Publications

This issue is the first from Jack Dunham as our new editor-in-chief. He has decided to use his column on occasion for substantive commentary on a single issue. His column, in this issue, addresses arbitration, a subject on which he is exceptionally well versed and has written a number of articles. In particular, Mr. Dunham takes issue with an article by Professor Sternlight, published in the Fall 2000 issue of this Journal. Professor Sternlight, in turn, had expressed strong disagreement with some of Mr. Dunham’s views, as expressed in his articles.




The Sternlight–Dunham debate(s) represents the finest in scholarly discourse, and they may continue. If Professor Sternlight writes a letter to the editor, I expect it will be published. That’s essentially what Mr. Dunham has done—write a letter to the editor. Only, since he is the editor, you will find his commentary in his column. John F. Dienelt, Chair Forum on Franchising

According to Bartlett’s Familiar Quotations, the long-forgotten Charles Caleb Colton (1780–1832) coined the enduring maxim, "imitation is the sincerest form of flattery."1 Unaware that Mr. Colton deserved the credit, I had always accepted it as a truism. No longer. Jean R. Sternlight has now persuaded me that, when it comes to flattery, attention from a respected legal scholar beats imitation by a mile.

In "Protecting Franchisees from Abusive Arbitration Clauses," her article in the Fall 2000 issue of the Franchise Law Journal, Professor Sternlight used two of my articles in this publication to tee up a wide-ranging critique of franchise agreement arbitration clauses. She wrote that "many franchisees . . . do not comprehend the full implications of accepting an arbitration clause" and "may not entirely understand what arbitration is."2 Conceding that she had no facts to support this thesis,3 Professor Sternlight mixed a pinch of economic jargon with a dash of social psychology to confect the blithe recommendation that "franchisees and their attorneys who determine that a particular arbitration clause is disadvantageous . . . search out legal arguments that might be used to void the clause."4 Later in the article, she catalogued a raft of doctrines that will supposedly serve that end.5 And although she acknowledged the absence of empirical evidence that franchisees need additional statutory protection—especially from arbitration—Professor Sternlight also endorsed state and federal "legislative reform."6

Jean Sternlight is a prolific writer, admirable scholar, and zealous advocate of her views. With all respect, however, those views are unsound, and Professor Sternlight’s advice to franchisee counsel imprudently downplays the applicable precedent and ignores crucial facts about the real worlds of franchising and arbitration.

I have already written at length on the issues that Professor Sternlight addressed,7 and in any event, the constraints of this column do not allow wholesale dissection of her article. But several particularly troubling features of her analysis require comment.

Professor Sternlight is correct that courts have refused to enforce arbitration clauses in certain consumer and employment contracts, especially when arbitration would prevent the consumer/employee "from vindicating specific statutory rights."8 She is wide of the mark, however, when she suggests that franchisee counsel should rely on this authority in attacking arbitration agreements, for even courts deciding these consumer/employee cases have expressly distinguished them from franchise disputes. In a consumer arbitration decision recently reversed in part for other reasons by the U.S. Supreme Court, for example, the Eleventh Circuit refused to follow two Second Circuit decisions enforcing arbitration clauses, precisely because they "arose in the context of a commercial franchise agreement, not a small consumer transaction or an employment agreement."9

As an Illinois appellate court recently observed, franchisees are not "vulnerable or helpless" workers or consumers.10 They are businesspeople who have decided to seize entrepreneurial opportunities. In our free society, opportunities entail choice, and the responsibilities that accompany choices made. To state the obvious, nobody is forced to become a franchisee at all, let alone in any particular system. Owning an independent business and working as someone else’s employee are always among the potential franchisee’s other options.

Within franchising, moreover, there is enormous variety in the industries, business formats, operating standards, initial costs, continuing expenses, franchisor support, and other material characteristics of different systems. Almost all systems, including those with relatively low barriers to entry, require a significant financial investment. Each person considering that investment, and the commitment of time and energy necessary to make any franchise a success, is able to appraise competing franchise offerings in full—the entire, integrated business concepts—and to perform his or her own calculus of each system’s benefits, burdens, and potential economic rewards.

