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Arbitration – an alternative to taking your chance in Court?

There has been much debate amongst lawyers in the last couple of years about whether the Courts are becoming more ‘franchisee-friendly’.  There have been a number of recent High Court judgments involving franchises as disparate as The Power Service, Kall Kwik, and Papa Johns where the Court has found in favour of the franchisee alleging misrepresentation or negligent advice.  In at least one case, that of The Power Service, the adverse judgment came to the attention of the franchisee network, which mutinied and the franchisor went into administration.  That is the potential nuclear effect of an adverse judgment.

Judgments of the High Court are routinely published.  Judgments of the County Court are rarely published but they are still judgments in open court and can be publicised by the press, the parties or interested bystanders such as other franchisees.

This publicity can be immensely damaging to a brand’s reputation, the atmosphere within a network and recruitment.  There is a view, which I have heard articulated by several franchise lawyers, that if you act for the franchisor you should start your case in the Chancery Division of the High Court, but if you act for the franchisee you start in the Queen’s Bench Division (QBD).  The three cases I referred to were all QBD decisions since 2008.  I recently had a case for a franchisor in the QBD and we had to go to the Court of Appeal to successfully overturn the decision that was made.  If a franchisee decides to sue their franchisor for misrepresentation or breach of contract, he or she will, as Claimant, get to choose the court to start their case.

Regardless of lawyers’ views on particular courts the fact is that franchisors are understandably wary of the uncertainties of litigation.  This may lead to an increasing reluctance by franchisors to enforce the contractual terms on which they have spent a good deal of time, money and thought to embody into a detailed franchise agreement.  They may decide to avoid instigating legal action with errant former franchisees, but that does not stop franchisees finding a lawyer online, some of whom advertise no win no fee agreements.

Is there an alternative to taking on the risks of litigation through the courts?  There are in fact two alternatives.  Most franchise agreements will contain a compulsory alternative dispute resolution or mediation clause.  Such a clause provides an opportunity to resolve disputes in a less adversarial setting.  Mediation is particularly helpful if the parties wish to preserve an ongoing relationship, but it also has a high success rate when the franchisee relationship has come to an end.  It is a confidential process and, if it results in a settlement, will be considerably cheaper and quicker than litigation.  The drawback with mediation is that it is an entirely consensual process.  The mediator can facilitate a discussion, but cannot impose his or her own judgement on the parties.  If one party refuses to settle on sensible terms, there is no agreement and the mediation fails.

The other alternative is arbitration.  It is an adversarial process and, unlike with mediation, the arbitrator has to reach a decision on the merits of a case.  That is his role.  He is not there to encourage the parties to settle but takes the role of a Judge.  The decision of the arbitral tribunal is final and binding.  Procedurally the parties can choose where the arbitration is to take place, can choose the rules to govern the procedure and could have choice in the appointment of the arbitrator (unlike a Judge).

The powers of the arbitrator derive from the arbitration clause in the franchise agreement as supplemented by the Arbitration Act 1996.  Usually the procedural rules are very similar to litigation.  As with particulars of claim and a defence in litigation, the parties must set out their statements of case at the initial stage.  There are important differences regarding the rules of disclosure between litigation and arbitration.  In litigation the parties are obliged to disclose all relevant documents, whether they are helpful to that party’s own case or not.  In misrepresentation claims the franchisee rarely has evidence which proves or disproves the representations made by the franchisor, for example as to turnover or profit projections.  That information is held by the franchisor and built up through their pilot operation, their own outlets if they are continuing, and the reports from existing franchisees.

The rules on disclosure can differ in arbitration dependent upon the rules that apply.  The International Chamber of Commerce (ICC) rules provide for the production of documents on which the party relies.  Thereafter the arbitrator has a general power to establish the facts of the case “by all appropriate means” which includes the power to order disclosure of documents.  However, in practice English litigation-style disclosure of every relevant document is extremely uncommon.  The London Court of International Arbitration (LCIA) rules require the production of copy documents with the statement of case, which are the “essential documents on which the party concerned relies”.  UNCITRAL rules also requires documents relied upon, where possible, to accompany the statement of claim or statement of defence.

If the franchise agreement is silent as to the rules which will apply to the arbitration, then the Arbitration Act 1996 applies.  That provides that the arbitrator has the power to determine “whether any and if so which documents or class of documents should be disclosed between and produced by the parties and at what stage”.  This means the arbitrator does not have to follow court procedures.  There is no general obligation of disclosure and although the arbitrator will require disclosure of some documents it does not necessarily mean that disclosure will be as wide ranging as would be ordered in litigation.  This will usually be to the advantage of the franchisor for whom disclosure in litigation could be an extremely time consuming and costly process.

