The ins and outs of franchise arbitration: what parties to a franchise arbitration agreement need to know

Similarities Between Arbitration and a Court Proceeding

There are some basic similarities between arbitration and a court proceeding.  At their core, both methods will likely have at least three fundamental phases:

• claim and response/defence;
• discovery of documents (and potentially witness examination), and
• the hearing or trial.

This will apply to all types of franchise disputes, such as rescission, breach of contract, and non-competition claims.

Like in court, the arbitrator’s decision is binding and has the same effect as a decision of a judge in court.

An arbitrator also has the power (unless provided otherwise in the arbitration agreement) to rule on any urgent injunction application that the franchisor or franchisee may bring for some interim measure before the full hearing of the case.  Types of injunction applications include, for example, a franchisor’s application to enforce a non-compete covenant after termination, and a franchisee’s application to restrain a franchisor from terminating the franchise agreement.

Differences Between Arbitration and a Court Proceeding

Arbitration is usually confidential, and unlike in court, it is not open to the public.  This can be favourable to the franchisor, in keeping the case confidential and avoiding damage to its goodwill with other franchisees and the public.  Conversely, it can take away a deterrence factor that a franchisee may have in a court proceeding, which is the public nature of court cases and the inherent risk of negative publicity for the franchisor from the case (unless of course the franchisor wins the case!).

Subject to official rules that may be set out in the arbitration agreement, the process and steps in an arbitration can be highly customizable. The parties involved in the dispute can control the process and design it to meet their needs.  If they cannot agree on the process, the arbitrator will designate the process and steps, or whatever elements are left in dispute.  This involves the discovery process, the steps in the case from the beginning to the final hearing, the evidence, and the entire timeline.

The ability to customize the arbitration process can be an advantage to a court proceeding, which has elaborate and structured “one-size-fits-all” rules and procedure, and can be unnecessarily complicated and time-consuming.  Most local franchise arbitrations will have relatively relaxed rules of evidence and procedure.  Both parties will still present their evidence, witnesses, and arguments, but in a more limited and streamlined process.

Another related benefit that arbitration has over a court proceeding is the timeliness of the case from start to finish.  The relaxed rules and procedures, and the ability to control the timeline of the case, can allow arbitration cases to proceed much faster than a court case.  The scheduling of steps and hearings in front of the arbitrator are only subject to the availability of the lawyers, the parties, and the arbitrator.

Except for cases where either franchisor or franchisee perceives delay as a tactical advantage after termination of the franchise agreement, where the parties are still in the franchise relationship, a speedier resolution to a franchise case will benefit both franchisor and franchisee because of the ongoing long-term franchise relationship.  Even after termination of the franchise agreement, both parties will usually prefer to reach final resolution and move on with their affairs in a timely manner.  Arbitration is very suitable for these circumstances, in its ability to deliver finality relatively quickly.

This is very different from court, where scheduling any hearing can take many months, and scheduling a trial hearing can take years.  In contrast, arbitration can take a few months or a year from beginning to end, depending on the complexity of the case and the steps that the parties agree to. This arbitration process can fast track the resolution of a franchise dispute to the benefit of all parties.  This process can also result in reduce legal fees.

Arbitrator Fees and Recovery of Costs

While a simpler arbitration procedure will likely shorten the timeline of the case from start to finish, and possibly reduced legal fees, arbitration does come with the cost of the arbitrator’s fees.  In franchise disputes, this can sometimes put a financial strain on the franchisee whose resources are typically more constrained than the franchisor’s.

The parties usually split the arbitrator’s fees in advance.  These fees can be significant – on average about $850/hour for an experienced local arbitrator.  The arbitrator’s time includes presiding over the hearing, preparation, and writing the reasons for decisions.  They will also be compensated for travel time and expenses if travel to a different city or province is required.

