Many franchise agreements contain “mandatory arbitration” clauses that require the parties to use private arbitration – as opposed to the court system – to resolve legal disputes between them.  If you’re a franchisee who has signed a contract containing that provision, you’re probably stuck with it.  In short, the Federal Arbitration Act favors the enforcement of contractual agreements to arbitrate (as do some similar state laws).  While reasonable minds can and do differ as to the fairness of mandatory arbitration, I’m in the camp that finds it unfair to franchisees. 

Proponents of arbitration often argue that it is more “streamlined,” more efficient, and less costly than court litigation.  The first two points are accurate, as arbitration usually involves fewer procedural niceties, less discovery, fewer motions, quicker resolution of the motions that do exist, and a shorter wait between the time that the action is initiated and the ultimate hearing date.

The third point, however, is debatable and likely depends on the circumstances.  Whereas the streamlined approach might result in savings of fees and resources that might have been devoted to the litigation process, the fact remains that, in addition to paying their own attorneys, the parties must pay the arbitrator for his or her time learning the case, addressing motions, attending the hearing, and issuing a decision.  (The arbitrator compensation issue becomes even more pronounced in those circumstances where the parties have agreed to a panel of two or more arbitrators.)  Further, to the extent that a third party arbitration service such as the American Arbitration Association (“AAA”) is involved, the parties also must pay sometimes significant administrative fees to the service.  In contrast, judges and the courts are essentially “free” to the litigants.  Finally, whereas court litigation will usually settle before trial, arbitrations tend to proceed through the entire evidentiary hearing.

Nonetheless, my main quarrel is not with arbitration in general, but as applied in the inherently unequal franchisor-franchisee context.  There are reasons that some franchisors not only favor arbitration, but love the concept so much that they’re willing to fight tooth and nail to require it.  Of course, they’ll typically cite some of the arguments set forth above – and perhaps sincerely believe those arguments – but conveniently fail to mention that it gives them even more advantages over franchisees than they’d otherwise have.

There are at least two glaring ways in which mandatory arbitration unfairly favors franchisors.  First, the “streamlined” and “efficient” nature of arbitration is not necessarily a benefit for the franchisee – unless the franchisee prioritizes promptness and efficiency over a chance to actually prevail.  In short, the corners cut by arbitration largely involve discovery – the pre-hearing fact-finding process involving depositions, interrogatories (written questions that are answered under oath), and the exchange of documents.  The franchisee often needs discovery to establish important claims and defenses such as fraud, and he/she/it usually would be entitled to substantial amounts of it in court proceedings.  The franchisor, in contrast, usually would rather see the case decided on little other than the “plain language” of the one-sided Franchise Agreement that it wrote for its own benefit, and its own self-generated, cherry-picked documentation of the franchisee’s alleged failures.  Through the “streamlined” arbitration discovery process, the franchisor is usually able to accomplish this goal.  (In some cases, in fact, the franchisor even forces the franchisee, through its mandatory arbitration provision, to agree that no discovery will be exchanged unless mutually agreed to by the parties – and then withholds its agreement.)

Second, although arbitrators used by organizations such as AAA are often upstanding, well-meaning, and intelligent people, the truth remains that the pool of potential arbitrators is not nearly as balanced as a reasonable franchisee might hope.  A disproportionate number of them come from the types of large law firms that typically represent enormous companies and therefore have a conscious or subconscious pro-franchisor, “strict-reading-of-the-contract” bias.  Again, since the Franchise Agreement was written by and for the franchisor, this approach is bad news for the franchisee.

If you’re considering a new franchise opportunity, be aware of mandatory arbitration clauses.  If you’re an existing franchisee who already agreed to mandatory arbitration, understand the drawbacks and limitations when evaluating disputes with your franchisor.