Fourth Circuit serves franchisors a double helping of arbitration and litigation

Many franchisors spend considerable time and resources analyzing whether to include a mandatory arbitration provision in their franchise agreements in hopes of warding off franchisees’ class action lawsuits and avoiding costly and drawn-out litigation. Such efforts are now even more complicated, at least in the Fourth Circuit.

Dickey’s is a national franchisor of quick-service barbecue restaurants. In a dispute between Dickey’s and several of its Maryland franchisees, the Fourth Circuit recently held that the clear and unambiguous language of provisions in the franchise agreement requires that some claims asserted by Dickey’s must proceed in arbitration, while the franchisee’s claims under the Maryland Franchise Law must proceed in the Maryland district court.

Dickey’s franchise agreements contained a provision requiring arbitration for “all disputes, controversies, claims, causes of action and/or alleged breaches or failures to perform arising out of or relating to [the franchise agreement] or the relationship created by [the franchise agreement].” In addition, the franchise agreement contained the Maryland-required provisions stating that the agreements “shall not require” the franchisees to waive their “right to file a lawsuit alleging a cause of action arising under Maryland Franchise Law in any court of competent jurisdiction in the State of Maryland.”

Relying on the arbitration agreement in the franchise agreement, Dickey’s brought arbitration proceedings against the franchisees for, among other things, failing to pass certain food safety inspections and receiving numerous customer complaints. The franchisees then brought suit in Maryland federal court seeking to enjoin the arbitration and asking the court to declare the arbitration provision unenforceable. The franchisees also brought claims against Dickey’s for violations of the Maryland Franchise Law, claiming that Dickey’s misrepresented start-up and other costs.

The court looked to the parties’ franchise agreement and intent and concluded that the parties intended to arbitrate all claims except for the narrow carve-out for Maryland Franchise Law claims. Therefore, the court held that Dickey’s common law claims must proceed in arbitration, while the franchisees’ claims under the Maryland Franchise Law must proceed in the Maryland district court.

The court acknowledged that requiring the parties to litigate in two forums may be inefficient and could lead to conflicting results. However, the court went on to note this outcome is mandated by the Federal Arbitration Act, which requires piecemeal litigation where, as here, the agreements call for arbitration of some claims, but not others.

Dickey’s further argued that all of the claims should proceed to arbitration because the Federal Arbitration Act (FAA) overrides state laws that render arbitration provisions unenforceable. The court noted that FAA preemption prevents states from carving out wholesale exceptions to arbitration. However, the FAA does not prevent private parties from agreeing to litigate, rather than arbitrate, specific claims. The court found that Dickey’s had a choice to do business in Maryland or not and, therefore, chose to include the Maryland-required provisions in its franchise agreements and, as such, Dickey’s voluntarily agreed to submit to litigation for claims arising under the Maryland Franchise Law.

This new Fourth Circuit case adds a new level of complexity to your arbitration versus litigation decision. If you have questions about managing your dispute resolution process with your franchisees, we are here to help.