Hotel Franchise Agreements: Mediation, Arbitration or Litigation?
Nobody Asked Me, But...
Many hotel franchise agreements stipulate arbitration over litigation. At first glance, this may appear to be more beneficial to franchisees but nothing could be further from the truth. Compulsory arbitration protects franchisor interests while diluting franchisee remedies.
What are the disadvantages of arbitration?
First, in court you can obtain a jury trial assuming that you have not waived this right elsewhere in the agreement. Having a dispute resolved by a jury of your peers is a valuable right which should not be underestimated. Arbitrators are usually lawyers who may be friendly with your franchisor or its attorneys since arbitration clauses typically require arbitration to take place in the city where the franchisor’s headquarters are located.
Second, arbitration is very expensive, even as compared to litigation. Unlike state and federal courts where judges are compensated by taxpayer dollars, you must pay the arbitrators by the hour (from approximately $250 to 500 per hour), and must pay significant additional filing and administrative fees for the arbitration process.
Third, the discovery process, during which each side gathers its evidence (depositions, documents, etc.) for a trial, is very limited. This aspect hurts a franchisee disproportionately because he or she has the “burden of proof,” and usually needs additional facts and documents in possession of the franchisor to build the case.
Fourth, the normal rules of evidence and procedure do not apply in the same way as they would in federal or state court. Instead, the law affords the panel a great deal of flexibility and discretion in conducting the arbitration hearing, and a reviewing federal court will rarely, if ever, reverse the panel’s decision – even if it is legally and/or factually incorrect.
The bottom line is – do not agree to arbitration if you can possibly avoid it.
A close cousin of the arbitration clause, the “no jury” clause, requires that the franchisee waive what would otherwise be its right to a trial by jury. Franchise companies believe that jurors may be “sympathetic” to a franchisee who has been mistreated. At the very minimum, the franchisee should be the one to decide whether to have a jury trial. Do not forfeit this option unknowingly when the franchise agreement is signed.
Who are the arbitrators?
Usually, each side selects an arbitrator and then the two arbitrators pick the third one. Arbitrators are usually certified by a Bar Association committee. They are local business people and/or lawyers who have at least two major drawbacks:
- Since the arbitration usually takes place in the headquarter city of the franchisor, the arbitrators are likely to know the franchisor’s attorneys.
- While the pool of arbitrators may have general business experience, very few have knowledge of the hotel franchise format.
A December 4, 2006 decision by the Ninth Circuit Court of Appeals (Nagrampa v. MailCoups, Inc.) found that an arbitration clause in a franchise agreement was uneforcable under California law. Some observers believe that if the arbitration clause in this case in unenforceable, then no arbitration commitment is safe. This decision calls into question all arbitration clauses. Be sure to have your attorney check it out.
Is there a better way to resolve problems?
Yes there is and it’s called mediation. It can solve many business problems quickly, cheaply and on terms acceptable to all sides.
Unlike arbitration, mediation is non-binding. Because the mediator doesn’t decide anything, the parties can, if they choose, ignore anything he or she says. A mediator is a go-between who tries to help the parties come to an agreement, not to tell them who is right or wrong. Mediations usually last one day and either result in agreement between the parties or continuation of the dispute, not an award, decision or judgment. Either party is free to file a lawsuit. Mike Amin, former Chairman of the Asian American Hotel Owners Association said, “Fostering dialogue is a necessity in the pursuit of a healthy system and non-binding mediation between the franchisor and franchisee could be a “win-win” situation. Not only is it a less costly process, but it’s also a system that could foster a stronger partnership between the parties rather than the adverserial roles that can come with legal intervention.”
F. Peter Phillips, senior vice president of the CPR Institute for Dispute Resolution, says, “Mediation works in almost every case. Of the franchise disputes that have been formally submitted to the National Franchise Mediation Program, more than 80 percent were resolved amicably.”
The NFMP has earned the endorsement of the International Franchise Association, the American Association of Franchisees and Dealers, the National Franchise Council and the Asian American Hotel Owners Association.
Here’s how mediation works: With CPR’s help, the parties decide who the mediator will be, how much the mediator will be paid, when the mediation will take place, how long it will take and other details. Control of the process is a key feature of mediation. Parties can use a mediator listed with the program or pick one of their own choosing who is not affiliated with it.
