More and more states are enacting franchise laws that bar out-of-state arbitration. These laws put them at odds with the Federal Arbitration Act (FAA). Courts, including the United States Supreme Court, have consistently held that the FAA preempts state laws that invalidate contractual arbitration clauses or a contractually chosen site of the arbitration. The question is how to go about ensuring enforcement of private arbitration clauses.
There are at least three steps every franchisor needs to take to ensure that its chosen forum for arbitration will be enforced:
- The arbitration clause and all related provisions need to be consistent across the franchise agreement, the FDD and any state addenda. While this is true for any key provisions of franchise documents, it is particularly true for an out-of-state arbitration clause. Courts have held that franchisors who fail to disclose their intent to rely upon the FAA to trump state law fraudulently induce franchisees to agree to out-of-state venue clauses.
- The arbitration clause of the agreement must clearly state the chosen forum for the arbitration, and the franchisor should consider adding language to the agreement explicitly stating that the parties agree the FAA trumps any state law to the contrary.
- Franchisors need to be prepared to support the fact that the FAA trumps preempted state laws requiring in-state arbitration both in the courts and with state regulators.
In registration states, step number three in particular could mean being prepared for a fight with the regulators that likely will slow down the registration process–or could result in rejection by the regulators. In that event, making sure that steps one and two are carefully followed becomes essential.
For further reading, I highly recommend the article, “State Regulators Circumvent Venue Clauses for Arbitration,” found in the Winter 2015 issue of The Franchise Lawyer. I tried to find a place to link to the article online, but was unable to find an online source. It does a great job of laying out the confusion states have created in enacting laws preempted by federal law.