarly-situated franchisees (or through a lawsuit brought by the Association). Arbitration clauses in franchise agreements often seek to preclude these possibilities by mandating that the arbitration will be limited to the claims of the particular franchisee, with class actions or association lawsuits being precluded. Once again, the deck is stacked against the franchisees.

7) The “savings” from arbitration are often elusive. Fans of arbitration like to claim that arbitration is intended to be less expensive and less time-consuming than litigation (mainly because discovery is strictly curtailed and pre-trial motions and appeals are eliminated). Very often this is not true. Some reasons why the “cost savings” argument is often backwards include: (a) arbitration requires additional fees that are not required in the court system (point one above); (b) the parties to arbitration may agree to more extensive discovery (or pretrial motion practice, as well as post-hearing briefing) than provided in the arbitration rules, thus bringing the expensive parts of litigation into the arbitration format; (c) the parties to arbitration often wind-up litigating issues as to whether the arbitration was, or will be, fair; and (d) most lawsuits in the court system are settled before trial (usually after the parties conduct some discovery and thus have more knowledge than they did at the start). Where litigation is settled, as typically occurs, the end cost may be less than going to full hearing in arbitration (which is more likely to happen, in cases where there was less discovery or less motion practice).

8) Arbitrators are not necessarily better qualified. It is no secret that most companies fear juries. Proponents of arbitration have concocted the notion that it is better to have a case decided by a more experienced and trained decision-maker than left to an unpredictable jury. For franchisors, that argument is extremely self-serving. In reality, most arbitrators are former judges who retired to increase their income, or experienced practicing attorneys, often from larger law firms, whose experience with franchising is usually on the franchisor’s side. It is unusual to find an arbitrator who has spent significant time in his or her career representing franchisees or dealers. This is not to say that most arbitrators do not strive to be fair. They do. However, the “experience” that they bring to the table is not necessarily a plus for franchisees. Most often, a franchisee or dealer will find the best justice from a jury of peers.

9) Arbitration impedes the development of the common law. The American legal system was adapted from the English “common law” which evolved over centuries, one case at a time. Important legal doctrines such as the implied covenant of good faith and fair dealing and the doctrine of unconscionability (that some contract clauses are too unfair to ever be enforced) find their roots in the common law. Further development of the common law, to adapt our laws to the issues of today and tomorrow, quite obviously depends on having judges and juries continue to reach their decisions one case at a time, and to have their decisions published for all to read, to stand as precedents for future cases. In arbitration, the law is essentially frozen in place. Cases decided in arbitration usually do not have the same precedential value that comes from a judicial decision. This is much more than an abstract problem. If a national franchisor were to lose a case with system-wide implications in a court of law, the precedential effect on that franchisor – and other franchisors – will be much greater than if the franchisor were to lose in arbitration. In other words, a franchisor can “afford to lose” more so in arbitration than in the courts. This means that franchisors have less incentive to settle in arbitration than they do in the courthouse. Their incentives in arbitration are instead to grind the franchisee into submission with all of the costs and burdens of travel, and the burden of standing alone in the fight.

10) Jury trials promote democracy. Arbitration does not. Jury trials are conducted in open court, with members of the press and fellow citizens free to observe and comment, and with six or twelve randomly chosen citizens empowered as jurors to render the verdict on the facts of the case. Because this process is so essential to our democracy and to our liberty, the right to trial by jury is enshrined in the Seventh Amendment to the United States Constitution and most if not all state constitutions. When we allow franchisor to impose mandatory pre-dispute arbitration clauses, we are not only agreeing to a proceeding that will be conducted in secrecy, without participation by our fellow citizens, and where the playing field has been tilted in favor of big business. We are squandering an important constitutional right that our forbearers fought for and we are leaving less democracy for our grandchildren.

For all these reasons, both personal to the good health of your franchise and to the good health of your communities and indeed our country, your vocal support for the Arbitration Fairness Act of 2009 is vital!

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