Tag: court

Courts Enforce Waivers of Class Actions in Arbitration By Franchisees, Employees and Small Businesses

July 18th, 2013

In 1925, the Federal Arbitration Act (“FAA”) was enacted to strengthen the ability of parties to enforce “purely voluntary” pre-dispute promises to have disputes determined through arbitration. See, e.g., David S. Clancy & Matthew M.K. Stein, An Uninvited Guest: Class Arbitration and the Federal Arbitration Act’s Legislative History, 63 Bus. Law. 55, 60-61 (Nov. 2007). In the decades since, countless federal and state statutes have been passed to protect consumers, employees, franchisees, small businesses and investors, and class and collective lawsuits have developed as an avenue to vindicate those statutory rights. In response, companies have used arbitration clauses to decrease the risks of having to defend against such large potential liabilities. Recent decisions by both the U.S. Court of Appeals for the Fourth Circuit and the U.S. Supreme Court have emphasized that, if the arbitration clause clearly bars class or collective actions, then the FAA precludes parties to the agreement from pursuing a class or group action through court or arbitration. This established trend of statutory interpretation also may be increasing the possibility of that the U.S. Congress will pass the “Arbitration Fairness Act” to limit companies’ ability to use arbitration clauses as a bar to collective legal actions.

Shuttle Express Case – Fourth Circuit

In the case of Muriithi v. Shuttle Express, Inc., issued April 1, 2013, the U.S. Court of Appeals for the Fourth Circuit required individual arbitration of claims due to a franchise agreement’s inclusion of an arbitration clause 1) forbidding any class or group actions, 2) requiring the parties to split the cost of arbitration, and 3) containing a one-year limitations provision.

Plaintiff Samuel Muriithi was a driver for defendant Shuttle Express, who provided transportation for passengers to and from the Baltimore-Washington International Airport. Muriithi filed a class action in federal court against Shuttle Express asserting claims under the federal Fair Labor Standards Act (FLSA) and under Maryland law on behalf of himself and all other Shuttle Express drivers. Muriihi alleged that Shuttle Express misled the drivers about the compensation they would earn, inducing them to sign franchise agreements when they would be employees as a matter of law. Shuttle Express moved to dismiss the complaint, or in the alternative, to compel arbitration under the arbitration provision. The district court refused to compel arbitration on the grounds that the agreement contained three unconscionable provisions, which rendered the arbitration clause unenforceable. On appeal, the Fourth Circuit reversed the district court’s decision, holding that all three provisions at issue were not unconscionable and, therefore, the arbitration clause was enforceable.

In addressing the enforceability of the class action waiver, the Fourth Circuit rejected the district court’s decision, which identified the class action waiver as a factor in preventing Muriihi from “fully vindicating his statutory rights.” The Fourth Circuit explained that, subsequent to the district court’s decision, the U.S. Supreme Court addressed the issue of class action waivers in AT&T Mobility LLV v. Concepcion, 131 S. Ct. 1740 (2011). According to the court, the FAA, as interpreted in the Concepcion decision and prior Supreme Court rulings, “prohibited courts from altering otherwise valid arbitration agreements by applying the doctrine of unconscionability to eliminate a term barring classwide procedures.” Because the district court reached an opposite conclusion prior to Concepcion, the Fourth Circuit reversed the district court’s decision, finding the class action waiver enforceable.

The Fourth Circuit then addressed the enforceability of the fee-splitting provision. The court found that Muriithi failed to meet his “substantial” burden of showing the likelihood of incurring prohibitive costs as required to invalidate an arbitration agreement. The court explained that a fee-splitting provision has the ability to render an arbitration agreement unenforceable if the arbitration costs are “so prohibitive as to effectively deny the employee access to the arbitral forum.” According to the court, a number of factors are considered when determining prohibitive costs including, “the costs and fees of arbitration, the claimant’s ability to pay, the value of the claim, and the difference between arbitration and litigation.” The court concluded that Muriithi did not meet his substantial burden for proving prohibitive costs because he failed to show the costs of arbitration, “the most basic element” of the challenge. The court further explained that Muriihi could not meet his burden “simply by showing the fees that some arbitrators are charging somewhere.” Muriithi also failed to show the value of his claims, which were necessary to determine the fees under the American Arbitration Association’s rules. Because Murihhi failed to prove these “critical factors”, the Fourth Circuit concluded that he had failed to meet the substantial burden required for a finding of prohibitive costs.

