Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—7th Cir.: Direct benefits estoppel required non-signatory to franchise agreement to arbitrate, (Nov 5, 2014)

By Peter Reap, J.D., LL.M.

Renee Everett, a non-signatory to the home restoration business franchise agreement that her husband Matthew Everett and franchisee EA Green Bay, LLC (“EAGB”) executed with franchisor Paul Davis Restoration, Inc. (PDRI), was required to arbitrate a dispute with the franchisor under the doctrine of direct benefits estoppel, the U.S. Court of Appeals in Chicago has decided (Everett v. Paul Davis Restoration, Inc., November 3, 2014, Cudahy, R.). Thus, a decision by the federal district court in Green Bay, Wisconsin was reversed.

Background

In 2004, PDRI entered into a franchise agreement with Matthew Everett and EA Green Bay, LLC (EAGB). EAGB was owned, controlled, and operated by Mr. Everett, but the evidence clearly showed it was also owned, controlled, and operated by Ms. Everett, the court noted. There was no dispute that Mr. Everett formed EAGB solely to comply with the PDRI franchise agreement’s requirement that the principals of the franchise form a corporate entity to operate the business.

Mr. Everett originally executed the agreement on behalf of EAGB as the franchisee company and individually in his own capacity as the 100% principal owner of EAGB. Despite Mr. Everett signing as the 100% principal owner of EAGB the record showed that Ms. Everett had a 50% ownership of EAGB potentially as early as June 11, 2004 and at the latest by 2008. Regardless of when Ms. Everett became a partial owner, the franchise agreement expressly stated that the Everetts were required to obtain PDRI’s consent before transferring ownership. The terms of the franchise agreement also clearly required that Ms. Everett sign the franchise agreement in her personal capacity as an additional principal owner. The Everetts never requested consent and never had Ms. Everett sign the contract despite their knowledge of these requirements in the agreement. Ms. Everett also played an active role in running EAGB, holding herself out as the Executive Vice President of the franchise and attending PDRI franchise meetings as the representative of the franchise.

In 2010 the franchise agreement was terminated by PDRI for cause. Rather than abiding by the non-compete clause, Ms. Everett, who now owned 95% of EAGB, continued to operate EAGB under a new name and with that business served the same customers from the same business location, employed the same people, and traded upon the goodwill and reputation built under the PDRI banner. The Everetts seemingly colluded to avoid the post-termination restrictive covenant by simply taking down the PDRI sign and removing Mr. Everett as a principal owner, the court noted.

PDRI responded by initiating arbitration. Ms. Everett then filed suit seeking a declaratory judgment that she was not bound to arbitrate because she did not sign the franchise agreement. The district court initially denied the preliminary injunction finding “abundant evidence” that she was bound by the franchise agreement under the direct benefits doctrine and that there was a scheme between the Everetts to try to avoid the non-compete provisions. Thus, the arbitration continued and the panel entered a unanimous award against Ms. Everett.

When PDRI returned to court seeking confirmation of the arbitration award, the district court re-versed itself, holding that Ms. Everett did not directly benefit from the franchise and was thus not bound by the arbitration clause. The district court vacated the arbitration award, finding the benefit to Ms. Everett to be indirect because it flowed through her ownership interest in EAGB and her relationship to Mr. Everett, but not to her directly. PDRI appealed.

Direct Benefits Estoppel

Under the doctrine of direct benefits estoppel, a non-signatory party is estopped from avoiding arbitration if she knowingly seeks the benefits of the contract containing the arbitration clause, the court observed. As the name suggested, in order to trigger the doctrine the benefit received by the non-signatory must flow directly from the agreement. Thus, a benefit derived from the agreement itself is direct. However, a benefit derived from the exploitation of the contractual relationship of parties to an agreement, but not the agreement itself is indirect.

Here, the lower court determined that as Mr. Everett’s spouse and co-owner she had a right to share the profits of the franchise, but that the benefits were indirect since they derived through her husband and the corporation. This was too narrow an interpretation of direct benefits estoppel, according to the appellate court. Ms. Everett was not merely exploiting the contractual relationship among EAGB, Mr. Everett and PDRI, but rather the benefit of the contract itself—namely owning and operating a PDRI franchise. Ms. Everett received the same benefits as her husband, which included benefitting from trading upon the name, goodwill, reputation and other direct contractual benefits of the franchise agreement, the appellate court determined.

The district court’s finding that “whatever benefit Ms. Everett derived from the franchise agreement was filtered through her ownership interest in EAGB and would therefore be considered indirect” was error. To say that the benefits of the franchise were indirect by flowing first to EAGB and then to Ms. Everett was a flawed interpretation of the doctrine of direct benefits estoppel. Ms. Everett’s ownership interest in EAGB was itself a direct benefit of the agreement, and not a separate relationship that the benefits of the agreement flowed through. Without the franchise agreement, EAGB and the business it operated would not have existed, and thus Ms. Everett’s ownership interest would not have existed, the court explained.

Relying on corporate formalities to argue that an ownership interest somehow diluted the benefits of a franchise agreement was not persuasive in this case. Rather, as PDRI asserted, ownership of EAGB was itself a direct benefit of the contract. Thus, the district court was reversed.

Confirmation of Award

Ms. Everett asserted a number of other reasons why the arbitration award should not be enforced. Although the lower court did not address any of these issues, they were easily disposed of, the appellate court said.

Wisconsin Fair Dealership Law. First, Ms. Everett asserted that the Wisconsin Fair Dealership Law (“WDFL”) invalidates the arbitration clause in its entirety, leaving the franchise agreement without any arbitration clause. Instead, the arbitration process, as PDRI conceded, was governed by the protections of the WDFL. Ms. Everett ultimately provided no support for her contention that the WDFL invalidated arbitration agreements that explicitly adopt the protections of the WDFL. Thus, Ms. Everett’s argument that the WDFL wholly invalidated the arbitration clause was rejected.

Ms. Everett further argued that the arbitration clause was unconscionable. This argument was frivolous, the court held.

Ms. Everett also alleged that the arbitration agreement violated Ms. Everett’s due process rights. This argument was wholly unavailing—none of the parties involved were state actors.

Finally, Ms. Everett argued that the district court should have vacated the arbitration award on the basis that the arbitration panel both exceeded its powers and exhibited bias favoring PDRI. Addressing the scope of the panel’s power first, Ms. Everett’s argument failed due to the limited nature of review of arbitration awards, the court held.

Ms. Everett’s claim of bias also failed. She based this claim on two factors: first that the structure of the panel exhibited bias because it was made up of PDRI franchise owners, and second that ex parte communications between the parties and members of the arbitration panel prejudiced the proceedings. Regarding the unfairness of the peer-franchisee arbitration system, the arrangement was fully disclosed to Mr. Everett and these types of arbitration panels have repeatedly been upheld, according to the court. Similarly, Ms. Everett failed to show that the ex parte communications between the arbitrators and the parties prejudiced the proceedings in any way.

The cases are Nos. 12-3407, 13-1036.

Attorneys: T. Wickham Schmidt (Conway, Olejniczak & Jerry, SC) for Renee Everett, and Building Werks of Wi LLC. Robert Eric Bilik (McGuireWoods LLP), and Daniel Janssen (Quarles & Brady LLP) for Paul Davis Restoration, Inc.

Companies: Building Werks of Wi LLC; Paul Davis Restoration, Inc.

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