January 15, 2004

Arbitration Agreements and the Franchise Dispute: the Likely, the Unlikely and the Imponderable

Although arbitration clauses are increasingly common in franchise agreements, they continue to be viewed by drafters as mere boilerplate confined to the back pages of the franchise agreement.  Few agreements spell out the basic procedural rules needed to govern an actual dispute, or specify which disputes are exempted from the ambit of the arbitration.  As David Sterns writes in this article, most disputes over franchise arbitration clauses are as costly and frustrating as they are preventable so long as proper care is taken at the drafting stage.

Arbitration agreements are an increasing fact of life in franchise relationships[1].  But even as Canadian franchisors and franchisees amass greater experience with arbitration as a means of dispute resolution, arbitration clauses are still too often viewed as “boilerplate”.  From the drafter’s standpoint, the desire to draft a compendious franchise agreement means that arbitration clauses are kept to the bare minimum and are relegated to the “Miscellaneous” section of the franchise agreement.  As a result, few agreements carefully define which disputes are subject to or exempt from arbitration, and even fewer speak to the manner in which arbitrators are selected.  Once the relationship sours, it is surprising to find just how costly and frustrating a deficient arbitration agreement can be to all parties.  A poorly drawn arbitration agreement can actually render arbitration a more costly and less timely process than traditional litigation.

Advantages of Arbitration Clauses in Franchise Agreements

Conventional wisdom holds that it is generally in a franchisor’s interest to insist on an arbitration clause in a franchise agreement.  While there can be little doubt that arbitration offers many advantages over conventional litigation, the decision of whether or not to include an arbitration clause, and how it should be drafted, should proceed from a careful analysis of the pros and cons.  The most obvious advantage which arbitration offers over traditional litigation is its relative speed.  If the arbitration agreement specifies a method of appointment, an arbitrator can be appointed within days and a hearing convened long before a trial date would otherwise be available.  The ability to tailor the proceeding to the nature of the dispute means that the length of a hearing can be restricted so that it bears some proportion to the amount in dispute.  The arbitrator can also be compelled to render an award within a fixed period of time, thus avoiding the long periods of reserve which can slow down the litigation process.  In addition, the parties can choose to render any decision of the arbitrator final thereby eliminating appeal delays from the process.

Another welcome feature of most arbitration Rules is that they generally require arbitrations to be conducted in private, away from the prying eyes of media, the general public and other franchisees.[2] The arbitral decision itself can be rendered confidential so long as neither side appeals the decision to the courts.  In this way, an adverse arbitration award which is not appealed will generally have little or no precedential value for other franchisees in the system and will therefore not adversely affect the franchisor’s relations with its other franchisees.

Arbitrations also tend to be less procedure-driven than traditional litigation.  Parties can agree to any number of procedural shortcuts.  In appropriate cases, an arbitrator can be directed to summarily decide the dispute based solely on a written record, or place strict limits on the duration of oral evidence.  Pre-arbitration hearings and motions are typically conducted by phone without the need for lengthy affidavits and facta.  Discovery rights and obligations are also less expansive than under the rules of civil procedure.  All of this amounts to substantial cost savings for both sides.  Because of its more relaxed rules and faster timelines, arbitration is generally considered the forum of choice when parties are engaged in an ongoing relationship and must deal with each other every day.  Arbitration places the focus on the substantive issues and resumption of normal business relations rather than on costly procedural wrangling.

A further benefit of arbitration agreements to franchisors is that they may in some cases prevent franchisees from bringing a class action.[3] While this consideration might not have been a factor when many franchise agreements currently in circulation were drafted, class actions have evolved considerably within the past few years.  The rise of class actions in Canada may give rise to a renewed interest in arbitration agreements as a potential shield for the franchisor.[4]

While the advantages of speed and efficiency apply equally to the franchisee, many practitioners believe that arbitration does not favour the franchisee to nearly the same extent as it favours the franchisor. Many franchisees, for instance, instinctively feel that litigation conducted in the public eye is preferable to arbitration conducted behind closed doors.  The public forum offers the franchisee the possibility to counter the franchisor’s superior financial resources with adverse publicity or the prospect of a bad legal precedent. Franchisees also quickly become aware that courts are taxpayer-funded while the costs of an arbitrator must be paid upfront by the parties.

In reality though, the primary drawback of arbitration for franchisees is that it offers more limited rights of discovery than traditional litigation. Broad discovery is of greater concern to the franchisee than the franchisor since the franchisor usually possesses the information which the franchisee needs to establish liability. For the franchisee, the ability to access a judge and seek sanctions if the franchisor is not complying with its discovery obligations is critical to its ability to prove its case. A franchisee will likely be dissuaded from advancing an ambitious counterclaim in response to a Notice of Arbitration if it knows that its discovery rights will be severely curtailed.