Does Arbitration Make Sense for Franchisors? a Litigator's Perspective

• Publication year: 2017
• Author: Kevin Adams

Does Arbitration Make Sense for Franchisors? A Litigator's Perspective

Kevin Adams

Kevin Adams is partner at Mulcahy LLP (mulcahyllp. com). His practice focuses on franchise and distribution litigation and counseling. Kevin is a certified specialist in franchise and distribution law by the State Bar of California, Board of Legal Specialization.

Let's face it; arbitration is not always the quicker, cheaper forum for parties to resolve their differences. Although arbitration does have the potential to be more economical and efficient than court, in practice, these benefits can prove elusive when arbitrating franchise disputes. Still, franchise agreements very often contain ADR provisions that require arbitration of all disputes. Given this, why do franchisors and their attorneys treat arbitration provisions as a one-size-fits- all addition to franchise agreements?

This article examines the current state of arbitration from a litigator's perspective, the flaws with some historically touted benefits of arbitration, and the real, present-day benefits of arbitration to franchisors with footprints that extend into California.

Is Arbitration Faster?

Because arbitration is considered a private proceeding, there is limited recent information available to the general public on the average length of time that elapses from the filing of a commercial arbitration dispute to the arbitrator's issuance of the final award. This creates a challenge when attempting to compare a typical arbitration timeline to that of a court action. However, the information that is available suggests that the often touted expediency of arbitration may be overstated.

For example, the Financial Industry Regulatory Authority (FINRA) reported the conclusion of 3,635 arbitrations involving securities and employment disputes during the 2016 calendar year.¹ The median length of these arbitrations from commencement to hearing was 17.1 months.² Similarly, during calendar year 2016, the median length of time from filing through trial of civil cases in the U.S. District Court for the Central District of California was 18.3 months.³ While these statistics, in a vacuum, leave a lot to be desired, they do suggest that the timeline for an arbitration proceeding may not be materially different than the time it takes for a litigated case to progress through the court system.

The length of the arbitration's related confirmation proceeding also must be considered when comparing arbitration to a court action. An arbitration award cannot be enforced until it is confirmed by a court and judgment is entered. The confirmation proceeding can easily extend the arbitration process by upwards of six months. The net result is an arbitration proceeding that easily can extend beyond the length of a typical court action.

Certainly, the purported temporal expediency of arbitration does not, by itself, justify the inclusion of arbitration provisions in franchise agreements.

Does Arbitration Cost Less?

Arbitration costs are tied to the length of the proceeding. Because arbitration is a creature of contract, technically, the parties are free to streamline the process. However, there is a practical limitation when attempting to expedite a franchise dispute—i.e., discovery is almost always necessary in commercial litigation. Trial without discovery is akin to going into battle blind: it's difficult to prepare for something you have not seen. Documents, depositions, and even written responses to interrogatories are tools that help the parties and their attorneys properly evaluate the case and prepare for trial. The discovery phase of a case can easily be the most time-consuming and costly to the client.

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Arbitration service providers appreciate the significance of discovery to commercial disputes. This is reflected in the evolution of their procedural rules. For instance, an earlier version of the Commercial Rules of the American Arbitration Association (AAA) granted arbitrators the limited authority to "direct (i) the production of documents and other information, and (ii) the identification of any witnesses to be called" at the hearing.⁴ The current version of the AAA's Commercial Rules significantly expands upon the type and form of discovery arbitrators may allow. This includes not only the exchange of documents in the parties' "possession or custody on which they intend to rely," but also an obligation to update the production as documents are discovered, the exchange of written discovery requests and requested materials, and, importantly, detailed instructions on the production and exchange of electronic discovery.⁵ Naturally, more discovery means more expense to the clients.

There also are significant costs associated with arbitration. These include the arbitrators' fees, administrative fees charged by the arbitration service provider, and fees charged by the facility that houses the hearing. In California Superior Court, a party must pay an initial filing fee of $435 to commence an unlimited civil action.⁶ In contrast, the AAA charges an initial administrative filing fee, depending on the amount of the claim, ranging from $500 to over $10,000.⁷ There is also a "Final Fee" charge—between $800 and $12,500— in the event the matter progresses to a hearing.⁸ Judicial Arbitration and Mediation Services (JAMS) charges a relatively nominal initial non-refundable filing fee of $1,200 to $2,000. ⁹ However, it also charges an additional "Case Management Fee" of 12% of "all Professional Fees, including time spent for hearings, pre- and post-hearing reading and research and award preparation."¹⁰Depending upon the nature of the dispute being arbitrated and the amount at issue, these administrative fees can be substantial.

While the administrative fees and facility rental can far outweigh court filing fees, all of these expenses are usually dwarfed by the hourly rates charged by the arbitrators. For example, this author recently received a "strike list" from one of the prominent arbitration service providers that identified eight potential arbitrators from Southern California with experience in franchising. The hourly rates of these arbitrators ranged from $350 to $600. Multiply this figure by three if the relevant contractual arbitration provision calls for a panel of three arbitrators. At the end of a complex commercial dispute, this figure can be staggering.

Of course, attorneys' fees are typically the most significant cost of litigation in any forum. If the arbitration is substantially shorter than the court action, then there should be a proportionate reduction in attorneys' fees. However, if the duration of each proceeding is substantially similar—as suggested above—commercial arbitration is not a viable cost-saving option to litigation in court.

What Happens If The Other Side Refuses To Pay For Arbitration?

In many instances, the high costs associated with arbitrating a case have been leveraged by the more affluent party to motivate the less affluent adversary to capitulate or settle. Typically, if a party did not pay, they were not permitted to pursue any affirmative claims in the arbitration and faced dismissal of the action altogether. However, franchisors may want to keep in mind that the recent trend in case law has placed the payment obligation on the party seeking to keep the matter in arbitration. This could substantially increase the costs of arbitration to the franchisor.

The Ninth Circuit case of Tillman v. Tillman is illustrative of this recent trend.¹¹ In that case, the claimant filed a malpractice lawsuit in court. The respondent law firm's motion to compel arbitration was granted by the court, and the matter was moved to the AAA. Ultimately, the claimant could not pay the AAA's required deposit of $18,562.50.¹² When the respondent refused to front the deposit for the claimant, the arbitration was terminated pursuant to the AAA's rules.¹³ Following the termination, the claimant again sought to pursue her claims in court, but the trial court refused, finding that the Federal Arbitration Act deprived the court of the authority to hear the claimant's claims because they were subject to arbitration.¹⁴ The matter was dismissed and claimant appealed.

On appeal, the Ninth Circuit reversed the trial court's dismissal, finding that although the claimant lacked the resources to pay the arbitration deposit, she was willing to arbitrate her claims "and the [respondent] firm could have fronted the costs but did not."¹⁵ According to the Ninth Circuit, the claimant's failure to pay the deposit did "not merit a harsh penalty, particularly given 'the public policy favoring disposition of cases on their merits.'"¹⁶ Because the AAA proceeding had been terminated consistent with the AAA's rules "before the merits were reached or any award issued, allowing [claimant's] claims to proceed in district court [was] the only way her claims [could] be adjudicated."¹⁷ Consequently, the trial court's ruling was reversed, and the claimant's lawsuit was allowed to go forward in court notwithstanding her failure to pay her share of the arbitration fees.

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The Tenth Circuit recently also reached a...