As with litigation witness statements are still exchanged and the arbitrator has the ability to determine what witnesses will be called to give evidence at a hearing, with the opportunity for cross-examination, and which witnesses can give written statements only.  Expert evidence can also be relied upon if it is relevant.  In reaching a determination it is possible for the arbitrator to refuse a hearing and to deal with the matter on the basis of the documents only.  Most arbitrators will order a hearing if either or both the parties request one.

As for timings there is often no significant difference between the timescale to get to a determination hearing in arbitration, and a time required to get a trial date in litigation.  This is because the arbitrator is usually a senior professional with expertise in the area in dispute and will have his or her own commitments to fit around dealing with the arbitration.

A franchise agreement, that has a compulsory arbitration clause, will normally set out how the arbitrator is appointed.  The parties can agree on an individual or the arbitrator could be appointed by, for example, the BFA or one of a number of arbitration organisations, such as ICC, LCIA or UNCITRAL.  The BFA’s own arbitration scheme has been in existence for many years but according to Andrew Quail there have been only a handful of arbitrations organised through the BFA to date.  This low take up, contrasted with the amount of litigation which comes out of the franchisor/franchisee relationship, suggests that compulsory arbitration clauses in franchise agreements have not been that common.

The parties can agree to resolve their dispute through arbitration regardless of the terms of the franchise agreement.  More usually arbitrations take place because the franchise agreement specifically provides for arbitration in the event of a dispute.  This could be a multi-tiered process so that arbitration only takes place if a mediation has first been attempted and failed.  The reference to arbitration could be carved out from certain types of dispute, for example if a franchisor wants to obtain an injunction to stop an ex-franchisee operating a similar business in the territory post-termination.  The arbitrator has no power to order an injunction and therefore a franchisor will wish to preserve the right to litigate through the Courts if an injunction is required.

Arbitration may not suit smaller value claims.  It should be possible to reserve the right to litigate if the claim or counter claim is less than, for example, £50,000, but to arbitrate if greater.

Where a contract provides for arbitration then that process of dispute resolution is binding.  It is not open for a party, unilaterally, to start Court proceedings to air their grievance and if they did so those Court proceedings would be put on hold until the arbitration is concluded.

The benefit, particularly for franchisors, is that arbitrations are confidential.  This means that the evidence disclosed in the arbitration proceedings, both documents and witness statements, the submissions by both parties, and the award itself is confidential and there are strict penalties if a party was to breach confidentiality.  Where franchisees bring misrepresentation claims, or who retaliate to a claim against them by counter claiming for damages for misrepresentation, arbitration can be very useful in minimising the wider impact of such allegations.  Therefore even if an arbitrator did find that a franchisor had misrepresented the franchise offering, provided the franchisor abided by the award, and made the awarded payment, that decision would at all times remain confidential.  As a result there should be no adverse impact on other franchisees nor on the franchisor’s recruitment programme.

An arbitrator has the power to award damages and a wide discretion in relation to costs, similar to a Judge.  Those awards can be enforced through the Courts without the issues being re-litigated and determined again.  There are only limited grounds for appeal against an arbitration award such as error on a point of law or serious illegality causing substantial injustice.  This is a high hurdle and means that arguments over the weight to be given to witness testimony are rarely appealed, whereas it can be a feature of appeals from Court judgments.

The main drawback for arbitration is cost.  With litigation through the courts a Claimant pays limited court fees of a few thousand pounds dependent on the amount of the claim.  There is no separate charge for the Judge’s time nor for the use of the courtroom.  With arbitration the parties must equally contribute to the arbitrator’s own costs, pay for the hearing venue, and, depending upon the referring organisation, pay the administrative costs if the arbitrator was appointed not by the parties, but by an independent organisation.  These costs will run into tens of thousands of pounds and are in addition to the parties’ own lawyers’ fees.  The arbitrator’s costs are payable equally as the case progresses but will form part of his or her costs award at its conclusion.  The parties to an arbitration are also able to pursue or defend claims under conditional fee agreements, or CFAs.  Those will become less attractive when the rules on recoverability of success fees and insurance premiums change in April 2013, but franchisors should note that a compulsory reference to arbitration does not itself prevent a franchisee finding a lawyer to run their case on a ‘no win no fee’ basis.

Litigation is inherently risky.  It is an expensive process.  An adverse decision can be catastrophic for a franchisor’s reputation and business.  Franchisees and their lawyers know this and it is that fear of an adverse decision and the publicity that follows which may encourage franchisees’ lawyers to assume that litigation will bring a franchisor to the negotiating table, even in claims that lack merit.  That threat is far less potent if the franchisee has to put his case in a confidential arbitration and franchisors need not be anxious over the potential nuclear fallout of an adverse decision.  It will be more expensive, but perhaps in some circumstances that is a price worth paying?

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