Disputing parties who decide to use the program split the administrative fee and usually also split the fee of the mediator. In the course of negotiation and mediation, the parties may agree to reallocate the fees.
In actual practice, a mediator will typically meet with both parties separately to get their complaints or points of view and then bring the two parties together to attempt to reach compromise that will result in a solution. A good mediator will listen to both sides of the story and try to discern common threads among the arguments. Mediators are free to devise solutions that a judge or even an arbitrator might not be able to suggest. Judges are bound by legal precedent and arbitrators by the terms of the arbitration agreement. But mediators have much more latitude.
Ronald K. Gardner, Jr. of Dady & Garner, a well-known Minneapolis law firm, warns that in order for mediation to be successful, the decision makers from both sides have to be present. For the franchisee that’s not usually a problem but franchisors do not always send a decision maker to an individual mediation. “You need someone high enough up, that they don’t have to make a call to the home office,” Gardner said.
You can find out more about this important program by logging on to FranchiseMediation.org.
Quote of the Month: Omar Khayyam, the poet and prophet writing more than 800 years ago said: “In the four parts of the earth, there are many that are able to write learned books, many that are able to lead armies, and many also that are able to govern kingdoms and empires, but few there be that can keep a hotel.” - Mark Twain in the appendix to his A Tramp Abroad written in 1878.
Stanley Turkel, MHS, ISHC operates his hotel consulting office as a sole practitioner specializing in franchising issues, asset management and litigation support services. Turkel’s clients are hotel owners and franchisees, investors and lending institutions. Turkel serves on the Board of Advisors at the NYU Tisch Center for Hospitality, Tourism and Sports Management. He is a member of the prestigious International Society of Hospitality Consultants. His provocative articles on various hotel subjects have been published in the Cornell Quarterly, Lodging Hospitality, Hotel Interactive, Hotel Online, AAHOA Lodging Business, Bottomline, New York Times, etc. If you need help with a hotel operations or franchising problem such as encroachment/impact, termination/liquidated damages or litigation support, don’t hesitate to call 917-628-8549 or email firstname.lastname@example.org.
Just a qualifier
While arbitration may become expensive, there may be costs associated with litigation that are significant enough that arbitration may be a cost-effective option.
Additionally, not all arbitration is binding and it would behoove you to determine if your franchise agreement stipulates that arbitration would in fact be binding (most likely it will be).
Also, while the Ninth Circuit did in fact rule against arbitration in that particular case, the Ninth Circuit is also notorious for being reversed and the Federal Arbitration Act has significant precendent that may suggest such a resolution - so I think that arbitration is far from a dead beast.
My concern would be that arbitration does not necessarily follow rationale legal procedures. The arbitrator may, or may not, have any legal experience. There may, or may not be any evidentiary rules. Arbitration can sometimes be decided more by one whose advocate is more persuasive than one whose position is more meritorious (not to say this would not occur during litigation as well - it does). But in litigation, there may be safeguards in place that minimize the likelihood of this occuring (qualified judges, etc.)
Thanks Stan Turkel for your excellent article.
In terms of the Federal Arbitration Act. Was this act the will of Congress because of the need to prevent those citizens who were members of unions from seriously damaging industries and our economy through strikes, etc.. as instruments of collective bargaining. That is, arbitration would be a more efficient and effective means to settle differences between parties where those differences could affect the economy adversely?
Because there is no collective bargaining before a franchise agreement, and during a franchise agreement, are those agreements constitutional that require arbitration and require the surrender of a right to a jury by the franchisee while allowing the franchisor access to the courts under their terminatikon provisions?
What was the background and the purpose of the Federal Arbitration Act. We know it wasn't to force franchisees of retail operations to give up their Constitutional rights, isn't this true!
Mediation can resolve certain disputes, but not all types of disputes.
When there is a clear cut property right, contractual term, or misrepresentation, then both parties are better served by adjudication - somebody is right and somebody is wrong.
Mediation is best used for those disputes which have not yet crystalized into legal rights.
Mediation makes sense as a problem solving exercise, it makes less sense as an adjudicative device.
As such, mediation, informal or formal, can be useful if both parties are committed to solving a problem. Formal mediation is needed when the parties are committed to solving a problem, but lack the necessary skills to address the difficulty.