In arbitration, a successful party may be entitled to receive a costs award for a significant part of its legal fees and all its arbitration fees.  Conversely, the defeated party can be liable for a great share of the other side’s legal fees, and the other side’s arbitration fees.  This is on top of the party’s own legal fees and its share of the arbitration fees.  Because of the usual unequal financial footing between a franchisor and franchisee, a franchisee can face severe financial repercussions from a lost arbitration.  The same general principle applies in court where the unsuccessful party is generally liable for a share of the successful party’s legal costs.  However, the recovered share of legal fees in arbitration can be much higher than in court proceeding, so arbitration cases tend to produce more of a “winner take all” result.

Choice of Arbitrator with Experience in Franchise Disputes

An arbitrator must of course be impartial.  It is also important that the arbitrator understand both sides of the franchise dispute.  A key advantage of arbitration in franchise disputes is the ability to select an arbitrator (depending on what is required in the arbitration agreement, which is normally contained within the franchise agreement).  That is a significant difference from court where judges are generalists who preside over all types of court disputes, including criminal, personal injury, family law, etc.  A judge assigned to hear a franchise dispute may possible have limited or even no prior experience with franchise cases and franchise law.  While judges in Canadian courts obviously have a high level of competence across the board, given the increasingly complex nature of franchise law, parties to a franchise dispute will benefit from the opportunity to select an arbitrator with knowledge of franchise law and deep experience in franchise disputes.

Franchise Disputes Involving Non-signatories of the Arbitration Agreement

There are various circumstances where an arbitration agreement contained inside a franchise agreement may be legally unenforceable.  Typical scenarios may include requirements on the selection of the arbitrator or the arbitration rules, for example, that are ambiguous and thus impossible to ascertain or enforce.  More unique to franchise disputes are scenarios involving “non-signatory” parties who are technically not bound by the arbitration agreement.  A franchise dispute can involve parties who did not sign the franchise agreement and, therefore, who had never agreed to an arbitration.

On the franchisee’s side, franchise disputes can involve the franchisee’s spouse, guarantor, or partner.  For example, a non-competition injunction application may be brought against people affiliated with the franchisee who are non-signatories of the franchise agreement.

On the franchisor’s side, franchise disputes can involve principals of the franchisors or affiliated companies.  For example, a rescission claim against a franchisor and its associates may include non-signatory defendants.

In these circumstances, it is possible that the case cannot proceed by arbitration, even if the franchise agreement requires arbitration of all disputes, since the case involves non-signatories who cannot be bound to the arbitration agreement.

Choice of Law and Venue Clauses

Franchise agreements drafted by US-based franchisors may require that an arbitration be governed by the laws of the state where the franchisor’s head office is located and that the hearing of the arbitration take place in that jurisdiction.  This can also happen in Canada, where the franchisor is based in another province and the arbitration agreement purports to apply the laws of that other province and to require that the hearing take place there. This normally is drafted to favour the franchisor.

However, the franchise legislation in Canada typically requires that any claim that is governed under that legislation – these are franchise disputes about disclosure, good faith and the franchisee’s right to associate with other franchisees – must be governed by the laws of the province.  Similarly in these cases, the venue of the hearing must be in the province where the franchised business is located.

For other franchise disputes that are not covered under franchise legislation, such as those limited to breaches of the franchise agreement and termination, it is permissible for a franchisor to require that the dispute be governed by the laws of another jurisdiction or to be heard in that jurisdiction.

Conclusion

Arbitration of a franchise disputes has unique advantages and some potential disadvantages to litigating a franchise case in court.  It can be a more expedient method of resolving a franchise dispute due to its relative informality and the ability to control the scheduling process.  It can also be heard by a qualified arbitrator with experience in franchise disputes.  That can benefit both sides to a franchise dispute.  Franchisors stand to benefit from the confidentiality requirement that can protect them from potentially harmful reputational and financial impacts.  There are also potentially significant arbitration fees that should be considered. Both franchisor and franchisees can benefit from the much more streamlined process and timely final resolution to a franchise dispute.