Contributed by Patrick Abramowich

Arbitration clauses can offer many advantages to franchisors. Most notably, they provide for resolution of disputes without a jury and pose obstacles to franchisee class actions. However, trying to extend those benefits too far can result in the clauses being unenforceable. 

The federal appellate court that covers Pennsylvania, New Jersey, and Delaware recently refused to enforce an arbitration clause in an employment contract because it was unconscionable, and because the employer had waived its right to seek arbitration. Nino v. Jewelry Exchange, Inc., 609 F.3d 191 (3d Cir. 2010). The Court found that very short response time periods, an arbitrator selection process that effectively allowed the entity who wrote the clause to choose the arbitrator, and a delay in demanding arbitration rendered the clause unconscionable. Although Nino was decided under Virgin Islands law, it relied upon general principles that a court would likely apply in future cases.

The lessons of Nino are clear – if you require all franchisees to agree to an arbitration provision, you should draft the provision in an even-handed manner and make a timely demand for arbitration once a case has been filed in court if you expect the provision to be enforced.

More details on the Nino decision can be found after the jump.

The court stated that a plaintiff challenging an arbitration provision on the grounds that it is unconscionable must prove that it is both procedurally and substantively unconscionable. Procedural unconscionability goes to the process by which the clause is obtained, and was proven in Nino because the employer had greater bargaining power and presented the clause on a take-it-or-leave-it basis. It would not be difficult for many franchisees to make similar arguments.

Substantive unconscionability deals with whether the clause is unreasonably favorable to the stronger party. The court found that this was proven in Nino for three reasons:

*          The clause required the employee to present a written grievance to the employer within five days of the action complained of, or the employee would forfeit the claim. The employer was required to respond in two days, and if the employee was still dissatisfied, he had to refile the grievance within two days. The employer then had five days to render a final determination. The court found these procedures “manifestly unreasonable,” noting that it previously found 30-day filing requirements to be unreasonable. The clause in Nino was especially egregious because if the employer missed a response, its last decision would stand as the final determination, thus insulating it from any penalty for non-compliance.

*          A clause requiring the parties to bear their own attorneys’ fees, costs, and expenses unduly restricted the remedies available to the plaintiff, including a possible award of attorneys’ fees under the federal anti-discrimination statutes.

*          The clause provided for a panel of four potential arbitrators. The employer was permitted to strike one arbitrator, the employee a second, and the employer a third – giving the employer the ability to choose between the final two arbitrators. The court found that this procedure had no apparent purpose other than to stack the deck in favor of the employer.

The court did observe, however, that a clause requiring the arbitration to occur at the employer’s place of business was not unduly favorable to the employer. The effect of a clause requiring the employer and employee to split the arbitrator’s and stenographer’s fees would depend on whether the amount of such costs posed an unreasonable barrier to the employee.

Even if the arbitration clause were not unconscionable, the court held that the employer waived the right to arbitrate by waiting 15 months to compel arbitration, responding to three motions to compel discovery, participating in 10 pretrial conferences with the judge, exchanging documents with the employee, and participating in four depositions.