Court Watch

The court found it important that neither party had requested rescission or any other equitable remedy. Although there was no counterclaim for damages in this case (because the contract had not yet been terminated), the distributor argued that the proposed termination would violate the WFDL and give rise to an action by the distributor for damages. The court agreed with the distributor and honored its demand for a jury trial. The court acknowledged, however, that the law was not clear on this issue. Therefore, to avoid a second trial if it were later decided that there was no right to a jury trial in this case, the court provided its own findings of fact and conclusions of law on the underlying issues.

Cynthia M. Klaus is a shareholder and Meredith A. Bauer is an associate at Larkin Hoffman in Minneapolis. They can be contacted at [email protected] or 952-896-3392 and [email protected] or 952-896-3263, respectively.

U.S. Supreme Court Enforces Class Arbitration Waiver

The U.S. Supreme Court recently released its opinion in AT&T Mobility LLC v. Concepcion, No. 09-893 (U.S. Apr. 27, 2011), addressing the question as to whether class arbitration waivers in standard form contracts are enforceable in actions brought by consumers. The Supreme Court reversed the District Court in California and the Ninth Circuit by holding that class arbitration waivers are enforceable and cannot be found unconscionable under state law. This decision presents considerable advantages to franchisors and business owners that choose to designate arbitration as their dispute-resolution mechanism, due to their ability to require and enforce bilateral arbitration.

This action was commenced by the defendants (the “Concepcions”) based on a standard-form contract for cell service that they entered into with AT&T Mobility. The Concepcions entered into the agreement, presented on a “take it or leave it basis,” in order to take advantage of AT&T's offer of “free” cell phones. The Concepcions were not charged for the phones, but they were charged $30.22 in sales tax based on the phones' retail value. They filed a complaint against AT&T alleging false advertising and fraud, which was subsequently consolidated into a putative class action in California.

AT&T moved to compel arbitration with the Concepcions, relying on an arbitration clause in the contract signed by the Concepcions at the time of “purchase” of the phones. The clause also contained a class arbitration waiver, requiring that all claims be brought in the parties' “individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.” The Concepcions opposed the motion on the basis that the provision was unconscionable and unlawfully exculpatory under California law, due to the fact that it disallowed class arbitration procedures.

The District Court in California and the Ninth Circuit agreed with the Concepcions, both holding that the arbitration provision was unconscionable under California law. These courts relied on what is referred to as the Discover Bank rule, which was derived in California in Discover Bank v. Superior Court , 36 Cal. 4th 148, 113 P. 3d 1000 (2005). In that case, the California Supreme Court interpreted a state law allowing courts to refuse to enforce any contracts found to be unconscionable. The court found that the law generally applies to most class arbitration waivers in consumer contracts. Therefore, California courts have frequently applied the Discover Bank rule to find arbitration agreements unconscionable in California.

The Supreme Court granted certiorari to consider whether the Federal Arbitration Act (“FAA”) pre-empts state laws and rules from making the enforceability of class action waivers conditional. The Court held that California's Discover Bank rule is pre-empted by the FAA, as it “stands as an obstacle to the accomplishment and execution of the full purposes and objectives” of the federal law. Thus, the Discover Bank rule is directly pre-empted by the FAA and its intent to promote arbitration, and the class action waiver in the standard form contract signed by the Concepcions is enforceable against them by AT&T. As a result, the Court reversed and remanded the case.

In conducting its analysis, the Court discussed arbitration and the FAA in detail, finding that the FAA was designed to promote arbitration, and that a “liberal federal policy favoring arbitration agreements” exists. The Court referenced the advantages of arbitration in general: an efficient and streamlined procedure that can be tailored to a particular type of dispute. In addition, according to the Court, the informality of arbitration can reduce costs and increase the speed of dispute resolution.

The opinion then examined the advantages and disadvantages of class arbitration, and found that “arbitration is poorly suited to the higher stakes of class litigation” for a number of reasons. First, class arbitration usurps several of the potential primary advantages of bilateral arbitration: efficiency, speed and lower costs. In class actions, arbitrators may get sidetracked by certain procedural issues, such as whether the class can be certified, whether named parties are sufficiently representative, and how discovery can be conducted. The Court examined data regarding 283 class arbitrations that had been opened by the American Arbitration Association as of September 2009. Of those arbitrations, 121 were active, and 162 had been withdrawn, settled or dismissed. However, none of them had resulted in a final award on the merits. With respect to actions that were no longer active at the time the data were presented, the median time from the filing of the action to settlement, withdrawal or dismissal, was 583 days, and the mean was 630 days.

Secondly, the Court found that class arbitration requires procedural formality by rules that mimic the Federal Rules of Civil Procedure for class litigation. This is contrary to the intent and advantages that arbitration presents.

