Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D. Ariz.: Franchisee initiating state court litigation could not compel arbitration, (Jun 17, 2015)

By Michael Menzhuber, J.D., LL.M.

A motion to compel arbitration and stay judicial proceedings, filed by a franchisee against a restaurant franchisor, was denied by the federal district court in Phoenix. The franchisee was found to have waived its right to arbitrate by pursuing litigation in state court rather than initiating arbitration (Texas Nrgize #1 Incorporated v. Kahala Franchise Corp., June 15, 2015, Campbell, D.).

Background. Texas Nrgize #1 entered into a franchise agreement with Kahala Franchise Corporation to operate a Nrgize juice and snack bar inside an L.A. Fitness gym. The sublicense agreement to the franchise agreement, which allowed Nrgize to enter the L.A. Fitness location to operate its franchise, contained an arbitration clause that required that any dispute or claim, upon written request of either party, be submitted to arbitration.

Nrgize later filed a complaint in Texas state court against Kahala that alleged breach of contract and violations of the Texas Business Opportunities Act. The case was removed, first to a federal district court in Texas and then to the federal district court in Arizona. Then, more than ten months after initiating its lawsuit, Nrgize moved to compel arbitration.

Choice of Law. Nrgize argued that Texas law should control the rules for arbitration because the arbitration clause in the sublicense agreement provided that the law of the state where the identified facility is located would govern the sublicense and any dispute arising there under. The court disagreed and cited the Ninth Circuit decision in Sovak v. Chugai Pharm. Co., 280 F.3d 1266 (2002), holding that a general choice of law provision does not override the strong presumption that federal law controls.

Waiver. The court noted that, because waiver of arbitration is not favored, any party arguing waiver of arbitration bears a heavy burden of proof. The court further noted that a party seeking to prove waiver of a right to arbitration must demonstrate: (1) knowledge of an existing right to compel arbitration; (2) acts inconsistent with that existing right; and (3) prejudice to the party opposing arbitration resulting from such inconsistent acts.

The court determined that all three prongs of the waiver test were satisfied. It found that Nrgize had knowledge of its right to compel arbitration because that right was specifically set out in the arbitration clause of the sublicense agreement that was signed by Nrgize’s representatives. Also, Nrgize admitted that it made a conscious decision to pursue litigation in state court, instead of initiating arbitration in accordance with the sublicense agreement, in order to minimize expenses.

The court also determined that Nrgize acted inconsistently with its right to compel arbitration because filing a lawsuit and seeking legal relief was inconsistent with that right. Specifically, the court found that Nrgize engaged in motion practice without mentioning the arbitration clause, participated in the case management conference, and served initial disclosures.

Finally, the court determined the Kahala suffered prejudice from Nrgize’s delay in seeking arbitration. As a result of Nrgize filing the lawsuit and then waiting ten months before seeking arbitration, the defendants incurred the expense of filing answers and counterclaims, removing the case to federal court, seeking and obtaining a transfer to Arizona, retaining Arizona counsel, participating in a Federal Rule of Civil Procedure 26(f) conference and preparing a Rule 26(f) report, participating in a case management conference, and providing initial disclosures. The concluded that these costs, and the loss of months in resolving the disputed, satisfied the prejudice requirement of waiver.

The case is No. CV15-0337-PHX-DGC

Attorneys: Charles Walsh Settle, Jr. for Texas Nrgize #1 Inc. Emily Ayn Ward (Fennemore Craig PC) for Kahala Holdings LLC, and Kahala Franchising LLC.

Companies: Texas Nrgize #1 Inc.; Kahala Holdings LLC; Kahala Franchising LLC

Cases: FranchisingDistribution ArizonaNews