Firms seek alternative ways to settle costly disputes

November 11, 2003
Nation's Restaurant News Magazine, November 3, 2003
Arbitration, a process as vilified as it is hailed, is helping restaurant operators resolve more than just franchise disputes these days. 
 
In an increasingly litigious society, where state court systems already are overwhelmed with civil suits, more businesses, including restaurant companies, are turning to arbitration — often viewed as less expensive, contentious and time consuming than traditional lawsuits — to diffuse their thorny frictions.
 
In addition, as revenue-strapped states look for ways to cut budgets, many legislatures are passing laws forcing companies to arbitrate or mediate their disputes up to certain monetary limits before taking them into courtrooms. 
 
Increasingly, cases involving sexual harassment, age and race discrimination, unfair terminations, denied health care benefits, investor complaints and union contract violations — as well as franchising flare-ups — all are finding their way before arbitrators rather than judges.  
 
According to the National Association of Securities Dealers, which claims to be the largest dispute resolution forum in the securities industry, the number of cases arbitrated between 1990 and 2002 more than doubled to 7,704 cases last year. And the number of cases arbitrated in 2002 was up 11.4 percent from 6,915 cases in 2001. 
 
The government also has turned more and more to arbitration as a means to solve its disputes, with the number of cases completed in 2002 reaching 2,866, which is more than five times the 509 cases completed in 1995, according to the U.S. Department of Justice. And the American Arbitration Association says it administered 230,255 cases in 2002, of which 3,298 were commercial cases with claim amounts of $250,000 or higher. 
 
Arbitration is one of several methods to settle legal disagreements through a process more broadly known as alternative dispute resolution, or ADR. Other widely practiced means include mediation, peer reviewing and the use of an internal ombudsman. 
 
But for all of its popularity and support, some say arbitration is a flawed and often unfair process. 
 
Many lawyers involved in union disputes, employment violations and discrimination cases say they worry about the methods used for selecting arbitrators and the fact that, in many cases, the arbitrator’s decision cannot be appealed. 
 
Moreover, as a growing number of mature restaurant brands include clauses in their franchise and employment contracts demanding arbitration to handle disagreements arising out of those contracts, critics complain that the process is one-sided in favor of the franchisor or company over the franchisee or employee.
 
Susan Kezios, president of the 30,000-member American Franchisee Association in Chicago, charges that, as it relates to encroachment, for example, many arbitrated cases are contested behind closed doors, resulting in no precedents or lessons that can be learned to help other chains deal with similar controversies.
 
“Arbitration is a dangerous thing for franchisees,” Kezios argues. “Whereas most provisions of a franchise agreement are aimed at pretty specific and limited situations, arbitration allows lawyers to establish a generalized view of the contract, and they become their own judicial systems — judge, jury and executioner — all within the bounds of the franchise contract.”
 
Kezios goes on to argue that certain employees in discrimination suits also are at a disadvantage as a result of employment contracts that require mandatory arbitration when fights arise over discrimination or sexual harassment. 
 
“These contracts with mandatory arbitration can be tantamount to giving away your civil rights,” she says. “I think it is pretty clear that even if an employee wins, say a harassment suit, they get lower damages than if a jury or judge had ruled on the same complaint.
 
“Everybody says litigation is bad. But why is it so bad?”
 
One reason it’s bad, explains Matt Shay, executive director of the Washington, D.C.-based International Franchise Association, a group whose history lies in protecting franchisors, is that lawsuits siphon off resources and time that could be better invested in the operations of the brand.
 
“The truth is there are frequently no winners in litigation,” Shay says. “The system loses because both the franchisor and the franchisee are spending time and resources, and then there’s the disruption on the relationship.
 
“Arbitration has become an effective means for franchise systems to try to achieve minimal disruption to the overall operation for the benefit of the franchisor and the franchisee,” he continues. “Let’s not forget that when the franchisor is engaged in pursuing lengthy and expensive litigation involving the system, that is time and effort and expertise that has to be devoted elsewhere.
 
“It hurts everyone, regardless of who the judge or jury declares the winner.”
 
Ed Anderson, managing director of the National Arbitration Forum — a Minneapolis- St. Paul-based group that promotes arbitration and provides arbitrators who specialize in various fields — agrees with Shay. He notes that franchising disputes are not the only conflicts where arbitration has proved to be a fair and lowcost way to settle disagreements outside of court.
 
