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Developments in alternative dispute resolution: do limitations on remedies undermine arbitration agreements? (Mediation. Arbitration. Litigation).

Fifty percent of American marriages fail. Less reliable information is available on the failure rate of franchised businesses. Whatever the real numbers are, unfortunately failures do occur. With failure comes anger, recrimination, and often litigation.

Dispute Resolution Provision Control

In franchise relationships, dispute resolution is almost always influenced by common provisions in the franchise agreement. Recent studies suggest that a majority of franchise agreements require arbitration of some, if not all, disputes between franchisor and franchisee. The great majority of franchise agreements contain provisions concerning the law that should govern disputes or where disputes should be heard.

Franchisor Generally Dictates Terms

Although reasonable people differ on whether legal consequences should flow from this fact, it is beyond dispute that these provisions are generally dictated by the franchisor. Virtually all franchise agreements are form documents. Some franchisors will negotiate none of its provisions. Others are more open to changes, but rarely does the pre-contract negotiation focus on dispute resolution provisions. Nor is it the case that most franchisors have a specific nefarious objective in mind in adopting choice of law, venue or alternative dispute resolution provisions. The franchisor that reflexively selects the law of its own state to govern the interpretation of the agreement and the relationship does not intend to deprive franchisees of any specific protections under the laws of 50-some other states and territories. The franchisor that opts for arbitration generally does so because it believes it is quicker and less expensive for both sides.

Regardless of what motivates these dispute resolution provisions; regardless of their clarity; regardless of whether they are the subject of any pre-agreement discussion at all, when a dispute arises, these provisions always have real-world consequences. And often those consequences are unappealing to one party or the other--most often, the franchisee. As a result, a lot of franchise litigation revolves around the ancillary questions of who will decide the case, where it will be decided, and under what law. The case law in this area reflects an ongoing struggle to balance freedom of contract--and franchise agreements are rarely entered into either literally or figuratively "at gunpoint"--against concerns that the franchisor's ability to dictate contract terms allows it to place a "thumb on the scales of justice."

Over-Reaching May Invalidate Arbitration Clause

In Greentree Financial Corp. v. Randolph, the United States Supreme Court overturned the Eleventh Circuit's finding that an arbitration agreement that was silent on splitting arbitration fees, was unenforceable because a party's ability to initiate a case could be prevented by "steep" arbitration costs; however, the court held open the possibility that an agreement to arbitrate which unreasonably limited or foreclosed a plaintiff from asserting statutory rights, could be set aside. Taking their cue from Greentree Financial, a number of franchisees have attempted to avoid agreements to arbitrate by arguing that franchisor efforts to control litigation risk or expense, or aspects of the arbitration process itself, prevent the effective assertion of important rights.

Antitrust Treble Damages Not Precluded by Punitive Damages Exclusion

Often, franchise agreements limit the remedies which an arbitrator can grant. Frequently, such limits are embodied in provisions that foreclose punitive or exemplary damages, or preclude awards of lost profits or other consequential damages. Efforts to deny enforcement to arbitration agreements as a result of such contractual limitations, have not met with notable success. In Investment Partners LP v. Glamour Shots Licensing, Inc., the court rejected a claim that a provision that "the arbitrator shall not award punitive damages" rendered arbitration an inadequate forum in which to vindicate rights under the federal antitrust laws by preventing the arbitrator from awarding antitrust treble damages. However, the Fifth Circuit's decision that this provision did not invalidate the agreement to arbitrate, was probably cold comfort to the franchisor, because the court narrowly interpreted the term "punitive damages" as not encompassing statutory treble damages. Therefore, said the court, the arbitrator was free to award treble damages if he found that the franchisor had violated antitrust laws.

Open Question Whether Exclusion of Statutory Damages Might Invalidate Arbitration Clause

The court did note that "provisions in arbitration agreements that prohibit punitive damages are generally enforceable," but this still leaves open the questions of whether more inclusive drafting could have cut off antitrust treble damages claims or whether effective remedy limits would render arbitration an inadequate--and therefore impermissible--substitute for a judicial forum for antitrust and other statutory claims.

Validity of Remedies Limits Held A Question For the Arbitrator

Another federal circuit court of appeals case, Arkcom Digital Corp. v. Xerox Corp., also framed the question of whether limitations on remedies can make an arbitration clause so unfair that it ought not be enforced. In that case, the arbitration agreement prohibited the arbitrator from awarding punitive damages, most lost profits, or any other indirect, special, exemplary, incidental, or consequential damages. The plaintiff argued that because the arbitration clause prevented the arbitrator from awarding remedies expressly available under the Arkansas Franchise Practices Act, it should not be enforced because it conflicted with essential rights and remedies conferred by the state statute. The Eighth Circuit refused to decide whether the limitation on remedies trumped the remedies available under the statute, saying that was for the arbitrator to decide. What the court did decide was that such remedies limitations did not invalidate the agreement to arbitrate.

Consider Objectives in Drafting Remedies Exclusions

In drafting remedy exclusions in franchise agreement arbitration clauses, franchisors should consider whether they are willing to risk a finding that the arbitration clause is unenforceable, by limiting the arbitrator's ability to compensate a prevailing franchisee for statutory violations. Although neither of the two federal circuit court of appeals decisions from 2002 struck down arbitration clauses because of remedy limitations, aggressively drafted remedy exclusions risk crossing the line that was suggested but not spelled out in the Greentree Financial case. Although a general punitive damages exclusion would probably pass muster, an agreement that prevents an arbitrator from awarding statutory damages will be suspect on fairness grounds and increases the chance that a franchise dispute will be decided by a jury rather than an arbitrator.

Marc P Seidler is a partner with the law firm of Seidler & McErlean in Chicago. He can he reached at 312-516-0701 or mseidler@ameritech.net.
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Author:Seidler, Marc P.
Publication:Franchising World
Geographic Code:1USA
Date:Jul 1, 2003
Words:1039
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