But mediation is never a substitute for adjudication. At times, we need adjudication because someone has to be right/wrong for all of us to move forward.
You have to make a decision whether dispute is mainly problem solving, or whether someone has to be right or wrong. That will determine whether you require mediation, or adjudication -whether by litigation or arbitration.
Notably, franchise agreements are rather stupid about how to make this choice. Mediation first, then binding arbitration is recipe that only make sense to transactional attorneys.
Michael Webster PhD LLB
It is a voluntary agreement...
In a sea of competing voluntary agreements (franchises). Pick the one you like or can live with! And stop your whining!
You may be focused too narrowly
While franchising does incorporate arbitration as a tool, it is far more prevalent in other industries, such as banking. Your credit cards likely sent you a notice stating that binding arbitration is now in effect, likely stating that if you object to the amendment including binding arbitration, then your account would be closed and you owe the entire balance, or something to that effect.
In that respect, arbitration is hardly consumer-friendly. In such cases, said financial institutions may develop relationships with the arbitration firms it requires in the agreement, thereby creating a situation where an "in theory" impartial arbitrator is forced to make an economic decision as to the merit of "biting" the hand that feeds him/her.
I would wager that this is less of an issue in the franchising industry as arbitration likely does not occur so frequently that this becomes an ethical issue for the arbitrators.
My understanding of the Federal Arbitration Act was that it was passed for the sake of judicial economy, meaning that even federal courts are clogged (state courts more so), and that alternative dispute resolution services were a means of reasonably and effectively assisting in resolving this situation. To that end, the FAA tends to favor ADR and there are arguments(perhaps viable, perhaps not) as to whether or not the FAA "trumps" state laws that would seek to otherwise limit the applicability of ADR in contracts.
Collective Bargaining are you out of your mind?
If I am a franchisor I am not interested in collective bargaining.
Why should I be?
Additionally, you assume each of the franchisees has an equal interest in all other franchisee's interests. Which is not true. In fact individual franchisee's interests may be at odds. Franchisees are dependent on the franchisor and not so much on each other. Collective bargaining is doom for franchisors and franchisees. However franchisors should get input from franchisees which is smart business.
Arbitration and Judicial Economy Narrow View
Thank you for your response to my question about the Federal Arbitration Act. I suppose all non-lawyers tend to focus too narrowly when they reflect on their personal experiences and the law.
If I understand you correctly, you indicate that it is your understanding that the FA ACT was passed "for the sake of judicial economy, meaning that even federal courts are clogged (state courts more so), and that alternative dispute resulution services were a means of reasonably and effectively assisting in resolving this situation!
Therefore, is it reasonable to assume that the FAA came about for only this reason; i.e. to "reasonably and effectively assist" in unclogging the courts.
I understand but does ADR as applied to the terms of franchise agreements work to the prejudice of the franchisee because of the financial implications for the franchisee in ADR, either mediation or arbitration. The franchisee in arbitration or mediation does not have the financial resources that the franchisor possesses.
Also, the franchisor seems to always have direct access to the courts for injunction, etc. as per the contract. while denying access to the franchisees under the franchise agreement.
Does the solution to the clogging of the federal courts work to the predjudice of franchisees in the franchisor-franchisee relationship that is premeditated to the franchisor's benefit in contracts of adhesion. (See today's article on Hotel Franchising Arbitration, etc)
Has the balance of power been inadvertently tipped in favor of the franchisor in the courts because of the necessity to relieve the federal courts of the clogging through the FAA and ADR.
In a democracy where "trial by jury" is promised in the Constitution and The Bill of Rights, should procedural and administrative matters and concerns be allowed to weaken due process of law and equal treatment under the law?
I understand that the "plea bargain" is the currency of the court in criminal matters and that "settlement" is the currency of the court in civil matters but when procedures work to deny due process of law and/or equal treatment of the parties under the law, can and is this justified because the courts are clogged. Do we need more courts and more judges? Isn't it important to protect democracy at home and aren't these constitutional guarantees the "food" of a healthy democracy.
The public has already been educated as to the concept of justice under our laws and understands that "small injustices" are to be dealt with in the small claims courts or on Television with actor judges who entertain us on a daily basis for much better pay than they would get on the bench.
