July 9, 2020
By: Thomas M. O’Connell
Esguerra-Aguilar, Inc. v. Shapes Franchising, LLC, 2020 WL 3869186 (N.D. Cal. July 9, 2020).
In an unreported decision, Judge Freeman of the United States District Court for the Northern District of California granted a franchisor’s motion to stay proceedings pending arbitration finding that the parties delegated the question of arbitrability to the arbitrator to decide by incorporating, by reference, the AAA and NAF arbitration rules.
Defendant Shapes Franchising, LLC (“Franchisor” or “Shapes”) is a franchisor of fitness and weight loss centers throughout the country. In 2018, Plaintiff Esguerra-Aguilar, Inc. and other related parties and individuals (“Franchisee” or “Defendants”) became interested in operating a Shapes franchise. Between August and December 2017, Plaintiffs allege that they spoke to several Franchisor representatives who understated the required initial investment, overstated revenue and membership projections, and did not accurately portray the resources that the Franchisor would provide to the Franchisee. Franchisee executed a franchise agreement on November 21, 2017. Thereafter, Franchisee alleges that they invested substantial sums of money into attempting to open and operate their franchise units and incurred substantial losses.
On January 25, 2020, Franchisees filed suit against Franchisor under various legal theories–including those related to fraud and the California Franchise Investment Law–seeking rescission of their franchise agreements and other related damages. Because Franchisees franchise agreements include an arbitration clause, Franchisor moved to stay the matter pending resolution of arbitration. Franchisees opposed.
The Court granted Franchisor’s motion to stay pending arbitration relying on the following analysis:
- The Federal Arbitration Act (“FAA”) embodies a national policy favoring arbitration and a liberal federal policy favoring arbitration agreements. Thus, “as a matter of federal law, any doubts concerning the scope of arbitration should be resolved in favor of arbitration.” Rajagopalan v. NoteWorld, LLC, 718 F.3d 844, 846-47 (9th Cir. 2013).
- While, the question of whether the parties have a valid arbitration agreement is presumptively reserved to the Court, parties may delegate the adjudication of this issue to the arbitrator if they “clearly and unmistakably” agree to do so (“Portland Gen. Elec. Co. v. Liberty Mut. Ins. Co., 862 F.3d 981, 985 (9th Cir. 2017)) including a “course of conduct demonstrating assent … or … an express agreement to do so” ( at 988).
- In the Ninth Circuit, “it is well-settled that incorporation of arbitration rules (such as the AAA or NAF rules) ‘constitutes clear and unmistakable evidence that contracting parties agreed to arbitrate arbitrability.’” Brenan v. Opus Bank, 796 F.3d 1125, 1130 (9th Cir. 2015).
- “While Plaintiff’s Franchise Agreements with Shapes are not a model of clarity,” they incorporate both the AAA and NAF arbitration rules. Consequently, the arbitration clauses of the parties’ franchise agreements delegated disputes over the existence, scope, and validity of the arbitration agreements exclusively to the arbitrator for the parties to the franchise agreement.
- For those parties that are not a party to the franchise agreement–particularly the Franchisor representatives that allegedly made false representations to the Franchisee during the sales process–the Court found that Plaintiff’s allegations establish an agency relationship between the individuals and the Franchisor, enabling the individuals to demand arbitration. Further, the NInth Circuit has explained that “nonsignatories of arbitration agreements may be bound by the agreement under ordinary contract and agency principles.” Consequently, the court found that “the claims against Shapes and Individual Defendants are so intertwined and connected with the sale of the franchises (and hence, the Franchise Agreements), denying a stay of the claims against the Individual Defendants would result in duplicative litigation which would undermine the efficiency of arbitration.
Franchisees have and continue to try to avoid arbitration of disputes while many, if not most, Franchisors favor arbitration. There are many reasons for this–discussed in a separate article–but this matter provides foundational guidance to franchisors when drafting their arbitration provisions. Specifically, if a franchisor wishes to try to avoid a challenge in court to the arbitrability of a dispute and validity of a franchise agreement, one avenue is to “clearly and unmistakably” delegate such authority to the arbitrator through either (i) the incorporation of the AAA or NAF arbitration rules or, even more conservatively and/or (ii) echo the language of either the AAA or NAF arbitrability provisions in the franchise agreement.
This article was originally published on the California Franchise Network.