Recalling evidence from an arbitration-related lawsuit between Hooters of America and a female employee, he says the average cost of employment litigation is about $50,000, and the average case takes about two and a half years to resolve. By contrast, Anderson says, a typical employment discrimination suit would take about seven and a half months and cost two-thirds to three-quarters less through arbitration.
 
Anderson argues that since most states have their own laws of judicial procedure, arbitration brings a measure of uniformity in handling disputes no matter how many states the brand operates in.
 
“The last thing any company wants to deal with is having to litigate under 50 different legal systems,” Anderson states. “But from the point of view of both the employer and the employee, they save so much time and money when you arbitrate, and the response is much quicker.
 
“Given today’s cost of litigation and the backlog in so many courts, arbitration is more rational, expedient and less expensive.”
 
But Anderson concedes that Kezios is correct on one point: Some restaurant industry employment contracts and franchise agreements in the past have been drafted to benefit the franchisor or the company at the expense of the franchisee or employee.
 
He pointed to a much-studied case some see as precedent setting in which Hooters of America lost a lawsuit in federal court in 2000 for drafting employment contracts with a one-sided arbitration clause that gave the company all of the advantages.
 
In that case, a female bartender at a Hooters in Myrtle Beach, S.C. — at that time a 10-year employee of the company — quit after her boss told her to “let it go” after she wanted to file a complaint for sexual harassment against another manager.
 
When she used a lawyer to inform Hooters’ corporate headquarters in Atlanta that her civil rights had been violated under Title VII of the Civil Rights Act of 1964, the company reminded her that she had signed a binding agreement to handle such complaints through arbitration. Later, Hooters sued the woman to force her to arbitrate the matter.
 
But the woman won the ensuing lawsuit.
 
The court held that Hooters’ arbitration policy was so “one-sided that their only possible purpose is to undermine the neutrality of the proceeding,” the judges said in their decision.
 
Specifically, the U.S. Fourth Circuit Court in Atlanta found six major unfair and bad-faith clauses woven into the agreement, four of which undermined the very nature of the definition of arbitration in law.
 
“Hooters so skewed the process in its favor that [the defendant] has been denied arbitration in any meaningful sense of the word,” the judges wrote. “To uphold the promulgation of this aberrational scheme under the heading of arbitration would undermine, not advance, the federal policy favoring alternative dispute resolution.” The policy to which the judges referred is the Federal Arbitration Act of 1925, a law that has been updated and strengthened numerous times over the past quarter-century.
 
The judges’ most damning criticism was aimed at the unfair way the arbitrators were selected.
 
“The employee and Hooters each select an arbitrator, and the two arbitrators in turn select a third,” the judges wrote in their decision. “Good enough. Except that the employee’s arbitrator and the third arbitrator must be selected from a list of arbitrators created exclusively by Hooters.
 
“This gives Hooters control over the entire panel and places no limits whatsoever on whom Hooters can put on the list,” the decision continued. “Hooters is free to devise a list of partial arbitrators who have existing relationships, financial or familial, with Hooters and its management. In fact, the rules do not even prohibit Hooters from placing its management on the list.”
 
The judges ultimately ruled that the bartender did not have to abide by binding arbitration and could sue the company without first going to arbitration. 
 
Mike McNeil, vice president of marketing for Hooters, says the company learned much from the judges’ decision and did not pursue further litigation against the woman. He said the company rewrote its arbitration clause using standards set down by the AAA, or American Arbitration Association, and “have enjoyed the benefits of arbitration ever since.”
 
While the judges may have called Hooters’ old contract an aberration, Kezios says she believes it is the norm.
 
Pointing to the Subway system as a case in point, she says many companies often stack the deck in arbitration cases by selecting arbitrators who are biased toward the franchisor. In Subway’s case, she says, the arbitrators are nearly always from Connecticut — the sandwich chain’s home state.
 
But Jack Dunham, a Connecticut trial lawyer who has represented several franchisors, including Subway in arbitration and in court, says Kezios’s point about where the arbitrators reside is irrelevant.
 
He notes that Subway, which has refined its arbitration language over the years, has developed one of the most scrupulously fair arbitration clauses in food-service.
 
