Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—7th Cir.: Refusal to compel arbitration, stay termination action upheld, (Sep 3, 2014)

By John W. Arden, J.D., LL.M.

A federal district court’s refusal to compel arbitration of a declaratory judgment action brought by Steak n Shake franchisees against their franchisor or to stay proceedings, pending appeal, was upheld by the U.S. Court of Appeals in Chicago. The district court properly held that the arbitration clause in franchise agreements was illusory and unenforceable (Druco Restaurants, Inc. v. Steak n Shake Enterprises, Inc., August 29, 2014, Rovner, I.).

Steak n Shake owns and operates 415 restaurants and franchises approximately 100 others. Druco Restaurants, Inc. operates two Missouri restaurants under franchise agreements signed in 2001 and 2004. People Sales & Profit Company, Inc. (PSPC) operates four Georgia restaurants under franchise agreements signed in 2007, a fifth Georgia restaurant under a franchise agreement signed in 2009, and a Brunswick, Georgia restaurant acquired from another franchisee, which had signed a franchise agreement in 1995.

From 1939 to 2010, all Steak and Shake franchisees had the right to set their own menu prices and had the option to participate in corporate promotions, according to the franchisees. After a corporate takeover in 2010, Steak n Shake adopted a new pricing and promotion policy, requiring franchisees to adhere to company pricing on every menu item and to participate in all corporate promotions. Because the franchisees were required to purchase all of their products from a single distributor, at a price negotiated by Steak n Shake, this new policy allowed the franchisor to control the purchase and sale price for every item sold by the franchisees.

This policy had an adverse effect on franchisee revenues, prompting the franchisees to file suit in the federal district court in Indianapolis, seeking a declaratory judgment that, under the terms of their franchise agreements, the franchisees were entitled to set their own prices and were not required to participate in corporation rate promotions.

Approximately one month after the lawsuit was filed, Steak n Shake adopted a policy requiring franchisees to engage in nonbinding arbitration upon the franchisor’s request. Steak n Shake moved to stay the lawsuits filed by franchisees and to compel nonbinding arbitration of the disputes. The franchise agreements (except for the Brunswick one) contained a clause reserving the franchisor’s right to institute a system of nonbinding arbitration or mediation. The district court, however, concluded that the clause was illusory and unenforceable because there was no limit on Steak n Shake’s ability to arbitrate (or avoid arbitration). In the alternative, the court found that, by its own terms, the arbitration policy applied only to prospective lawsuits and not to pending ones. Finally, the court held that the nonbinding arbitration or mediation contemplated by the franchise agreements did not constitute “arbitration” under the Federal Arbitration Act. With regard to the Brunswick franchise, the court simply noted that the franchise agreement contained no language implicating arbitration. Thus, there was no basis for granting a stay of proceedings and compelling arbitration.

On appeal, Steak n Shake contended that the district court erred in concluding that the arbitration clauses of the franchise agreements were illusory under Indiana law; maintained that its arbitration policy applied to disputes pending at the time the policy was adopted; and argued that nonbinding arbitration was within the Federal Arbitration Act’s definition of arbitration.

In order to compel arbitration, a party must show: (1) an agreement to arbitrate, (2) a dispute within the arbitration agreement, and (3) a refusal by the opposing party to arbitrate. When deciding whether parties agreed to arbitrate a certain matter, courts generally apply ordinary state-law principles that govern the formation of contracts. In this instance, the parties agreed that Indiana law applied to all of the franchise agreements. Under Indiana law, the existence of an arbitration agreement is a matter of contract interpretation and a matter of the parties’ intent. Unless the terms of a contract are ambiguous, they should be given their plain and ordinary meaning, the appeals court observed.

At oral argument, Steak n Shake conceded that none of the franchise agreements contained the terms of the later-adopted arbitration policy. Rather, each contract contained an option of sorts, reserving the franchisor’s right to institute nonbinding arbitration at any time. Each contract also contained a provision for litigating in courts of competent jurisdiction. Steak n Shake decided to exercise its option to institute a system of nonbinding arbitration after the franchisees had filed suit. “But Steak n Shake was also free under the terms of the franchise agreements to ignore the arbitration provision and never adopt an arbitration policy,” the appeals court noted.

The district court correctly found the arbitration clauses illusory under Indiana law because their performance was entirely optional. The franchisor was free to exercise or not exercise the arbitration clauses at its whim. Steak n Shake also retained the discretion to determine the circumstances and procedures under which arbitration may take place, including deciding what types of claims would be subject to arbitration. “Indeed, nothing in any franchise contract precludes Steak n Shake from instituting a new system of nonbinding arbitration at any time, changing the rules and procedures as the company sees fit.”

In order for an agreement to be enforceable, it must be sufficiently certain and definite in all of the essential terms, so that a court may ascertain when and whether it has been performed. Under this standard, these arbitration clauses were simply too vague and indefinite to be enforceable, the Seventh Circuit concluded.

Because the district court was correct in finding the arbitration clauses illusory and unenforceable, the appeals court did not have to address whether the disputes were within the scope of the arbitration agreements or whether nonbinding arbitration fit within the definition of the arbitration in the Federal Arbitration Act.

The case is Nos. 13-3489, 13-3490, and 13-3491.

Attorneys: Kirsten Moder Ahmad (Greensfelder, Hemker & Gale, PC) for People Sales & Profit Co., Inc., Scott's S&S Inc., and Druco, Inc. Fredric A. Cohen (Cheng Cohen LLC) for Steak n Shake Enterprises, Inc.

Companies: People Sales & Profit Co., Inc.; Scott's S&S Inc.; Druco Restaurants, Inc.; Steak n Shake Enterprises, Inc.

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