Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—E.D. Mo.: Cleaning service franchisees’ RICO claims were subject to arbitration, (Feb 4, 2014)

By Linda O’Brien, J.D., LL.M.

RICO claims brought by five cleaning service franchisees against a system franchisor and its regional master franchisors for engaging in a fraudulent scheme to induce the purchase of franchises were subject to an arbitration clause of their unit franchise agreements, according to the federal district court in St. Louis (Torres v. Simpatico, Inc., February 3, 2014, Perry, C.). Thus, the defendants’ motion to compel arbitration was granted.

Stratus Franchising LLC is a commercial cleaning services business. Stratus sells master franchises, which serve the exclusive franchisor in a regional market and sell unit franchises within that geographic area. Five owners of Stratus system unit franchises filed a class action suit against Stratus, three master franchisors that the franchisees contracted to purchase unit franchises, (Simpatico, PHSCCH SBS, and Stratus Building Solutions of Houston), several non-signatory master franchisors, and numerous individuals. The franchisees alleged that the defendants fraudulently induced them to purchase unit franchises and extracted exorbitant fees from the franchisees without fulfilling their own contractual obligations in violation of RICO.

The franchisees also alleged that the Stratus system was an illegal scheme that (1) defrauded unit franchisees by misrepresenting the system’s organization and nature; (2) misrepresented the unit franchisees’ financial prospects; (3) oversaturated geographical markets; (4) grossly underpriced the franchisees’ work to customers; (5) deceptively churned franchisee service accounts; and (6) charged undisclosed and inflated fees to the franchisees.

The franchise agreements between the unit franchisees and the master franchisors contained a broad arbitration provision. The defendants moved to compel arbitration. The plaintiffs contended the arbitration clauses were not enforceable as substantively unconscionable.

The court determined that, because the arbitration provision sanctioned enforcement by third parties and the franchise agreement required the plaintiffs to indemnify Stratus and its franchisees, Stratus and the non-signatory master franchisors were third-party beneficiaries that could enforce the arbitration agreement.

The plaintiffs acknowledged that the unit franchise agreement contained a standard form arbitration clause; however, they argued that the clause was invalid for unconscionability. The Federal Arbitration Act (FAA) established a liberal federal policy favoring arbitration agreements, according to the court. The plaintiffs failed to show that the filing and pre-hearing entrance costs precluded arbitration. Moreover, although the clause entitles the prevailing party to reimbursement of costs, the arbitrator is granted discretion to allocate costs among the parties under the clause.

The plaintiffs’ RICO claims that they were defrauded by the unit franchise agreement fell within the arbitration provision. Finally, under Missouri law, third-party beneficiaries may enforce the terms of the contract where the contract clearly expresses an intent to benefit that party. As intended third-party beneficiaries of the unit franchise agreement, Stratus and the non-signatory master franchisors could enforce the arbitration provision, the court concluded.

The case is No. 4:12CV2373 CDP.

Attorneys: Jonathan E. Fortman (Law Office of Jonathan E. Fortman, LLC) for Jose Torres. Glenn E. Davis (Hepler Broom) for Simpatico, Inc. and Stratus Franchising, LLC.

Companies: Stratus Franchising LLC; Simpatico; PHSCCH SBS; Stratus Building Solutions of Houston

Cases: FranchisingDistribution RICO MissouriNews