Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D. Conn.: Transferee not subject to franchise agreement’s arbitration clause, (Jan 6, 2014)

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

Claims brought by the transferee of a New Jersey Subway sandwich franchise against a former franchisee, the franchisor, and the franchisor’s real estate affiliate were not subject to an arbitration agreement in the franchise agreement, according to the federal district court in New Haven, Connecticut (Doctor’s Associates Inc. v. Edison Subs, LLC, January 3, 2013, Hall, J.). The transferee, which was not a signatory to the franchise agreement, did not knowingly exploit the agreement.

Edison Subs, LLC—a transferee of a Edison, New Jersey Subway restaurant—brought an action in New Jersey state court against the franchisor (Doctor’s Associates, Inc.), the former franchisee (Aliya Patel), and the franchisor’s affiliate (Subway Real Estate Corp.), alleging breach of contract, fraud, violations of the New Jersey Consumer Fraud Act, negligent misrepresentation, and violation of the covenant of good faith and fair dealing.

The action alleged that Edison entered into an oral franchise agreement with Doctor’s Associates, whereby Edison would pay the costs of outfitting franchise premises and pay transfer fees to Patel in exchange for “all of the benefits of ownership of the Subway franchise business.” Edison claimed that Patel fraudulently induced it to enter the oral franchise agreement through a series of material misrepresentations and omissions and breached the terms of the oral franchise agreement by involuntarily ejecting Edison from the franchise premises.

Subsequently, Doctor’s Associates brought an action in the federal district court in New Haven to compel arbitration of the claims brought in the New Jersey state court action. It moved to enjoin Edison from prosecuting its claims, except through arbitration proceedings in Connecticut, as required by the original franchise agreement between Doctor’s Associates and Patel.

It was undisputed that Edison did not sign the franchise agreement. Edison contended that it did not even receive a copy of the agreement. Nevertheless, Doctor’s Associates argued that Edison could be bound by the agreement under common law principles of contract and agency, including estoppel. Under an estoppel theory, a party knowingly exploiting an agreement with an arbitration clause can be estopped from avoiding arbitration, despite never having singed the agreement. In cases where a signatory seeks to compel a nonsignatory to arbitrate, the nonsignatory must have directly benefitted from the agreement to trigger estoppel, the court explained.

In the Second Circuit, a nonsignatory must have “knowingly accepted the benefits of an unsigned agreement, and the benefits must be direct.” The doctrine of “direct benefits estoppel” is a narrow one. Such benefits must flow directly from the written agreement, according to the court. The fact that a nonsignatory is merely a signatory’s successor or corporate parent need not trigger estoppel. However, a nonsignatory may be estopped from refusing to arbitrate if it had notice of the unsigned agreement’s terms and, for example, used a trade name or received a significantly lower insurance rate pursuant to that agreement.

Doctor’s Associates argued that Edison directly benefitted from the franchise agreement. Edison argued that its New Jersey lawsuit sounded in fraud, not in contract, and did not rely on the franchise agreement signed by Patel. However, Edison indisputably held itself out as a franchisee and reaped the benefits of being a franchise, including using a Subway operations manual and the franchsior’s marks. The court held that some of Edison’s claims rested on the alleged ownership and operation of a Subway franchise.

Nevertheless, Edison could not be compelled to arbitrate because there was no evidence to support a finding that Edison “knowingly exploited” the franchise agreement containing the arbitration clause. Doctor’s Associates nowhere alleged or offered evidence that Edison, prior to allegedly receiving any benefits as a franchisee, had received a copy of the franchise agreement. Edison explicitly represented that it did not receive the franchise agreement.

Edison’s New Jersey lawsuit was based on an alleged oral franchise agreement, entered into by itself, Patel, and Doctor’s Associates. A fair reading of the complaint showed that the benefits allegedly received by Edison were received pursuant to the oral franchise agreement, the court found. Furthermore, Doctor’s Associates failed to allege or offer evidence that Edison otherwise had notice of the terms of the written franchise agreement signed by Patel. Thus, even if the benefits received by Edison as a franchisee could be construed as being direct, the court could not find that they were “knowingly accepted.”

The franchisor’s allegation that Subway franchise agreements always require arbitration was unavailing, absent a signed agreement containing an arbitration agreement or proof that the case fell within one of the common law exceptions recognized by the Second Circuit.

The case is Civil Action No. 3:13-CV-839 (JCH).

Attorneys: Bethany L. Appleby (Wiggin & Dana) for Doctor’s Associates, Inc. Stuart A. Margolis (Berdon, Young & Margolis) for Edison Subs, LLC.

Companies: Doctor’s Associates, Inc.; Edison Subs, LLC

Cases: FranchisingDistribution ConnecticutNews