“You Made Your Bed, Now Lie In It!” Dickey’s BBQ And Franchisees Stuck Litigating And Arbitrating

August 26th, 2015

Takeaway: Before you enter a franchisee/franchisor agreement, try to devise an efficient and fair dispute resolution system so you don’t end up in this sticky situation.

Where and how a dispute between a franchisor and franchisee must be decided can have a major impact on the outcome of the case. Franchisees generally want the case to be decided in the court where they live and by a jury, while franchisors want it decided in their city and by a private arbitrator or a judge. State regulation of franchise sales intended to bolster franchisee’s rights on this issue can result in the franchisor and franchisee having to engage in both arbitration and court litigation in two different states. We explore how franchisors and franchisees might reasonably avoid that unwieldy situation.

The Maryland Securities Commissioner, as a condition of approving a registration, routinely requires franchisors to agree that its Maryland franchisees will have the right to bring a claim in a Maryland court for violation of the Maryland Franchise Registration & Disclosure Law (the “Franchise Law”) – even if the franchise agreement requires arbitration of all claims in the franchisor’s home state. However, what happens when a franchisor files an arbitration demand against a Maryland franchisee in its home state, and then the franchisee sues in a Maryland court alleging violation of the Franchise Law? In Chorley Enterprises, Inc. v. Dickey’s Barbecue Restaurants, Inc., the U.S. Court of Appeals for the Fourth Circuit ruled that the franchisor’s claims must be decided through arbitration in Texas, but the franchisees’ Franchise Law claims must be decided by a jury trial at the U.S. District Court in Baltimore.

The court’s reasoning was solid and logical. Dickey’s franchise agreement included a provision, specific to stores located in Maryland, stating that the franchisee had the right to sue in courts located in Maryland for claims arising under the Franchise Act. Otherwise, the agreement had a broad clause requiring arbitration of all claims arising from or related to the agreement or the parties’ relationship. The court noted that Dickey’s did not seek to obtain registration by the Maryland Securities Commissioner without including the litigation carve-out for Franchise Act claims, and it did not seek a court order declaring that the Securities Commissioner could not require such a carve-out from the arbitration provision. Instead, it chose to include the language typically required by the Securities Commissioner so that it could sell Maryland franchises. Accordingly, the court ruled that Dickey’s “made its own bed” and therefore would have to defend the Franchise Act claim in court.

However, the decision was not a clear victory for the franchisee. The next step in the dispute will be for the U.S. District Court judge to decide whether to delay the franchisees’ court case until the arbitration is completed in Texas. (The arbitration had been stayed pending the appeals court ruling.) If the court does so, then the franchisees will have to defend against Dickey’s claims in the arbitration and probably present their evidence showing that the Franchise Act violations, to convince the arbitrator that the franchise agreements are unenforceable. But win or lose in arbitration, to preserve their right to have a jury trial of their Franchise Act claims, the franchisee will have to present its case a second time in court to actually get a judgment against Dickey’s.
Is there a way to solve this mess going forward? Franchisors registering in Maryland probably should not include an addendum provision allowing franchisees to pursue Franchise Act claims in Maryland courts. If the Securities Commissioner demands that change, as is likely, then the franchisor should consider offering to agree that all claims (including Franchise Act claims) will be decided through arbitration, but the venue for arbitration will be in Maryland. The location of the dispute resolution is the big issue for franchisees, and having everything decided in one proceeding is ultimately to the benefit of both parties. Such a franchisor will benefit being able to avoid facing a franchisee group or class action in court and from having cases decided by arbitrators rather than court juries.

For most prospective franchisees, it would be best to negotiate away the right to bring a claim under the Franchise Act in Maryland court, if the franchisor will agree that all claims will be decided through arbitration conducted in or near Maryland. If dispute resolution is necessary, most franchisees will be better off not being stuck on “two tracks” and instead have all issues decided efficiently in a fairly convenient forum – even if that means giving up the right to have its “day in court.”

