Unconscionable Clauses In Franchise Agreements
by Mario Herman
Prospective franchisees with the aid of their franchise attorney should
challenge problematic clauses in the franchise agreement through
pre-contract negotiation, rather than through the courts. This case
validates the importance of having a qualified franchise attorney review the
franchise contract before it’s executed.
In the recent case of Htay Htay Chin v. Advanced Fresh Concepts Franchise
Corp. (April 20, 2011) before the California Court of Appeal, the Plaintiff
argued that the arbitration provision in the Franchise Agreement was
unconscionable and hence unenforceable. The Court of Appeal concluded
that, even if the delegation clause in the arbitration provision (which
provided that the arbitrator, and not the court, should decide if the
arbitration agreement was enforceable) was unconscionable, none of the other
terms of the arbitration provision were unconscionable, thereby rendering
moot the question about the delegation clause. The Court of Appeal held that
the trial court erred in finding that “the arbitration agreement is
unconscionable as it limits damages to actual or compensatory damages and
elimination of [sic ] equitable claims and defenses.” The Court of Appeal
found that declaring the delegation clause unenforceable would serve no
purpose unless some other term of the arbitration provision is
Ultimately the Court of Appeal reversed the trial
court’s order denying the motion to compel arbitration, despite its finding
that substantial evidence supported the implied finding that the franchise
agreement had the qualities of an adhesion contract (a contract so
imbalanced in favor of one party over the other that there is a strong
implication it was not freely bargained).
The trial court found two unconscionable terms to the arbitration
provision. The first was the provision that “any award shall be based
on established law and shall not be made on broad principles of justice and
equity.” The trial court found this language to be unconscionable because it
eliminates equitable claims and defenses. The Court of Appeal found that
all this clause did was to provide in an accepted way the limiting the
arbitrator's broad powers and allowing judicial review on the merits of an
arbitration award, and that the limitation was not intended to bar
cognizable equitable claims and defenses, and the trial court erred in
deeming it unconscionable.
The second portion of the arbitration provision the trial court found
unconscionable was that which limited recovery to actual compensatory
damages and did not allow for noneconomic and punitive damages. The
Plaintiff argued that punitive damages are available under the California
Franchise Investment Law ( CA
Corp. Code, § 31000 et seq.), but the complaint alleged no violation of
that statute, nor did she claim that she could amend her complaint to allege
such a violation. The Court of Appeal held that the damages limitation
was facially mutual, and there may be cases in which a franchisor seeks to
vindicate its own statutory rights against a franchisee (for example by
seeking exemplary damages for willful and malicious misappropriation of
trade secrets), and as such it was not unconscionable.
Had the Plaintiff in Chin sought the advice of an experienced franchise
attorney prior to entering into the Franchise Agreement, perhaps some or all
of these clauses could have been negotiated out of the agreement prior to
its execution. Or, at the very least, an experienced franchise
attorney would have advised of these red flags, so they could have been
properly considered before the relationship began.
Mr. Herman based in Washington, D.C., represents franchisees domestically
and internationally in negotiation, mediation, arbitration, and litigation.
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