Inedible Arrangements: Can Arbitration Clauses and Franchisee Associations Co-Exist?

Vol. 15, No. 1

By

Kern & Hillman LLC

I. The Case

Even though the members of plaintiff EA Independent Franchisee Association LLC (the “Association”) had binding arbitration clauses in their franchise agreements (the “Franchise Agreements”), on July 19, 2011, the United States District Court for the District of Connecticut declined to dismiss EA Independent Franchise Association LLC v. Edible Arrangements Int’l, Inc., et al., Bus. Franchise Guide (CCH) ¶ 14,650 (D.Ct. 2011). On September 11, 2011, the Court reaffirmed its decision on reconsideration. Case No. 3:10-cw1489(WWE), 2011 U.S. Dist. LEXIS 78008. The Court ruled that, while it reserved the right to reconsider the Association’s standing later in the litigation, the Association could now sue in court for declaratory relief. Further, on reconsideration, it ruled that the defendants simultaneously could seek to compel individual arbitration.

The Association, a Michigan entity, represents more than 170 franchisees of Edible Arrangements International, Inc. (“Edible”), a Connecticut corporation that has several Connecticut corporate affiliates, including EA Connect, Netsolace and Dipped Fruit. The Association alleges that: (i) Edible violated the FTC Franchise Rule by failing to disclose its relationships with its affiliates while requiring its franchisees to do business with them; (ii) Edible failed to disclose fees associated with franchisees’ mandatory use of an online ordering system provided by EA Connect and computer software provided by Netsolace; (iii) Edible improperly imposed new rules requiring longer franchise hours of operation and the purchase of supplies from only certain vendors; (iv) Edible sanctioned franchisees who do not comply with the new rules by imposing special costs and barring them from filling orders placed via the Edible website; (v) Edible used money that franchisees paid for national advertising for the benefit of itself and Dipped Fruit, which operates a website selling products similar to those of Edible; and (vi) Edible unfairly allows only selected franchisees to fill orders for Dipped Fruit.

The Association seeks a declaratory judgment that defendants breached the Franchise Agreements, violated the implied covenant of good faith and fair dealing, and violated the Connecticut Unfair Trade Practices Act (CUTPA), Conn. Gen. Stat. § 42-110a et seq. Because an ascertainment of damages suffered by each franchisee would require the participation of each franchisee, but the principles of associational standing forbid such individual participation, see, infra, the declaratory judgment action was the proper vehicle.

II. The Issues: Associational Standing to Sue in Court and the Effect of Arbitration Clauses

The standing issue presented is: Can the franchisees, through an association, make an alleged “end run” around an arbitration clause in their franchise agreements that permits litigation for injunctive (but not declaratory) relief, where the association is not required to and cannot be forced to arbitrate? Leaving aside the nice drafting distinction between injunctive and declaratory relief, ignored by the Court in its rulings, the broader issue is what effect franchisees’ arbitration clauses have—and should have—on the ability of their association to seek relief for them. Could a very carefully drafted arbitration clause (more exacting than in the Edible Franchise Agreement) eviscerate the ability of an association to pursue litigation for its members, making the association a toothless tiger?

III. The Complaint

In the Complaint, the Association (“EAIFA” in the Complaint) alleges the following concerning standing:

The EAIFA has standing to maintain this action. At least one of its members (indeed, all of its members) will suffer injury in fact by the real and immediate threatened harm, from Defendants’ conduct.

Further, the interests sought to be protected by this action are germane to the EAIFA’s purpose.

The interests sought to be protected are the rights of [Edible’s] franchisees to prevent [Edible] from unfairly and unilaterally modifying the terms of the franchise agreement and the relationship of the parties and to change system standards in the manner so as to render the terms of the parties’ franchise contracts commercially impracticable.

Pursuant to Article II of the EAIFA’s bylaws . . . . “The purpose of the EAIFA bylaws are: . . . . (3) To protect and promote the rights of EA franchise owners (“Members”) in their EA franchised business (“Store”) . . . . (8) To promote fairness in the franchise relationship between it Members and the Franchisor . . . .”

