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Arbitation Clauses: Do They Make Sense in Franchise Agreements?

September 01, 2003

Litigation of franchise disputes, like litigation in general, can be expensive, frustrating, lengthy and inefficient. Arbitration, a form of alternative dispute resolution, is becoming an increasingly popular alternative for avoiding litigation altogether. But do arbitration clauses in franchise agreements make sense for franchisors?

Arbitration is, in essence, a legal process that takes place outside of the court system, yet results nonetheless in a final and legally binding decision similar to a court judgment. It can offer a franchisor many benefits. By agreeing in the franchise agreement to arbitrate the disputes, a franchisor can have its dispute with a franchisee resolved by a neutral third party arbitrator, usually experienced in the subject matter, in a faster, less expensive and more informal proceeding than going to court. And it also has the advantage of being private and confidential, unlike legal proceedings.

But other considerations need also to be weighed by franchisors. Including an arbitration clause in a franchise agreement may not make sense where a franchisor believes the franchisee will be less able to withstand expensive and protractive litigation, thus giving the franchisor added leverage over a franchisee through court litigation. An especially important consideration for franchisors, moreover, are the in-term and post-term covenants not to compete that prohibit franchisees from operating, directly or indirectly, competing businesses. These covenants can only be enforced through court-issued temporary restraining orders and injunctions –– remedies typically not available in the arbitration proceedings. Unless specifically carved out of the arbitration clause, these types of remedies would be deemed waived by the parties, leaving only a money damage claim to be arbitrated. Thus, if electing to include an arbitration clause in a franchise agreement, the franchisor must ensure that the arbitration clause provides an exception for injunctive remedies, stating that the parties may seek to obtain court issued injunctions, while arbitration proceedings are pending, to enforce certain provisions of the franchise agreement.

A variety of other factors –– like selection of the arbitrator, prohibiting awards of punitive damages, the sharing of expenses of the arbitrator, and how much discovery should be employed in an arbitration proceeding –– also enter into the equation. Ultimately, a franchisor should consult counsel in deciding whether an arbitration clause is in its best interests, and, if so, what type of arbitration clause makes the most sense.

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