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 unconscionable.

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.

mherman@franchise-law.com
www.franchise-law.com
www.internationalfranchiselaw.com
202-686-2886 (ph)