Finally, neither the claim asserted nor the relief requested requires the participation of individual members of EAIFA (i.e. the franchisees) since the EAIFA can prove its allegations of [Edible’s] breach of the duty of good faith and fair dealing, which is both contractual and implied by law, and other franchisee abuses through [Edible’s] own internal documents and data, and through expert testimony. The claim for relief involves issues that are common to all members of the EAIFA and do not require determination on an individual basis. The claim is for declaratory relief only and does not involve any potentially differing claims for monetary compensation.

Complaint, ¶¶ 21-25 (emphasis in original).

IV. The Principles of Associational Standing

Franchisees who belong to an association and who are contemplating litigation relating to their franchises turn naturally to their association as the vehicle for their suit. From their viewpoint an association is the ideal plaintiff; it can amass a litigation war chest through member contributions, and it can provide a conveniently anonymous plaintiff in the event that a total rupture with the franchisor is not contemplated.

A franchisee association, like other plaintiff associations, must surmount a challenge based on standing. While state law may permit associations to sue and be sued, the association is not allowed to proceed with a claim for damages unless it can show some injury to itself. If its only claim is for damages to its members, it will be dismissed in a summary proceeding. But it may seek equitable relief for them.

The oft-cited case that addresses this issue is Warth v. Seldin, 422 U.S. 507, 95 S. Ct. 2197 (1975). In that case, the Supreme Court stated:

Even in the absence of injury to itself, an association may have standing solely as the representative of its members. [Citation omitted.] The possibility of such representational standing, however, does not eliminate or attenuate the constitutional requirement of a case or controversy. [Citation omitted.] The association must allege that its members, or anyone of them, are suffering immediate or threatened injury as a result of the challenged action of the sort that would make out a justiciable case had the members themselves brought suit. [Citation omitted.] So long as this can be established, and so long as the nature of the claim and of the relief sought does not make the individual participation of each injured party indispensable to proper resolution of the cause, the association may be an appropriate representative of its members, entitled to invoke the court's jurisdiction.

95 S. Ct at 2211-12.

This theme was elaborated in Hunt v. Washington State Apple Advertising Commission, 432 U.S. 333 (1977), in which a state agency that represented Washington apple growers, although without “members” as such, was held to have standing to pursue a claim on behalf of the growers. The Court held that an association has standing to bring suit on its members’ behalf when:

(a) its members would otherwise have standing to sue in their own right; (b) the interests it seeks to protect are germane to the organization’s purpose; and (c) neither the claim asserted nor the relief requested requires the participation of individual members in the lawsuit.

Id. at 343. The three Hunt elements are those evaluated in resolving associational standing issues.

V. An Evaluation of the District Court’s Application of the Principles

As to the first element, the District Court found the plaintiffs could have standing individually, while not focusing on the arbitration clause as a possible bar. It ruled they would have no trouble showing concrete actual or imminent injury traceable to defendants’ conduct, and capable of redress by the Court. The second Hunt prong was not placed in issue.

The battle was joined over the third prong. In that regard, the Franchise Agreements all contain mandatory arbitration clauses for all claims, but with a carve-out allowing the parties “to seek temporary restraining orders and temporary preliminary injunctive relief from a court of competent jurisdiction, provided, however, that they must contemporaneously submit their dispute for arbitration on the merits . . . .” (Franchise Agreements, ¶ 20(F)). Interestingly, as noted above, the litigation carve-out is not for equitable relief in general, and by its terms does not include the relief sought by the Association: declaratory relief.

The defendants argued that individual members would be required to participate in the suit, and that the Association was evading the arbitration requirement by forming the Association and seeking to use it to bring litigation.

Defendants did not focus on the carve-out in the arbitration clause even though it arguably precludes franchisees from bringing declaratory judgment actions in court, perhaps logically assuming the Court would not split hairs. The Association did not focus on the possible dichotomy between injunctive relief and declaratory relief in the carve-out, logically leery of the subject.

