Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—N.D. Cal.: Arbitration of assets purchase dispute not preliminarily enjoined, (Mar 17, 2014)

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

A metal convenience store franchisee was denied a preliminary injunction prohibiting arbitration of an assets purchase dispute with his franchisor (Moody v. Metal Supermarket Franchising America, Inc., March 10, 2014, Hamilton, P.). The federal district court in Oakland found that the franchisee failed to show a likelihood of success on its claims that the arbitration clause of the franchise agreement was unconscionable and that it would suffer irreparable from the arbitration.

While the district court ruled that all of the franchisees’ claims were subject to arbitration, it refused to dismiss the action at this stage, providing the franchisee with an opportunity to show cause why the complaint should not be dismissed for failure to state a claim.

Terrence Moody purchased two franchises from Metal Supermarkets Franchising America. Under the terms of the two identical franchise agreements, the franchisor had the option at the end of the franchise term to purchase franchise assets. The agreements set out a formula for determining the purchase price of the assets—the greater of (1) the net book value or (2) three times the annual pre-tax operating income. In July 2012, Moody took out a small business loan in which the lender required that the formula in each franchise agreement be amended to provide that Moody would receive fair market value in the franchisor’s assets purchase.

In August 2013, the franchisor indicated its intent to exercise its options to purchase the assets of the two franchises. It sent a notice of such intention on November 11, 2013, prior to the November 14, 2013 expiration of the franchise agreements, and followed up with a November 15, 2013 letter restating the intent to exercise the option. The parties disputed the proper purchase price. Moody maintained that he should receive fair market value, as required by the 2012 amendment, while the franchisor argued that the original formula applied.

Moody filed an action in state court, seeking a declaration of the purchase price of the assets. Metal Supermarket Franchising America filed a demand for arbitration of the dispute in Washington, D.C. as provided by the franchise agreements and then removed the case to the federal district court. Moody filed an application for a temporary restraining order, seeking to prohibit arbitration. The district court denied the temporary restraining order, finding that Moody had not identified any irreparable harm resulting from the arbitration proceeding, since any damages to him would be monetary. Moody subsequently filed this motion for a preliminary injunction against arbitration.

Moody maintained that the franchisor failed to exercise its purchase option. Specifically, he argued that the November 11, 2013 notice was premature—and therefore ineffective—because it was made before the expiration of the franchise agreements on November 14, 2013. The franchise agreements specify that purchase option may be exercised “by giving written notice thereof within ten days of the expiration of the agreement.” Because the agreement expired on November 14, 2013, Moody argued, the 10-day exercise period began on November 15, 2013 and ended on November 24, 2013 and the November 11, 2013 notice was a nullity.

The district court disagreed. “The court finds that, even if defendant’s November 11, 2013 notice was premature, its November 15, 2013 letter did indeed communicate defendant’s ‘unqualified intention’ to exercise the option . . . The court also notes that, if it were to accept plaintiff’s argument that defendant never exercised its option, this entire case would be mooted—as plaintiff asserts only a single cause of action, seeking declaratory relief regarding the purchase price of the franchises’s assets.”

Having established that the action was not moot, the court turned to the four-part test for preliminary injunctive relief. Regarding the first part—likelihood of success on the merits, Moody did not actually present arguments on the issue of the purchase price of the franchise assets. Instead, he sought a ruling precluding arbitration of the issue, arguing that the arbitration provision of the franchise agreements was unenforceable as both procedurally and substantively unconscionable.

Likelihood of Success on Merits

Procedural unconscionability. Moody claimed that the arbitration provision was procedurally unconscionable because he had no opportunity to negotiate the terms of the provision and therefore the arbitration provision was a contract of adhesion. While the court agreed that the franchise agreements appeared to be standardized contracts, it noted that Moody was represented by counsel and successfully negotiated some provisions of the agreements. These facts weakened the level of procedural unconscionability and required Moody to make a stronger showing of substantive unconscionability in order to establish a likelihood of success on the merits of his claim.

Substantive unconscionability. Moody argued that there was a lack of mutuality in the parties’ rights and remedies in the arbitration provision of the agreements, which allowed the franchisor, but not the franchisee, to “obtain at any time in any court of competent jurisdiction any injunctive relief.” The California Supreme Court has held that the lack of mutuality in a contract of adhesion does not necessarily render the contract invalid. A contract may grant a “margin of safety” providing the party with superior bargaining power a type of extra protection for which it has a commercial need. As applied to this case, the district court found that the rights afforded the franchisor, but not the franchisee, were rights based on legitimate commercial needs. The provision allowing the franchisor to obtain injunctive relief was limited to instances where no adequate remedy at law may be available or where the franchisor may suffer irreparable harm. Irreparable harm included infringement of the franchisor’s trademarks and use or disclosure of the franchisor’s confidential information.

Other allegations of lack of mutuality in the ability to recover attorney fees and punitive and exemplary damages were without merit. A further contention that the arbitration’s venue selection clause was unconscionable was rejected on a ruling that forum selection clauses are to be enforced only if the place and manner are unduly oppressive, which the provisions at issue were not.

Accordingly, the court found that Moody had not shown a likelihood of success on the merits of his claim that the arbitration clause was unconscionable.

Irreparable Harm

Moody’s claim that he would suffer irreparable injury from the loss of real property from the arbitration’s threat to shut down his business was unavailing. He was not arguing that the arbitration proceedings themselves would cause him irreparable injury; he was arguing that an adverse decision in arbitration could cause him irreparable injury. Moreover, the injury alleged by Moody from the arbitration proceeding in Washington, D.C. constituted only monetary injury in the form of legal and travel expenses. Thus, Moody failed to establish irreparable injury.

The case is No. C 13-5098 PJH.

Attorneys: Alan Scott Nopar (Law Offices of Alan S. Nopar) for Terrance A Moody. Jason J. Stover (Jason J. Stover) for Metal Supermarket Franchising America, Inc.

Companies: Metal Supermarket Franchising America, Inc.

Cases: FranchisingDistribution CaliforniaNews