Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—N.D. Cal.: Restaurant franchisees required to arbitrate fraud and state law claims against franchisor, (Nov 13, 2015)

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

Claims of fraud and violations of California’s Franchise Investment Law (CFIL) and Unfair Competition Law (UCL), brought by franchisees against the franchisor, Dickey’s Barbeque Restaurants, Inc. were required to be arbitrated, according to the federal district court in San Francisco (Meadows v. Dickey’s Barbeque Restaurants, Inc., November 12, 2015, Tigar, J.).

Background. California residents Amy Meadows, Dawn Toff, Donna Schiano, Alfred Pena, Christy Bagby, James Domsic, Charyl Hart, George Jones and GJones3 Ventures purchased a Dickey’s franchise after receiving Dickey’s franchise disclosure documents and signing a franchise agreement. The franchise agreements, which were approximately 60 pages long and printed in small type, contained: (1) an arbitration provision; (2) terms permitting Dickey’s, but not its franchisees, to bring certain claims in court without participating in mediation or arbitration; (3) a Texas choice-of-law provision; and (4) a venue clause.

The arbitration provision, in the franchise agreements signed by Meadows, Bagby, and Jones (collectively, “Meadows plaintiffs”), stated that all disputes, including those as to the validity of the franchise agreement, were encompassed by binding arbitration. However, the definition of “disputes”, in the arbitration provision in the franchise agreements signed by Toff, Schiano, Pena, and Domsic (collectively, “Toft plaintiffs”), did not include the validity of the franchise agreement as being subject to binding arbitration.

The plaintiffs brought a class action suit against Dickey’s that alleged fraud, as well as CFIL and UCL violations. In support of their claim, the plaintiffs alleged that: (1) the franchise disclosure documents contained several misrepresentations; and (2) Dickey’s employees made additional misrepresentations outside of the franchise disclosure documents. In addition to their claim for damages and injunctive relief, the plaintiff sought a declaration that the arbitration provision in the franchise agreements was unenforceable. In response, Dickey’s filed a motion to compel arbitration.

Arbitrability. Dickey’s argued that the evidence showed a “clear and unmistakable” agreement to delegate all questions to the arbitrator because: (1) the arbitration provides contained a broad delegation clause that included arbitrability; and (2) the commercial rules of the American Arbitration Association (AAA) was incorporated, by reference, in the franchise agreements, thus showing an intent to delegate. The court found that the arbitration provision in the Meadows plaintiffs’ franchise agreements clearly and unmistakably indicated the parties’ intent to delegate the threshold issue of arbitrability because the definition of “disputes” for purposes of binding arbitration, encompassed the validity of the franchise agreement.

However, because the “validity of the franchise agreement” language was absent in the definition of “disputes” in the arbitration provision for the Toft plaintiffs, the court could not conclude that there was “clear and unmistakable” evidence of delegation required to defeat the presumption that the court, not the arbitrator, would decide the issue of arbitrability. Dickey argued that the incorporation of the AAA rules in the franchise agreement provided that “clear and unmistakable” evidence. The court, however, determined that whether the incorporation rules met that standard required an inquiry as to the positions of the parties. Because there was evidence that the Toft plaintiffs were far less sophisticated as Dickey’s, the court found that the incorporation rules did not meet that standard. Consequently, it decided to determine the question or arbitrability as to the Toff plaintiffs.

Challenge to delegation clause. Because the Meadows plaintiffs “clearly and unmistakably” delegated the question of arbitrability to arbitration, the only remaining question was whether the delegation provision was itself unconscionable. Because the Meadows plaintiffs did not challenge the delegation clause, but rather challenged the entire arbitration provision, the court concluded that their unconscionability challenge must be heard by an arbitrator.

Challenge to arbitration provision. The Toff plaintiffs’ franchise agreements specified that Texas law would apply to any dispute. The court determined that the parties agreed to be bound to this choice-of-law provision because: (1) they received franchise disclosure documents prior to executing franchise agreements; and (2), although the franchise disclosure documents stated the choice-of-law clause may not be enforceable, the other provisions in those documents made it clear that Dickey’s would insist on the application of Texas law.

After concluding that the parties agreed to apply Texas law, the court considered whether to apply Texas law in determining the enforceability of the arbitration provision. The court first determined there was a substantial relationship between Texas and the parties because Dickey’s headquarters were in Texas and the franchise agreement required that payments be due in Texas.

The court then considered whether applying Texas unconscionability law would be contrary to the fundamental public policy of California. The plaintiffs gave two reasons why California law should apply: (1) Texas law conflicted with the CFIL because it had no counterpart to the CFIL and, thus, depended on conflicting common law; and (2) there were significant differences between Texas and California unconscionability law.

The court found it unnecessary to address the plaintiffs’ first argument because the question before the court was not what law applies to their substantive claims but, rather, only which state’s law governs the enforceability of the arbitration provision. With respect to the plaintiffs’ second argument, the court determined that the plaintiffs’ focusing on the differences between the two states’ unconscionability, and the stricter standards under Texas law in establishing unconscionability, was not a valid reason to apply California law. Because the arbitration provision did not eliminate the ability to recover punitive damages under the CFIL, there was no actual conflict with California policy.

After determining that Texas law applied, the court analyzed the enforceability of the parties’ arbitration provision under Texas law. The plaintiffs argued that the arbitration provision was procedurally unconscionable because Dickey’s: (1) occupied a superior bargaining position; and (2) affirmatively mispresented the nature of the arbitration provision. The court disagreed because there was no evidence that the plaintiffs were incapable of understanding the arbitration provision or that Dickey’s misrepresented the existence of the arbitration clause or otherwise engaged in fraud.

The plaintiffs’ argument that the arbitration provision was substantively unconscionable because it precluded the ability to obtain punitive damages under the CFIL was also rejected. The court noted that Dickey’s retained the right, under the arbitration provision, to litigate certain claims. It determined, however, that although reservation of the right to litigate lacked mutuality, under Texas law this “allocation of risk because of superior bargaining power” was enforceable.

The case is No. 15-cv-02139.

Attorneys: Rebecca B. Morrison (Thorsnes Bartolotta McGuire LLP) for Amy Meadows and GJones3 Ventures, LLC. Jordan David Grotzinger (Greenberg Traurig, LLP) for Dickey's Barbecue Restaurants Inc.

Companies: GJones3 Ventures, LLC; Dickey's Barbecue Restaurants Inc.

Cases: FranchisingDistribution CaliforniaNews