Many franchisors employ arbitration as its preferred method of dispute resolution.  Generally, courts view arbitration agreements favorably. An agreement to arbitrate waives the fundamental right to have a court decide the merit of their disputes. As such, valid, enforceable arbitration agreements are required to waive this essential right. Two recent decisions highlight the importance of ensuring that a valid agreement to arbitrate exists between the parties.

arbitration agreement
Copyright: designer491 / 123RF Stock Photo

Theo’s Pizza, LLC v. Integrity Brands, LLC

In this case, the franchisee sued the franchisor for violation of the South Carolina Business Opportunity Sales Act and breach of contract. The franchisor sought to dismiss the action because all actions related to the franchise agreement were subject to arbitration (per the Franchise Agreement). The parties entered into a Market Development Agreement under which the franchisor granted franchisee the right to open multiple units. The Market Development Agreement explicitly stated that the parties must execute a separate franchise agreement for each unit. Despite the franchisee opening its first unit, the parties never signed a Franchise Agreement. The Market Development Agreement and Franchise Agreement both contain clauses that require arbitration of all disputes.

The Court held that the claims arose out of the operation the unit, not the Market Development Agreement.  Thus, in the Court’s opinion, there was not an explicit agreement to arbitrate disputes because the parties never signed the Franchise Agreement.  Additionally, the Court refused to impute an agreement to arbitrate where the franchisee had not expressly agreed to one.

Stockade Companies, LLC v. Kelly Restaurant Group, LLC

In this case, the franchisor terminated the Franchise Agreement for failure to pay royalties. The franchisee continued to operate its business after the termination of the Franchise Agreement. Subsequently, the franchisor filed for an injunction against the franchisee for its continued operation of its business. The franchisor argued that the franchisee’s continued operation of the business infringed on franchisor’s trademark rights and violated the post-termination non-competition clause. The franchisee argued that the franchisor was not entitled to an injunction because all actions under the Franchise Agreement must be arbitrated. However, the Franchise Agreement provided that the franchisor may file for injunctive relief where necessary to protect its proprietary marks and other rights or property.

The franchisee argued that the claims fall within the arbitration clause because (a) they are not “actions” within the meaning of the exclusion clause, (b) they are not “necessary” to protect the franchisor’s property, and (c) the exclusion clause is vague and invalid. The Court dismissed each of the franchisee’s arguments noting that the exclusion clause permits the specific action the franchisor took (the filing of a request for injunctive relief). Further, the franchisor’s (i) right to enforce its non-compete protects its property, and (ii) trademark infringement claims protect its proprietary marks. Lastly, the Court noted that the language of the exclusion clause was clear and that the franchisor had carved out its right to seek injunctive relief. As such, the Court held there was no valid agreement to arbitrate the injunction action.

Conclusion

These cases illustrate it is of utmost importance to ensure that your franchise agreements are well-written and explicit when it comes to dispute resolution procedures. Additionally, when entering into a development relationship, a franchisor must ensure that it enters into a separate franchise agreement for each unit so it is bound by those terms. Lastly, a franchisor must ensure that all reserved rights to obtain injunctive relief are clear and conspicuous. While these recommendations are not earth-shattering, these cases are important reminders of the consequences of improper franchise administration and documentation.