The public has already been educated as to the concept of justice as a product that can be purchased with money because of the famous criminal trials, OJ, etc... and some of the famous civil trials that have been made into movies where the Corporations win because of their ability to outspend and outlast the smaller law firm who doesn't have the resources to survive on truth alone.
You indicate that "the FAA tends to favor ADR and that there are arguments (perhaps viable, perhaps not) as to whether or not the FAA "trumps" state laws that would seek to otherwise liminit the applicabioity of ADR in contracts>."
This, again, looks like public policy has been developed at federal level to tip the balance of power to the franchisors because of the new law that requires that "class actions" be certified and heard by the federal courts under their rules and procedures.
What is the history of class actions concerning franchisors that have been heard by the federal courts? Or, is there any history? If the federal courts hear these cases under the law of the states in which class actions are filed against one and the same franchisor, how do the federal courts reconcile the differences in the state laws when rendering judgements? Are the federal courts then making a body of new federal case law upon which new class actions may or may not be filed?
I agree! Why should Franchisors be Interested In Collective Bar
Why would you be if you always get the best of the bargain through the unbargained franchise agreement?
I am beginning to understand that it is because franchisors have no capital invested in the physical units that wear their brand name and thus no ownership, they feel they have to control the relationship always to their advantage through unconscionable and bullying terms in the contract.
The alave-master mentality of some of the terms in these contracts of adhesion ensures that "Franchisees are dependent on the franchisor and not so much on each other" as you say, and the franchisor ensures that the assets of the franchisee's business in which they have no ownership will always serve the interests of the franchisor until death do they part.
Collective bargaining would be doom for franchisors ----this is true, and this is why franchisors will always work against any initiative that will in any way alter the balance of power in the relationship.
Again you assume too much...
There are franchisees that have considerable resources and there are franchisors that have less resources than one or more of their very own franchisees. It is reckless of you to absolutely state "The franchisee in arbitration or mediation does not have the financial resources that the franchisor possesses" (i.e., if you mean the franchisor has more money?).
I ask you sir; how do you know?
Unfortunately, there are too many suppositions in your argument
Again, I think it would be somewhat myopic to view the FAA as coming into being "solely" as a result of assisting in unclogging the courts. Although I have not done so, a review of the legislative history behind the FAA may be enlightening as to the actual legislative intent.
I do not think that ADR is necessary flawed or even unreasonable. There are many situations where ADR is an effective alternative. In some situations, it is unwarranted. The praticalities of the US legal system is that there frequently are large costs associated with litigation, as well as the time required to pursue your claim to eventual failure or fruition. All too often, the "potential" cost and time benefits of ADR are touted as the primary reason as to its efficacy. In not all instances is this necessarily accurate.
The fact that franchisors may, or may not, use ADR to their advantage does not make ADR a potential problem. As to your concern that procedural and administrative regulations and concerns weaken Constitutional due process and the like, I think you can calm your fears somewhat. Despite recent events to the contrary, legal precedent tends to favor protecting due process, and this necessarily extends on some level to the rules and regulations promulgated to govern the practice of law. Again, there are always exceptions, justified or not (*cough* Guantanamo *cough*).
I did mention the potential for bias in arbitrators catering to repeat customers, however, again, I do not see that this is necessarily the case in franchising. Additionally, the argument that ADR necessarily infringes upon due process may be a stretch. While you could make said argument, I don't think it would be difficult to prove that this is actually not the case, and there are valid public policy concerns that make laws re: ADR appear to be legitimately in the public interest.
Although I did not mention it previously, the fact that arbitration results are frequently not disclosed makes for no precendent, creating a system of rulings that may deviate substantially even in the event of identical facts and applicable law. I would agree that there is insufficient oversight over this industry; HOWEVER, I think it is an exaggeration to categorize ADR as not having any value. I think that while it does fulfill one of its primary purposes, to ease the burden on an already taxed legal system, it is susceptible to being abused, often at the expense of the "little guy."
Is doom for franchisees!
For your slave/master construct of franchising to be true requires franchisees to be mindless pawns. I don't believe franchisees think of themselves that way at all. I think that there are many succesful franchisees that have made great businesses out their franchises.
I also think you are here in this forum to exact your punishment on franchising because of your failed franchise venture. You actually know very little about the successes of franchising. You only know what you know about your singular experience. Your knowledge is simply incomplete and lacking in just about every respect as it relates to franchising and business. Your blindness and rage are all you have.