How To Tell If You Are “Doing Business” In A Foreign State And Why It Is Important To Know

August 19th, 2015

In our previous article on the Moe’s Southwest Grill case, posted June 16, 2015, we explained the importance of complying with state filing requirements to maintain limited liability status in any state where your company is regularly doing business. The case demonstrated how a failure to do so could cost your business the ability to protect its rights and have other substantial legal repercussions. Now, we take up the important question of what instate activities constitute “doing business” to require such state registration as a foreign entity.

What does it mean to “do business” in a state?

Generally, a business’s level of activity in a state is a good indicator of whether or not they would be considered “doing business” for state registration purposes. For some corporations, it can be obvious when their business is operating a store or shop to conduct regular business in a state, as was true for Moe’s Southwest Grill restaurant. For companies not engaged in traditional retail or service provision businesses, it may be more unclear when the blurry line between “doing business” and conducting minor transactions is crossed. It is important to be mindful of this opacity and take caution so that your business is prepared to make the necessary arrangements for compliance.

The March 4, 1988 decision by the Maryland Court of Special Appeals in J.C. Snavely & Sons, Inc. v. Wheeler, No. 963, Sept. Term, 1987, outlined the test that Maryland courts use to determine if a corporation is “doing business” in the state. The Court established that a foreign corporation is essentially doing business in any state where it “transacts some substantial part of its ordinary business.” Unlike the similar jurisdictional standard, the “doing business” standard for state registration purposes calls for more than mere business solicitation, it requires an extensive set of activities and management functions within the state. It may be difficult to determine whether your corporation meets this vague standard because the factors, and their relative weights, vary with unique circumstances on a case by case basis. The March 7, 1994 decision by the Maryland Court of Appeals in Tiller Const. Corp. v. Nadler, No. 126, Sept. Term, 1993, affirmed the test from the Snavely case and restated four factors that should be particularly examined among other various factual considerations.

  1. Whether the foreign corporation pays state taxes. This is often demonstrated through contracts with local suppliers where sales taxes are paid, or where substantial inventory is bought and paid for locally with local taxes paid.
  2. Whether it maintains property, an office, telephone listings, employees, agents, inventory, research and development facilities, and advertising and bank accounts in the state. Although it is definitely possible to “do business” in Maryland without satisfying everything on this list, courts will examine the extent to which the corporation does maintain the listed items because as a whole they may indicate either substantial business activities over a long period of time, as opposed to lesser or temporary transactions within the state.
  3. Whether it makes contracts in the state. Courts consider the number of contracts with instate entities and their respective lengths because a few occasional contracts do not sufficiently indicate that a corporation is regularly “doing business” in that state.
  4. Whether its management functions in the state are pervasive. If few or none of the corporation’s decisions are made in Maryland, the instate interactions may be more transactional than they are suggestive of “doing business.”

According to the Tiller case, Maryland’s laws for foreign corporations are not unique. Such considerations to determine if a corporation is “doing business” for state registration purposes are fairly typical throughout the United States, as they are seemingly based on the Model Business Corporation Act. While this issue for limited liability companies (“LLCs”) has not been analyzed in any Maryland cases, based on the similarity of treatment between corporations and LLCs in other contexts it is likely that Maryland courts would use the same or similar analysis should an LLC context a finding that it is doing business in the state.

Conclusion

It is important to know whether your corporation or LLC is “doing business” in a state to the extent that it must be registered as a foreign entity. Failure to register a limited liability entity that is doing business in a state can have considerable consequences, including the prohibition from bringing suit in the state’s courts. Maryland’s fairly typical approach to determine if a company is subject to such state filing requirements is to consider the unique circumstances of each entity, and make an evaluation based on the “nature and extent of the business and activities which occur in the forum state.” Since this is not a straightforward test, the four factors delineated in both the Snavely case and the Tiller case may be indicative of whether your entity would be considered “doing business” in a state.

Jenny Morris, a J.D. candidate Class of 2017 Georgetown University and a law clerk with WTP in 2015, contributed to the preparation of this article.