One of the many factors in the precontract decision-making mix is a franchise system’s dispute resolution approach, which can never be kept secret. The FTC Rule and UFOC guidelines mandate a detailed listing of all lawsuits, counterclaims, and arbitrations brought against the franchisor. If a matter is decided against the franchisor, or settled in a manner adverse to the franchisor’s interest, it must stay in the disclosure document for ten years. In addition, the franchise agreement’s dispute resolution terms receive prominent disclosure in the UFOC.

Professor Sternlight cites a study (not yet published) by Professor Chris Drahozal of the Kansas University Law School, of the UFOCs and franchise agreements that "seventy-five leading franchisors" filed with the State of Minnesota.11 Professor Drahozal found that 45 percent of the contracts included an arbitration clause. To Professor Sternlight, this statistic confirms that franchisees need new protection from the insidious forward march of arbitration. If Professor Drahozal’s survey proves anything, however, it is that the extraordinary array of choice in franchising extends to dispute resolution. There are many different forms of franchise agreement arbitration clauses, and more damning still to Professor Sternlight’s thesis, the majority of the contracts studied (including those for many of the best-known franchising brands) did not have arbitration clauses.

The notion that franchisees should not be expected to read and understand contracts before signing them is squarely at odds with the fundamental expectations of the franchise relationship—not to mention with centuries of well-reasoned American jurisprudence. Why should a franchisee, who purchased a business after deciding that the potential rewards justified the inherent risks, be free to walk away from contractual promises? Even in the typical consumer arbitration case, traditional contract principles should still govern. In Hill v. Gateway 2000,12 a unanimous Seventh Circuit panel (Judge Easterbrook writing) tartly rejected a challenge to an arbitration clause that was included in the standard terms and conditions shipped to the plaintiffs for the first time along with their home computer and software:

The Hills say that the arbitration clause did not stand out: they concede noticing the statement of terms but deny reading it closely enough to discover the agreement to arbitrate, and they ask us to conclude that they therefore may go to court. Yet an agreement to arbitrate must be enforced "save upon such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C. § 2. Doctor’s Associates, Inc. v. Casarotto, 134 L. Ed. 2d 902, 116 S. Ct. 1652 (1996), holds that this provision [ 3] of the Federal Arbitration Act is inconsistent with any requirement that an arbitration clause be prominent. A contract need not be read to be effective; people who accept take the risk that the unread terms may in retrospect prove unwelcome. Terms inside Gateway’s box stand or fall together. If they constitute the parties’ contract because the Hills had an opportunity to return the computer after reading them, then all must be enforced.13

Judge Easterbrook’s reasoning obviously applies with even greater force to the business relationship of a franchise, especially given the now venerable presale disclosure requirements of state and federal franchise law.

Under traditional contract principles and existing franchise statutes and regulations, wise counsel to prospective franchisees is very simple: Before you sign the contract, take full advantage of the disclosure laws and all the information available to you. Investigate, consult trained advisors, assess the risks and rewards, and understand both your rights and obligations. Once you have signed, unless there is objective proof that you were not in your right mind, or were genuinely the victim of fraud, coercion, or duress—keep your promises.

Professor Sternlight, it seems, would add (at least for franchisees and others she perceives as vulnerable) another ground for invalidating contract provisions: "the clause is disadvantageous."14 No doubt she understands, however, that stated so baldly this proposition is unlikely to fare well in court; she therefore urges lawyers representing franchisees to garb it in a rich array of legal finery, including arcane doctrines like Rooker-Feldman and "various types of abstention," in an effort to parry franchisor attempts to enforce arbitration clauses.

Unfortunately, she neglects to mention one key fact: if you burden courts, waste your own time, and waste your client’s (or your own) money pursuing such a course, there is an overwhelming probability that you will lose.15

Nowhere in her text does Professor Sternlight even acknowledge, much less confront and try to overcome, all the precedent rejecting so resoundingly her theoretical bases for attacking arbitration agreements and thwarting franchisor suits to enforce those agreements. If you represent franchisees and find yourself beguiled by her advice, do yourself and your clients a favor: read the decisions cited in the next footnote.16

Finally, Professor Sternlight clearly assumes that a franchisee can almost never get a fair hearing and a just result in arbitration, especially if it happens in the franchisor’s home forum. She should spend some time talking to all the franchisors and their counsel who regard arbitration with a heartfelt blend of disdain and horror.