Finally, the Fourth Circuit held that the one-year limitations provision could not be considered in a motion to compel arbitration because it was “not referenced in the Arbitration Clause.” The court referred to Section 2 of the FAA, which states that a party challenging the enforceability of an arbitration clause must rely on grounds that “relate specifically to the arbitration clause and not just to the contract as a whole.” The court stated that the one-year limitations provision related to the general agreement itself rather than the arbitration clause because the language and terms of the provision “did not overlap” with the language of contract’s arbitration clause. Therefore, its enforceability was an issue to be decided by the arbitrator and could not be considered in the motion to compel arbitration.

American Express Antitrust Case – U.S. Supreme Court

In American Express Co. v. Italian Colors Restaurant, No. 12-133 (June 20, 2013), the U.S. Supreme Court, by a 5-4 majority, held that the prohibitively high cost of pursuing an individual claim is not a sufficient reason to invalidate a class action waiver in an arbitration agreement. This decision reinforces Concepcion in demonstrating the Court’s willingness to allow arbitration clauses to be used as class action avoidance mechanisms. This ruling also validates the Fourth Circuit’s interpretation of Concepcion in its Shuttle Express decision.

American Express (“Amex”) requires all of its merchants to enter into a standard form contract. These agreements contain arbitration provisions that require all disputes between the parties to be resolved by arbitration and prohibit all class action claims. In this case, a group of merchants filed individual claims against Amex, claiming that Amex used its “monopoly power” to force them into contractual agreements that violate anti-trust laws. Amex moved to dismiss and to compel arbitration. The district court agreed with Amex, and the merchants appealed. On appeal, the United States Court of Appeals for the Second Circuit reversed, finding the class action waiver unenforceable because the costs that an individual merchant would incur to pursue its claim would substantially exceed the amount of that individual merchant’s damages. The Supreme Court reversed the Second Circuit’s decision.

Justice Scalia, writing for the narrow majority, emphasized that the “overarching principle” of arbitration is a matter of contract, and that courts must “rigorously enforce” arbitration agreements by their expressed terms unless the FAA’s mandate has been “overridden by a contrary congressional command.” The majority failed to find any contrary congressional command that would require a rejection of the class action waiver. According to the Court, antitrust laws do not guarantee that a claim will be resolved affordably, nor do they “evince[e] an intention to preclude a waiver” of class-action procedure.

The Court rejected the merchants’ argument that enforcing the waiver of class arbitration bars effective vindication because merchants have no economic incentive to pursue their antitrust claims individually in arbitration. The Court declined to apply the “effective vindication” exception to the case at hand on the grounds that the exception’s purpose is to prevent “prospective waiver of a party’s right to pursue statutory remedies.” The Court explained that not being worth the costs to prove a statutory remedy is not an elimination of the right to pursue that remedy. In other words, according to the Court, class action waivers merely limit arbitration to the two contracting parties and do not eliminate parties’ rights to pursue statutory remedies.

The majority referred to its decisions in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20 (1991) and AT&T Mobility LLC v. Concepcion, 130 S. Ct. 1740 (2011) (also decided by a 5-4 vote), to validate that class action waivers in arbitration agreements are, indeed, enforceable and therefore do not preclude the effective vindication of statutory rights. In Gilmer, the Court had “no qualms in enforcing a class waiver in an arbitration agreement even though the federal statute at issue…expressly permitted collective actions.” In Concepcion, the Court stated that class arbitration was not necessary to prosecute claims “that might otherwise slip through the legal system.”