Franchisors have less resources than franchisees?
Example, please, of those franchisors who have less resources than their franchisees so prospective buyers can avoid building and paying for a business that bears their brand name.
Correction: The Franchisee in arbitration or mediation generally does not have the financial resources that the franchisor possesses.
I guess you are indicating that the government allows under- capitalized franchisors to sell products to the public that puts both the franchisee and the franchisor at great risk? Your message is unclear but your intent is obvious.
Thank you! Little guy susceptible to abuse in Legal System
Thank you for your comments on my comments. Unfortunately, ii is necessary to think and reflect based upon suppositions that are not always supported by proven facts when you haven't been schooled in the law.
I guess it was supposition that the new federal law that throws the certification and hearing of Class Actions to the Federal Courts might inadvertently result in tipping the balance of power even more to the franchisors.
The reason for the new federal law is, as advanced by the government, was because "class actions" were being abused by attorneys and juries and judges in the state courts and that it was for the public good to require class actions to be looked at by the federal courts who would not allow the same kind of abuses of the public that were being experienced in the state courts.
I am new to this kind of research and new to research on the computer. I assume that the new law that throws "Class Actions" to the federal courts was intitiated by the Congress and not the Courts, but where would I find background on the initiative for this new law?
Thank you for any help you can give me!
I didn't mean to categorize ADR as not having any value. Of course, I see its value when two parties with equal access fairly debate a solution to the matter in dispute and end the dispute in agreement.
I do believe, however, that the parties in a franchise dispute do not stand on equal ground before the dispute or during the dispute, and I don't believe that ADR is always a successful substitute for due process of law ---for the reasons you advanced.
You misinterpreted what I said ----I indicated a "slave-master mentality" as demonstrated by the contracts of adhesion that give the franchisor an unfair advantage and control over the franchisee and the franchisee's business assets until death do they part.
The franchisee-franchisor relationship is not one of employer-employee, or a partnership; it is not a fiduciary relationship. While the franchisee takes a risk of a 100% loss in failure, the franchisor doesn't share in this loss when the unit is transferred to a second-generation franchisee. Even is the unit isn't transferred and is terminated, the franchisor takes no loss and can acquire the assets of the franchisee for almost nothing.
It is a relationship where the franchisor can be profitable even when the franchisee is not operating at a profit and it is this element that produces so many of the problems in the relationship.
I know you understand that the franchisor gets his royalties on the gross sales of the unit regardless of whether or not the franchisee is operating at a profit, and the franchisor bears none of the losses of operating the unit.
Of course there are successful franchisees and successful concepts and the high visibility of franchises in our economy hasn't all been produced through the churning of first-generation franchisees.
You unfairly engage in personal attack and don't address the matters I put forward. Apparently, your blindness and dishonesty are all you have.
You are assuming again - You don't know
"Correction: The Franchisee in arbitration or mediation generally does not have the financial resources that the franchisor possesses."
How do you know?
"I guess you are indicating that the government allows under- capitalized franchisors to sell products to the public that puts both the franchisee and the franchisor at great risk? Your message is unclear but your intent is obvious."
I wish you were obvious instead of obtuse. You should stop guessing and supposing. You need to realize that there is risk in franchising, it is disclosed and the government is not you mommy. You failed with your franchise and if you have damages arising from something the franchisor did you should sue them and stop persecuting the rest of us.
Your quote - "The franchisee-franchisor relationship is not one of employer-employee, or a partnership; it is not a fiduciary relationship. While the franchisee takes a risk of a 100% loss in failure, the franchisor doesn't share in this loss when the unit is transferred to a second-generation franchisee. Even is the unit isn't transferred and is terminated, the franchisor takes no loss and can acquire the assets of the franchisee for almost nothing.
It is a relationship where the franchisor can be profitable even when the franchisee is not operating at a profit and it is this element that produces so many of the problems in the relationship.
I know you understand that the franchisor gets his royalties on the gross sales of the unit regardless of whether or not the franchisee is operating at a profit, and the franchisor bears none of the losses of operating the unit."
Based on your characterisation how would you change the franchise-franchisor model? How would it work?