These arbitration skeptics speak from experience—the experience, among other things, of:

• No meaningful discovery
  
• No dispositive motions
  
• No rules of evidence
  
• Arbitrators fear that excluding evidence subjects the award to challenge, so that every piece of the franchisee's case comes in
  
• Arbitrators who earn their living as plaintiffs' lawyers, dislike big business, and cut the little guy (and his cousin) great slack
  
• Arbitrators less concerned with the law than with "doing equity" by their own lights
  
• The likelihood of arbitrator-imposed settlements, in the form of dissatisfying compromise awards
  
• No meaningful appellate review17

Experienced franchisee lawyers understand that each of these perceived drawbacks for franchisors often has a corollary benefit for franchisees,18 and that arbitration can be an especially hospitable forum when the goal is to avoid getting hung up on technical legal concepts (e.g., the actual contract terms) and to focus on what feels "fair."

This is not merely a theoretical construct to compete with Professor Sternlight’s. There is timely real world proof of my point. Elsewhere in this issue are two articles discussing the path-breaking award in the Drug Emporium Internet encroachment arbitration. The franchisee claimants there prevailed against a large, publicly traded company represented by one of America’s most prestigious law firms. In recent years, moreover, as many courts have driven the covenant of good faith and fair dealing toward the margin of franchise litigation, arbitrators in several prominent franchise disputes have warmly embraced it, awarding claimant franchisees substantial damages for franchisor breach of the covenant.19

My parting messages? To all you franchisee attorneys out there: understand the hurdles your clients face if they try to avoid arbitration, and consider that arbitration may in fact afford meaningful advantages over litigation, in time, expense, and outcome.

To Jean Sternlight: many thanks for your thought-provoking contribution to the Journal. As I hope this column makes clear, your flattery turned my head, but your arguments haven’t changed my mind.

1. In the original, "imitation is the sincerest of flattery." John Bartlett, Familiar Quotations 393 (Justin Kaplan ed., 16th ed.1992).

2. Jean R. Sternlight, Protecting Franchisees from Abusive Arbitration Clauses, 20 Franchise L.J. 45, 70 (2000).

3. "In the end, only empirical investigations will yield conclusive answers to such questions as what the typical characteristics of franchises are, what impact arbitration clauses have on franchisors and franchisees, and whether seemingly unfair clauses actually benefit franchisees as well as franchisors. But, lacking such information, which is not likely forthcoming, we will all need to make our own best judgments." Id.

4. Id. (emphasis added).

5. Id. at 72–76.

6. Id. at 76.

7. See Edward Wood Dunham, Enforcing Contract Clauses Designed to Minimize Franchisor Risk, 19 Franchise L.J. 91 (2000); Edward Wood Dunham, et al., Franchisor Attempts to Control the Dispute Resolution Forum: Why the Federal Arbitration Act Trumps the New Jersey Supreme Court’s Decisions in Kubis, 29 Rutgers L.J. 237 (1998); Edward Wood Dunham, The Arbitration Clause as a Class-Action Shield, 16 Franchise L.J. 141 (1997); Mark Kravitz and Edward Wood Dunham, Compelling Arbitration, Litigation, Fall 1996.

8. Randolph Green Tree Financial Corp.—Alabama, 178 F.3d, 1149, 1159 (11th Cir. 1999), aff’d in part and rev’d in part, No. 99-1235, 2000 WL 180319 (U.S. Dec. 11, 2000).

9. Id. The Eleventh Circuit distinguished Doctor’s Associates, Inc. (DAI) v. Stuart, 85 F.3d 975 (2d Cir. 1996) and DAI v. Hamilton, 150 F.3d 157 (2d Cir. 1998), cert. denied, 525 U.S. 1103 (1999) in which the Second Circuit rejected, among other things, claims that the arbitration clause in the Subway franchise agreement was unconscionable. Mr. Dunham represented DAI in both cases.

10. Bishop v. We Care Hair Development Corp., No. 1–00–0528, 2000 WL 1459799, at 10 (Ill. App. Ct. Sept. 29, 2000) (citing We Care Hair Development, Inc. v. Engen, 180 F.3d 838, 843 (7th Cir. 1999)). Mr. Dunham represented the defendants in Bishop and the plaintiff in Engen.

11. This article is scheduled to appear in the University of Illinois Law Review in 2001. Professor Drahozal was kind enough to furnish the author a copy.