In Justice Kagan’s dissent, she emphasized that the purpose of the FAA is to resolve disputes and facilitate compensation of injuries. According to Justice Kagan, the majority’s decision “admirably flaunt[s]” the fact that monopolists get to use their power to force merchants into contracts that deprive them of all legal recourse. “Too darn bad,” says Justice Kagan, as she describes the majority’s decision in a nutshell. Justice Kagan explains that the majority’s decision offers support to parties who intend to confer immunity from potentially meritorious federal claims through arbitration clauses in standardized form “contracts of adhesion”, which is contrary to the purpose of the FAA as enacted in 1925.

What does this mean?

In light of the body of U.S. Supreme Court precedent in this issue, nearly all parties offering contracts to large groups of similarly situated persons such as employees, franchisees, and consumers of services, should strongly consider including an arbitration provision in the contract that explicitly bars class or collective actions. Under current law, those waivers will almost certainly be enforced and therefore sharply limit the likelihood that the company will have to defend against large-scale litigation brought by disaffected members of such groups. Such arbitration clauses do need to be carefully drafted and implemented to avoid other defenses to their enforcement, and they should be prepared and implemented with the assistance of experienced counsel.

Of course, ubiquitous arbitration clauses and these judicial decisions sharply limit the ability of private practice attorneys to deter violations of protective statutes through civil dispute resolution, leaving an even greater burden of enforcement on overburdened government regulators. This is unlikely to change unless the FAA is amended through legislation. In recent years, the “Arbitration Fairness Act” has been pending in the U.S. Congress. This act would invalidate the enforceability of pre-dispute arbitration clauses with regard to employment, consumer, and civil rights disputes, and antitrust class action proceedings. The bill has been languishing in recent years, and it remains to be seen whether the Supreme Court’s latest decision spurs more aggressive Congressional action on this issue.

AUTHOR’S NOTE: THIS ARTICLE WAS CO-WRITTEN BY DAVID L. CAHN, CHAIR OF THE FRANCHISE BUSINESS LAW GROUP AT WHITEFORD TAYLOR & PRESTON, AND KATELYN P. VU, WHO IS A SUMMER ASSOCIATE AT THE FIRM AND A 2015 J.D. CANDIDATE AT UNIVERSITY OF BALTIMORE LAW SCHOOL.

PLEASE ALSO NOTE THAT THIS ARTICLE REPRESENTS THE VIEWS OF THE AUTHORS AND NOT THE VIEWS OF WHITEFORD TAYLOR & PRESTON L.L.P.

Lessons for Both Sides of the Table from the Recent Jackson Hewitt Franchisor Liability Cases

June 16th, 2010

Even in the best of franchise relationships, franchisors must be wary of litigation and potential liability arising out of their franchisees’ business operations. Where a franchisor imposes and exercises substantial controls over its franchisees’ operational and administrative methods and procedures, the franchisor may well find itself a defendant in lawsuits brought by customers and employees of its franchised outlets, claiming that the franchisor’s exercise of control makes it liable for its franchisees’ negligence or misconduct.

Two recent cases involving employee and customer claims against Jackson Hewitt shed light on this issue. In one case, a customer of a Jackson Hewitt franchised tax center in Louisiana filed suit against the franchisor based upon a privacy breach committed by the franchisee. In the other, an employee of a Jackson Hewitt franchise in Pennsylvania sued the franchisor for sexual harassment based upon the alleged actions of certain owners and managers of the franchise. In asserting their claims against the franchisor, both plaintiffs relied heavily upon language in Jackson Hewitt’s franchise operations manual and other documentation, and also the direct involvement of Jackson Hewitt representatives in the operations of its franchisees. The courts in both cases were willing to consider the plaintiffs’ claims against Jackson Hewitt despite clear admonitions in the Franchise Agreement and Operations Manual that the franchisee and its employees “shall not be considered or represented [by the franchisee] as [Jackson Hewitt’s] employees or agents” and that franchisee has exclusive responsibility over hiring and matters relating to personnel.