He insists that the company does not have a choice in selecting arbitrators because it and the franchisee- plaintiff select from a pool of arbitrators previously assembled by the AAA, the nation’s largest and most influential alternative dispute resolutions group.
 
Dunham explains that in making their choices for arbitrators, the company and the franchisee have the right to strike potential panelists from the AAA pool. After they have eliminated potential arbitrators, those remaining in the pool are chosen by the AAA to participate on the panel.

“So Subway’s arbitration clause gives neither the company nor the franchisee control over the arbitrators,” Dunham insists.
 
Meanwhile, Krispy Kreme is weighing whether it is going to appeal an arbitration ruling it lost earlier this year that cost the company $9 million and led to a 32-percent decline in fourth-quarter earnings. The case involved a dispute over an investor’s ownership in a California Krispy Kreme franchise company.
 
Neither Krispy Kreme investor relations officer Robin Moore nor corporate counsel Frank Murphy returned phone calls by presstime.
 
Ralph Berger, a Brooklyn, N.Y.-based attorney and fulltime arbitrator and mediator who has helped restaurant companies, hotels, professional sports leagues and other industries settle some 3,800 disputes since 1982, says despite its imperfections, arbitration still offers foodservice operators a cheaper alternative to traditional court.
 
He, too, depicts the Hooters case as an aberration, arguing that, in the main, most contracts he has seen now specify neutrality.
 
But Berger says he is troubled that despite arbitration’s long history as a bona-fide means for settling potentially damaging and costly lawsuits, some states and companies still treat arbitration as a second-rate means for settling cases dealing with discrimination, especially when it comes to employment.
 
“California, for example, is beginning to flip-flop on the issue,” Berger reports. “It looks askance at discrimination cases being handled in arbitration rather than the courts. Yet we know that the institution of arbitration has made great strides in protecting an individual’s due-process rights and as an industry has worked very hard and diligently in advocating procedural safeguards.
 
“Many arbitrators, including myself, will not accept an appointment to a case in which due-process protocols have not been adhered to,” he explains.
 
To be sure, however, arbitration doesn’t work for everyone in every situation.
 
When Boston-based Legal Sea Foods earlier this year sued New York-based B.R. Guest and a former Legal chef now employed by B.R. Guest for violating a noncompete and confidentiality agreement, the defendants thought arbitration might have been a good way to resolve the dispute.
 
Unfortunately, as Carolyn Richmond, general counsel for B.R. Guest, explains, Legal Sea Foods sought a temporary restraining order that would have required either the firing or transferring of the chef to another restaurant, and so there was no time to adjudicate the matter through arbitration.
 
More pertinent, Richmond says, is that Legal Sea Foods seemed determined to make a point in public what the closed doors of arbitration might have left private had they won. Instead, a federal district court judge ruled against Legal Sea Foods.
 
“The reason arbitration didn’t work for us is that the timing wasn’t right,” Richmond says. “They wanted a temporary restraining order, and, as general counsel for B.R. Guest, I evaluated the merits of the case and the factors involved and determined that a jury or judge, given the time we were dealing with, would ultimately decide in our favor.”
 
Richmond, an attorney who practiced labor law before joining B.R. Guest, adds, however, that she prefers mediation over arbitration as the former is not as binding, allowing disputants to appeal — an option not always available in arbitration.
 
“What mediation does that arbitration does not [do] is . . . speed up resolutions even faster,” Richmond says. “A mediator is genuinely a third-party, outside observer of the facts, has no allegiances and takes the case where the facts lead them.”
 
According to a study by the National Arbitration Forum, many future legal disputes between companies or corporations and employees may have to be resolved through ADR.
 
The NAF report found that because many states are facing tax shortfalls limiting their ability to fund court personnel payrolls and the usual hours of operations, they are mandating that civil suits up to a certain monetary settlement amount be presented to arbitrators.
 
In California, for example, a bill is wending its way through the state house that would allow arbitrators to decide superior-court cases under $50,000 instead of a court or jury trial. In Utah, the NAF found that the state had passed a law encouraging health care providers to bypass the court system and use arbitration in legal disputes with patients.
 
Other states that either have passed laws or are contemplating legislation to advance ADR are Alabama, whose fiscal crisis is bordering on bankruptcy; Oregon, whose courthouses only operate four days a week; Colorado; Massachusetts; and New Hampshire.