12. Hill v. Gateway, 105 F.3d 1147 (7th Cir. 1997).

13. Id. at 1148. See also Johnson v. West Suburban Bank, 225 F.3d 366, 376–78 (3d Cir. 2000) (holding that consumer claims under Truth in Lending Act and Electronic Fund Transfer Act were arbitrable, even though this might make class actions to pursue statutory claims unavailable).

14. Sternlight, supra note 3, at 70. This is not a variant on the theory of "efficient breach," which recognizes that a party to a contract may decide to breach when performance would be economically disadvantageous. That theory still recognizes the breach, whatever its efficiencies, and the breaching party is still liable for damages. (Indeed, the party’s efficiency analysis must compare the costs of breach, including likely damages, to the costs of contract compliance.) In sharp contrast, Professor Sternlight posits voiding the arbitration clause, liberating the franchisee entirely from the consequences of her contractual undertaking.

15. Lawyers who stray too far from existing law as they "search out" ways to avoid arbitration can also get themselves sanctioned. See, e.g., Doctor’s Associates, Inc. v. Kroll, Nos. 95–7804 and 96–7048 (2d Cir. Apr. 29, 1996); see also Weible v. Doctor’s Associates, Inc., Bus. Franchise Guide (CCH) ¶ 11,062 (Cal. Ct. App. Nov. 27, 1996). The author represented the franchisor in both these cases.

16. See, e.g., Doctor’s Associates, Inc. (DAI) v. Jabush, 89 F.3d 109 (2d Cir. 1996) (rejecting unconscionability defense); DAI v. Stuart, 85 F.3d 975 (2d Cir. 1996) (rejecting unconscionability and fraud defenses as well as right to a jury trial under FAA); DAI v. Hamilton, 150 F.3d 157 (2d Cir. 1998), cert. denied, 525 U.S. 1103 (1999) (rejecting attack on forum selection clause in arbitration agreement); DAI v. Distajo, 107 F.3d 126 (2d Cir.), cert. denied, 522 U.S. 948 (1997) (Distajo II) (rejecting Rooker-Feldman and various abstention doctrines); DAI v. Hollingsworth, 949 F. Supp. 77 (D. Conn. 1996), aff’d, No. 96–9599 (2d Cir. Feb. 5, 1998) (blocking class action); Subway Equipment Leasing Corp. v. Forte, 169 F.3d 324 (5th Cir. 1999) (rejecting waiver defense). Mr. Dunham represented DAI in each of these cases.

17. With all these flaws, why would any franchisor even consider arbitration? Because, in this imperfect world, it may well beat the alternative. For a discussion of the reasons why, see Edward Wood Dunham, et al., Franchisor Attempts to Control the Dispute Resolution Forum: Why the Federal Arbitration Act Trumps the New Jersey Supreme Court’s Decisions in Kubis, 29 Rutgers L.J. 237, 270 (1998).

18. For example, in most arbitrations, franchisors are unable to tie up franchisees with burdensome, expensive discovery, and the chances of the franchisor knocking the case out with a motion to dismiss or summary judgment motion are vanishingly small.

19. See, e.g., Matter of the Arbitration between Rose Equipment, Inc. and Freightliner Corp. (Oct. 5, 1999) (Phillips, Arb.) (arbitrator awarded $819,550 for breach of implied covenant of good faith and fair dealing); Matter of the Arbitration between Handlebar Cycle, Inc. and Polaris Indus., Inc., No. 56 181 0014098 (American Arbitration Association Sept. 15, 1999) (Hergott, Arb.) (arbitrator awarded $175,750 plus attorneys’ fees and costs of $93,248 for breach of implied covenant of good faith and fair dealing); Matter of the Arbitration between Brown’s Tractor, et al. and Fiat Tractor North American Operations, et al., Bus. Franchise Guide (CCH) ¶ 11,539 (American Arbitration Association Nov. 6, 1998) (Subak, Arb.) (arbitrator awarded $1,187,997 plus $240,143 in attorneys’ fees and costs).

Edward Wood Dunham is Editor-in-Chief of the Franchise Law Journal. This column expresses Mr. Dunham’s personal opinions and does not reflect the viewpoint of the ABA Forum on Franchising or the Franchise Law Journal.