Jackson Hewitt provided its franchisees with detailed mandatory policies and procedures for center operations. It required all franchisees to provide customers with a copy of the “Jackson Hewitt Privacy Policy” promising that the confidentiality of personally identifying information (e.g., social security numbers) would be safeguarded. It also provided franchisees’ employees with a Code of Conduct, which made no reference to the existence of franchises, and which included numerous references to the reader as an “employee” of Jackson Hewitt. Jackson Hewitt also operated an Intranet site through which franchise employees could apply for employment positions with other Jackson Hewitt offices, could obtain Jackson Hewitt policies, and could communicate with Jackson Hewitt representatives. In addition, franchise employees were directed to call Jackson Hewitt’s corporate office to resolve issues with tax returns. All of these factors weighed in favor of establishing a sufficient level of control over franchisees’ operations to impose liability on Jackson Hewitt. The court also found significant control in the Jackson Hewitt system relating to training and termination of employees of the franchises.

The conclusion to be drawn from the Jackson Hewitt litigation is that franchisors are essentially presented with two options when drafting their franchise agreements and operations manuals. The first option is to impose significant operational controls over their franchisees’ operations, similar to those described above, and assume the attendant risk of facing liability for third-party claims arising from actions taken in accordance with the operational mandates. The other option is to limit the franchise operations manual to providing examples, general guidance and non-mandatory recommendations for operating procedures and specifications.

The first approach allows franchisors to impose greater control over, and have more say in, their franchisees’ operations—which is an attractive proposition for many franchisors. In addition, franchisees may perceive greater value in a franchise system that provides strict operating standards and procedures, which may help to distinguish the franchisor from competing brands. If the franchisor chooses this approach, it should consider increasing the minimum policy limits required for franchisees’ insurance policies and the types of required policies. It may also want to explore direct insurance coverage for the franchisor for all claims arising from franchised operations.

The advantages of the second option are demonstrated by a recent court decision from Illinois, Braucher v. Swagat Group, LLC, Bus. Franchise Guide (CCH) ¶ 14,355 (Mar. 19, 2010), in which Choice Hotels International, Inc. avoided liability in a wrongful death claim for the alleged negligence of one of its franchisees in maintaining its indoor swimming pool and whirlpool. Choice provided very limited operational guidance and controls with regard to swimming areas, and this approach allows a franchisor to avoid potential liability associated with imposing mandatory operational controls over franchises. However, it also carries the potentially negative business implications of allowing franchisees a measured level of discretion in running their businesses under the franchised brand. The term “measured” is important, because the franchise agreement should still include rights of termination or other remedies for acts or omissions that have the potential to cause material detriment to the franchise system’s goodwill. In addition, franchisees may view a franchisor that employs this approach as providing very little in terms of affirmative guidance and support, not acknowledging that the information and non-binding recommendations of a franchisor can provide value in and of themselves, irrespective of whether compliance is deemed mandatory.

A prospective franchisee can also glean guidance from the information provided above. When evaluating a franchise opportunity, a prospective franchisee should seek to review the franchisor’s operations manual, even if its table of contents is provided in the Franchise Disclosure Document (“FDD”). It is acceptable for a franchisor to require the prospect to sign a non-disclosure agreement with regard to the Manual. If the operations manual provides detailed mandatory specifications and procedures, the prospective franchisee should be wary of the likelihood that the franchisor will pursue rigorous enforcement, to account for the assumption of the significant liability risks described above. While the “deep pocket” franchisor’s potential “joint and several” liability for third-party claims may seem like a benefit to the franchisee, the prospect should be aware that indemnification and contribution provisions in the franchise agreement is likely to shift the ultimate financial burden back to the franchisee, unless it can prove that the franchisor’s actions caused the third party’s claim.

