Arbitration clauses in Franchise agreements are becoming the norm, but is that a good thing from a franchisee’s perspective? Some franchisees hold the belief that, since the franchise agreement is drafted by the franchisor, any clause in the agreement must be to the benefit of the franchisor and to the detriment of the franchisee. This is not necessarily always true regarding an arbitration clause, but it can be, if a franchisee is not careful. Before agreeing to arbitrate a dispute, a franchisee needs to understand what arbitration entails, some of its pros and cons, and the five primary pitfalls to look for in an arbitration clause.

Simply put, arbitration is an alternative method of resolving a dispute between parties outside of court, in which a neutral third party (sometimes a panel of arbitrators) makes a decision that is typically binding and enforceable on the parties. Arbitration is a less formal process than court adjudication and does not require strict adherence to the rules of evidence that are otherwise applicable in court. For example, some arbitrators allow “hearsay” to be admitted into evidence.

Some of the “pros” of arbitration from a franchisee’s perspective are that it generally results in a quicker and less expensive resolution of the dispute. However, the initial cost to file an arbitration proceeding can be much more expensive than filing an action in court--i.e. a couple thousand dollars versus a couple hundred dollars. Additionally, the flexibility of arbitration can benefit franchisees when the “law” is not particularly favorable, but the facts of the case are so egregious that an arbitrator may apply principles of equity and fairness to fashion relief for the franchisee. On the downside, the same flexibility sometimes results in an arbitrator ignoring the applicable law to the detriment of a franchisee. Perhaps one of the greatest advantages of arbitration is that the process is less adversarial in nature, which can be beneficial in the franchisor-franchisee context, especially when the parties may need to maintain a working relationship for years to come.

One of the “cons” of arbitration is that a franchisee waives the right to a jury trial. Even worse, if the arbitrator’s decision is extremely unfavorable to the franchisee, the decision is generally not appealable, unless the award was the result of fraud, corruption or a “manifest injustice of the law.” Arbitration awards also have minimal precedential value--meaning that courts have no obligation to follow them in other cases with similar facts.

With these pros and cons in mind, franchisees need to be aware of the following five potential pitfalls that may appear in an arbitration clause drafted by a franchisor:

What rules govern the arbitration and how is the arbitrator selected? A franchisee needs to make sure that the rules governing the arbitration and the procedure for selecting an arbitrator(s) are neutral. For example, a franchisee would have a difficult time getting a fair shake where the sole arbitrator or all of the arbitrators were chosen from a list prepared only by the franchisor.

Is there a limitation on the remedies available to the franchisee? Franchisees need to be aware of franchise clauses that preclude an arbitrator from awarding punitive damages. Punitive damages are awarded as a means of punishing the wrongdoer in situations where he or she acted intentionally or completely disregarded the rights of others. Franchisees also need to be suspect of clauses that alter the statute of limitations—the time in which a franchisee must bring an action or is otherwise barred forever.

Does the arbitration clause preclude joinder of parties or class arbitration? It is not uncommon for franchisors to include a provision limiting the right of the franchisee to join with other franchisees in the same action to resolve an issue common to them all. Often times, it is important for a franchisee to preserve the right to join with other franchisees in the resolution of a dispute because it allows them to pool their resources, where otherwise it may not be feasible for a single franchisee to arbitrate the dispute.

Where is the arbitration to take place? Franchisors usually choose a forum for the arbitration that is a convenient location for them, such as their principal place of business. This can pose a substantial hardship on franchisees in terms of cost, time and inconvenience if they are forced to travel to a distant location to resolve the dispute, which could take days to resolve.

Do any of the provisions give rights to the franchisor that the franchisee does not also enjoy? A franchisee should be wary anytime a franchisor reserves rights to itself that are not also available to the franchisee. Of particular importance is a clause that allows the franchisor to appeal the arbitration decision to a court, but which does not confer that right on the franchisee. The franchisor should not be allowed the proverbial “second bite at the apple” if the franchisee is not allowed the same opportunity.

Arbitration can be a reasonable way to resolve disputes between franchisors and franchisees, but it can also lead to unfair advantages for the franchisor if the franchisee is not careful. The preceding list is not inclusive of all the potential traps that a franchisee needs to be aware of. As always, before signing an arbitration agreement, a franchisee should seek the advice of an experienced franchisee attorney.

Source: Franchise Bison