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BOSTON – The First Circuit Court of Appeals issued its decision late last month in favor of the Fantastic Sams Regional Owners Association, allowing franchisees to proceed to arbitration as an association instead of individually.
Minneapolis attorney W. Michael Garner, representing the franchisee organization, explained the 18-page exhaustive ruling in simpler terms. He said if an arbitration clause in a franchise agreement says the parties will arbitrate their dispute, and it doesn’t say anything more than that, then the question is, is that language broad enough to allow associations to step in for the franchisee. And is it broad enough to allow a group of franchisees to arbitrate together or to permit a class action?
A matter of “associational” arbitration
The dispute began when the Fantastic Sams Regional Owners association, consisting of franchisee members with a total of 35 license agreements, demanded arbitration against the franchisor seeking declaratory and injunctive relief. They claimed Fantastic Sams had engaged in a pattern of conduct that was depressing the price of franchisees’ businesses by making it impossible to offer or sell their salons on the open market. In doing so, the association alleged the franchisor violated their franchise agreements.
Fantastic Sams filed a petition in federal court in August 2011 to compel franchisee association members to arbitrate their dispute. It asserted that 25 of the 35 license agreements of franchisees prohibited “class-wide” arbitration and therefore barred the Fantastic Sams Regional Owners from representing those members in arbitration as an association.
The 10 remaining agreements of salon owners did not expressly prohibit class-wide arbitration. Fantastic Sams took the position that the franchise owners association was barred from representing those 10 in view of the Supreme Court’s 2010 decision in Stolt-Nielsen v AnimalFeeds International Corp.
Basically, the high court ruled that the language in the arbitration clause had to clearly state that no class or collective arbitration may proceed unless the agreement expressly authorized it. Fantastic Sams interpreted it to mean the 10 regional owners could not arbitrate as an association because their agreements do not specifically state that “class or collective'” arbitration is authorized.
The regional owners association opposed the franchisor’s argument saying it had misread the Stolt decision. FSRO argued that Stolt does not require the specific language of “class-wide” arbitration be used in contracts. They also argued that “class-wide” is different than “associational” arbitration, and urged the court to send the dispute to arbitrators in order to get a ruling.
The federal court denied Fantastic Sams petition as to the 10 regional owners on the grounds that the arbitration clause in those contracts were very broad and applied to all controversies or claims related to their agreements.
The First Circuit Court of Appeals affirmed the federal court decision, agreeing with Fantastic Sams Regional Owners that the franchisor reads Stolt-Nielsen too broadly. It ruled that the Supreme Court in Stolt-Nielsen did not extend its ruling to the “associational” action filed by Fantastic Sams Regional Owner, which is different from “class-wide” arbitration. In making its decision, the First Circuit sided with the Second and Third Circuits in limiting the application of Stolt in class arbitration.
Attorney Garner summed up the decision this way: “The First Circuit said no, we are not extending Stolt in this case. We are letting the arbitrators decide whether or not that language is broad enough. And the arbitrator said the language states “all disputes”, and we think that is broad enough to include associations.
Gregg A Rubenstein of Nixon Peabody, representing Fantastic Sams, said they were very disappointed by the ruling. “Although the Second Circuit had adopted a position similar to it, we hoped the First Circuit would see the error of that decision. But it didn’t.”
Will this problem for franchisors resolve itself as older franchise agreements are replaced with new versions containing the right language to prevent class-wide arbitration?
Ruberstein said, “Certainly lots of systems have different lengths of their contracts, but to the extent that there are longer term contracts I think that this issue is going to continue to come up for some time. Franchisors will have to deal with it unless the Supreme Court says otherwise.”
The Boston attorney feels the ruling was wrongly decided. “I think it’s unfortunate that the First Circuit adopted a position that basically says the Supreme Court decision in Stolt-Nielsen has no application whatsoever beyond the facts of that case. I don’t think it is First Circuit’s job, or any other circuit’s job, to limit a Supreme Court’s decision to its facts. But that in essence is what they did. No party is likely to again stipulate specifically that an agreement is silent concerning class arbitration. Absent that, the Supreme Court decision really is going to have no effect. That is unfortunate,” Rubenstein said.
Franchisee attorney Justin Klein of Marks & Klein thinks the First Circuit got it right following what the Second and Third Circuits have ruled. He said that all three are chipping away at the Stolt-Nielsen decision, which was first seen as a bright line test clearly defining the rules in class arbitration.
Klein feels that what we are finding now is courts giving more deference to arbitration clauses and more power to arbitrators. “This case is another example of franchisors not drafting franchise agreements as cleanly as they may think they are, and trying to use legal remedies to backdoor their way into legal protection,” the New Jersey attorney explained.
Klein has had ample experience in dealing with these types of arbitration cases in past years. He said most of these agreements in conflict are older ones and that’s the reason there are different franchisees with different contracts. “Some expressly prohibit class actions and some are silent on the issue. But most of the ones I’ve read in the past five years specifically exclude class actions.”
So, what’s the net result? Klein said, “Perhaps it will lead to legislation.”
He said most franchisees do not understand at the time they sign franchise agreements the impact of not being able to join with others in a legal dispute. He feels collective arbitration is important when going up against franchisors. Klein stressed that arbitration on an individual basis is very expensive.
But the franchisee attorney said what is more important is for prospective buyers to do their due diligence when investigating a system. “They need to see what legal remedies they are permitted when they get into a dispute with the franchisor.” Klein said not enough franchisees do that.
|Fantastic Sams Arbitrator Interim Award Denying Mot Dismiss ( 4-23-12).PDF||1.05 MB|
|Fantastic Sams 1st Circuit Opinion (6-27-12).pdf||56.03 KB|