Thirdly, class arbitration “greatly increases risks to defendants” because more informal procedures are used in arbitration than in litigation. In addition, the absence of multilayered review can make it more likely that mistakes made will not be subsequently corrected. As the Court stated, “it is at the very least odd to think that an arbitrator would be entrusted with ensuring that third parties' due process rights are satisfied.”

Due to the significant disadvantages of class arbitration described above, the Court found that class arbitration is not arbitration as envisioned by the FAA and lacks the benefits that it is intended to provide. Also, arbitration is a “matter of contract,” and the FAA “requires courts to honor parties' expectations.” Accordingly, state laws should not be able to require parties to submit to class arbitration when the parties contractually agree to waive class arbitration proceedings. Therefore, the FAA pre-empts the Discover Bank rule in California and state laws intending to limit the enforceability of class arbitration waivers.

As a result of this decision, franchisors may want to consider the dispute-resolution mechanism that they have identified in their franchise agreements. Whether to designate arbitration or traditional litigation is a business decision to be made after contemplation of many different factors. However, this recent Supreme Court decision and the ability to waive class arbitration should be considered when weighing the pros versus cons of each option.

Narrow Interpretation of a Settlement Agreement Prevents Termination of Franchisees

A Federal District Court in Massachusetts recently interpreted a settlement agreement to prevent termination of certain franchise agreements by the plaintiff franchisors (KFC Corp. v. Springfield Food System, Inc., Bus. Franchise Guide (CCH) ' 14,558 (D. Mass. Feb. 14, 2011) The court found that successive violations of various different operational standards did not constitute default of the settlement agreement, and it interpreted the agreement to require a separate default notice and cure period for each distinct violation of any operational standard.

In this case, the defendant franchisees operated multiple chain restaurant outlets, including Kentucky Fried Chicken (“KFC”), A & W, and Long John Silver's. The three franchisors commenced an action against the franchisees for breaches of their franchise agreements and for declaratory judgment regarding the status of the franchise agreements. The action was stayed when the parties entered into a settlement agreement in November 2009. The settlement agreement granted the franchisees an opportunity to sell their franchises by a certain date, after which the defendants' ownership of the franchises would terminate.

Until the sale, the franchisees were required to comply with all operational standards of the franchisors; otherwise, they would be in default of the settlement agreement. Specific to KFC, the settlement agreement provided that the franchisees would have 10 days from the date of notice from KFC of a default to cure the default “PROVIDED, HOWEVER, that KFC shall not be obligated to give more than one (1) such notice during any 120 day period.” If the franchisees did not cure, or if another default occurred after the first “such notice,” the franchisor had the right to lift the stay and have judgment entered against the franchisees, thereby terminating the franchise agreements.

On three separate inspections, KFC found the defendants in default ' first with respect to food temperature, then to hot water, and then to hand-washing policies. KFC sent notice of the first two violations, which were then cured. After the third violation, KFC moved to lift the stay and terminate the franchise agreements, arguing that it had provided notice and an opportunity to cure after the first two violations, and it was only required to provide an opportunity to cure the first operational default.

The court interpreted the settlement agreement more narrowly, however, and determined that because each violation related to a different operational standard, the franchisees were entitled to a notice and curative period with respect to each of the violations. The franchisors could only move to lift the stay and terminate the franchise agreements after multiple violations of the exact same operational standard. Therefore, the court found that the franchisees had not violated the settlement agreement and denied the franchisors' motion.

Wisconsin Court Decides a Declaratory Judgment Action Must Be Tried to a Jury

In Kaeser Compressors, Inc. v. Compressor & Pump Repair Svcs., Inc., Bus. Franchise Guide (CCH) ' 14,585 (E.D. Wis. Mar. 18, 2011), a federal district court in Wisconsin found that a declaratory judgment action requesting a determination that a manufacturer had good cause to terminate a distributor under the Wisconsin Fair Dealership Law (“WFDL”) should be tried to a jury. In general, claims that are equitable in nature are tried to a judge, and legal claims are tried to a jury. The nature of the claims becomes more complicated, however, in the declaratory judgment context. In this case, the court looked to what type of claim would have been filed if there were no declaratory judgment remedy available. If the case would not have sought an equitable remedy but was instead an inverted lawsuit, in which the plaintiff would have been the defendant in an action for damages, then the parties had the right to a jury trial.

The court found it important that neither party had requested rescission or any other equitable remedy. Although there was no counterclaim for damages in this case (because the contract had not yet been terminated), the distributor argued that the proposed termination would violate the WFDL and give rise to an action by the distributor for damages. The court agreed with the distributor and honored its demand for a jury trial. The court acknowledged, however, that the law was not clear on this issue. Therefore, to avoid a second trial if it were later decided that there was no right to a jury trial in this case, the court provided its own findings of fact and conclusions of law on the underlying issues.

Cynthia M. Klaus is a shareholder and Meredith A. Bauer is an associate at Larkin Hoffman in Minneapolis. They can be contacted at [email protected] or 952-896-3392 and [email protected] or 952-896-3263, respectively.