Because the UFOC acts as a license for the franchisor to sell the franchise more than effective disclosure of the risks for prospective franchisees, the actual risks involved in purchasing most franchises is obscured from the view of prospective franchisees.
It is my opinion that this lack of effective disclosure is intentional for the reasons I have stated before in my postings. Franchising activity is essential to the health of our economy and government believes it is in the public's best interests not to inhibit investing in franchising by requiring franchisors to disclose the actual risks involved. If the actual risks reflect the Bell Curve and the truth is that one third of all franchisees operate at a profit, one third operate at break even, and one third fail, would this inhibit the purchase of franchises if this were disclosed to the public? Obviously, the "powers that be" don't want to know.
The franchisors and the government, in my opinion, do not want to take any risk of inhibiting the fires of development in our economy through full discclosure of the risks of franchised business opportunities.
Because franchisors can sell franchises without sales or earnings figures or average overhead costs, etc.. and also obscure the failure rate of their business plan, the franchisee enters into the contract, this legally binding long-term relationship, with none of the information that would have to be revealed in a partnership or a fidiciary relationship of any kind.
The due diligence experts tell you that they can get this information for you and I agree, in retrospect, that is is foolish not to use an objective third party expert when you are going to invest your money in a franchise.
But, the fact remains that many middle-clsss Americans who are looking for a solution to the loss of a job or the supplementation of their income to meet their expectations for the future do invest in franchises without paying for an expert evaluation of the investment from an objective third party. This is especially true when the franchisor has a large and visible presence in the community and in the nation.
Franchises are advertised and sold as proven business models; it is the proven business model with its brand name that the franchisee is renting and wearing while making the entire investment in the physical unit that wears the brand name, and the more visible the network of proven business models becomes, the more the visability itself acts as "the proof of the pudding" and a sales tool to acquire even more visability through the sale of new franchises and the building of new units. The business media also interprets this visability with viability of the business plan and promotes the sale of these units like Quiznos and UPS to the public.
Agasin, because it is possible for the franchisor to be profitable even when many of his franchisees are operating at a loss, or at break even, the failure rate of units in the network is obscured in Item 20 of the UFOC through the use of statistics relating to "transfers" and "acquisitions", etc... Inexperienced and naive prospects may interpret these transfers, turnovers, as ref;ecting successful franchisees who just wanted to leave the network and don't understand that most of the "transfers" are actually business failures.
When the failure of first-generation units becomes disproportionate to the whole, the large networks then invoke "churning" as a management tool to maintasin their own viability and their own profits through the direct or indirect acquisition of failing first generation franchised stores for second generatikon franchisees for almost nothing, and, at the same time, continue the sale of new units to new prospects who interpret the visibility of the network as representing the viability of the business plan.
All of this activity is obscured from view in the disclosure regulations and treated as "turnover" by the regulators who themselves have no idea of the "churning" within the networks. When the reason for or the status of the transfer is not required to be disclosed under the law, the regulators themselves don't know wherher or not these transfers reflect a loss or a gain or a wash to the transferee, the franchisee.
Thus, churning franchisors are enabled to present the appearance of the viability of the business plan to the public that is false and untrue while at the same time the franchisor maintains his own profits and viability. Their profits and viability are built on the stream of royalties and fees, etc.. and the sale of new franchises and the failing of the first-generation franchisees is not a failure for them if these assets go on to serve the brand in a fire sale to a second-generation franchisee.
I, of course, have no hope that the model of the franchise-franchisor relationship will be changed. Although, others in Associations have indicated that there should be some "give" or adjustment in the royalties provision until "breakeven" is achieved because the franchisor doesn't share any of the costs of the investment in the unit that wears the brand name or any costs or liability in the failure of the unit that wears the brand name.
I post because I hope that our Congress and the government will look at the inequities and injustices and that franchised business opportunities will be regulated at least as well as securities are regulated in the interests of middle-class Americans who put their retirement savings and their homes ast risk to buy these business opportunities and famous brand names.
They use circus mirrors?
I don't know? You tell me.
The bottom line is when franchisors can maintain viability and profitability even when a fair percentage of their franchisees are just breaking even or failing, the franchisors have no real incentive to fix the problems for their franchisees until the costs of the law suits starts to affect their profitability.
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"...But Few Can Keep A Hotel"
That quote is so good it's worth repeating. Great article!