If the operations manual provides only examples and recommendations for franchisee policies and operational procedures, as opposed to detailed mandates, the franchisor may be attempting to avoid any direct performance obligations to its franchisees, or it may simply be attempting to limit its exposure. In performing its due diligence, a prospective franchisee should attempt to gain as much information as possible from the franchisor and its active franchisees to discern the quality and operational support the franchisor actually offers.

The operations manual and other forms and operational materials can be valuable tools for franchisors and franchisees alike. But, depending on how they are written, they can expose the franchisor to liability and raise serious questions in the minds of franchisees as to the benefit to be derived from subscribing to a particular franchise. Parties on both sides of the table should be sure to carefully evaluate these documents to ensure that they serve and meet their needs and expectations.

The “Litigation Hold” and the Importance of Electronic Document Retention

October 1st, 2009

The “Litigation Hold” and the Importance of Electronic Document Retention

As email and text-messaging have become standard means of communication in the business world, issues relating to document retention are more and more complex. When you become aware of a lawsuit filed against your company, or when you are exchanging heated telephone calls or e-mails and think a lawsuit might occur, it is critical for you to take measured steps to ensure that all relevant electronic documents and communications are preserved. Failure to preserve documents, and to comprehensively and timely comply with an opposing party’s discovery requests, can lead to both monetary and non-monetary sanctions. Non-monetary sanctions, which may include an instruction to the jury to make an adverse presumption based on your improper failure to produce requested documents, can have a substantial and devastating impact on your ability to pursue or defend against a lawsuit.

A 2004 case issued by the United States District Court for the Southern District of New York provides guidance on the steps that need to be taken in order to adequately preserve electronic data and avoid these types of sanctions. Zubulake v. UBS Warburg, LLC started out as a simple employment discrimination case that ballooned into a three-year battle over UBS’s failure to preserve emails relating to the employee’s termination. Through evidence obtained from depositions and re-depositions (at UBS’s expense), and inferences drawn from emails that were produced, the plaintiff was able to show that UBS had at least negligently, and perhaps intentionally, permanently erased relevant emails and discarded backup tapes, which would have preserved the emails even after their deletion from UBS employees’ active computer systems. As a result, the Court ordered UBS to pay the costs of the plaintiff’s motion, and also to pay for additional depositions and re-depositions of its employees so that the plaintiff could ascertain the contents of the deleted emails. The Court also held that, as to the emails that were lost or deleted, the jury would be instructed to infer that they contained information that was damaging to UBS.

To avoid sanctions like those imposed on UBS in Zublake, parties facing pending or likely litigation or arbitration must institute a “litigation hold” in order to put officers, employees and representatives on notice that documents and data relevant to the suit must be preserved. This should be done with the cooperation and advice of an attorney in order to ensure that all affected individuals receive proper notice regarding the documents that need to be maintained. In addition to emails and active documents, deleted and archived files must be preserved, and potentially relevant backup tapes from servers may need to be segregated in order to ensure they are not recycled. While “key players” and information technology personnel certainly need to be actively addressed, all employees who could potentially have relevant information must be contacted as well. Document retention policies will also need to be preserved and likely produced, though mere reliance on an internal retention policy without affirmatively enforcing the litigation hold will be insufficient to protect against sanctions. Moreover, the litigation hold will need to be consistently reinforced and updated throughout the duration of the lawsuit.

Document retention is a serious matter that weighs heavily in the outcome of litigation. While the temptation to hit “delete” on damaging emails might be strong, the force of sanctions, and perhaps even contempt of court proceedings, should be stronger. Compliance with the “litigation hold” requirements will help to ensure that you are in the best position possible to protect the interests of your company in a dispute. For specific advice regarding document retention and “litigation hold” matters, please contact us by telephone or e-mail.

Copyright Franchise and Business Law Group, 2009