The Association opposed defendants’ “individual participation” argument by pointing out the Association had no right or obligation to arbitrate for the franchisees, and the Court ruled in its initial opinion on that basis that the individual arbitration clauses did not deny the Association standing. The Court also accepted the Association’s argument that, while there are several types of Franchise Agreements and FDDs, and arguably several franchisee witnesses would be required, that was insufficient to bar standing, especially as the basic issues were common to all the Franchise Agreements. The Court pointed out that damages to the franchisees were not sought and could not be the subject of the Association’s suit. Finally, it accepted the argument of the Association, at this early stage, that it would prove its case without calling franchisee witnesses, but instead through experts and documents.

On reconsideration, defendants re-argued the point that the Court was allowing the franchisees to circumvent the arbitration clause, a reprise of defendants’ initial argument, hence a tenuous ground for reconsideration. Edible, which had not sought to compel arbitration as yet, argued that the case should be dismissed immediately and individual arbitrations instituted. The Court adhered to its prior provisional ruling, however, and in the face of no “controlling decisions” adverse to it, noted that defendants’ authorities were from decisions invoking motions to compel arbitration, not to dismiss for lack of standing—alas, a distinction without a difference. See In re Managed Care Litigation, 2003 WL 22410373 (S.D. Fla. Sept. 15, 2003).

Defendants had argued from the start of the case, and restated on reconsideration, that the Association members had attempted to skirt their obligation to arbitrate by advancing claims through the Association, a “blatant misuse of the associational standing doctrine [that] flies in the face of the strong federal policy favoring enforcement of agreements to arbitrate.” Defendant’s Memorandum in Support of Their Motion to Dismiss for Lack of Standing, at 22. They relied principally on Conn. St. Med. Soc. v. Oxford Health Plans (CT), Inc., 272 Conn. 469, 480, 863 A.2d 645, 651 (2005), where the Connecticut Supreme Court refused to allow an association to sue when its members were parties to arbitration agreements; Penn. Chiropractic v. Blue Cross Blue Shield, 713 F. Supp. 2d 734, 744 (N.D. Ill. 2010) (holding the need for individual members to testify so as to determine whether their claims were arbitrable mitigated against associational standing); and In re Managed Care Litigation, supra, at *9, observing that ”[a]ssociations suing in a representative capacity are generally bound by the same limitations and obligations as the members they represent.” Defendants’ Memorandum, supra, at 22-23).

While the Penn. Chiropractic case is beside the point (there was no serious dispute that the substantive claims were subject to the arbitration), the Connecticut Supreme Court decision is on point philosophically, as is the Florida decision.

Considering the issue frontally on reconsideration, the District Court relied instead on Penn. Psychiatric Soc’y v. Green Spring Health Serv., Inc., 280 F.3d 278, 286-87 (3d Cir. 2002), cited by the Association. There, the Third Circuit ruled that, where the individual association members were subject to an arbitration clause, but the association represented it did not require more than “limited individual participation,” the case should not be dismissed even where the association had a questionable chance of success. The Court in Edible therefore allowed the case to proceed, while not expressly precluding the franchisor from seeking to compel individual arbitration (presumably as to the damage aspects of the claims). 2011 U.S. Dist. LEXIS 78008 at *7 It has now moved to do so while also seeking certification of the standing question for immediate appeal under 28 U.S.C. 1292.

Penn. Psychiatric Soc’y, the Third Circuit decision on which the Edible Court relied, is of little relevance here. In that case, the Appellate Court actually affirmed the denial of standing for an association to advance claims of the member patients, on grounds of lack of direct injury, and it did not hold the association had standing to pursue the claims of its doctor-members. It merely remanded to the District Court to determine the effect of the arbitration clauses in the contracts of doctors who were association members. Therefore, it did not dismiss that association’s case, pending further review.

VI. Conclusion

The Court in Edible also decided not to “bite the bullet” yet, and it signaled it may well revisit the standing issue later in the case. With respect, that is not sound judicial policy because, unlike the case on which it relies, here there is no doubt that the substantive claims for damages are arbitrable. Hence, the parties may spend more time and legal fees, and the District Court could be faced again with the same issues: (1) is the Association end-running the arbitration clauses of the individuals; (2) how material is it that the individuals can seek injunctive relief in court but perhaps not declaratory relief in court (an arbitrator certainly can declare rights); and (3) what is and ought to be the relationship between the preeminence of arbitration, the important rights advanced by associations, and the ability of parties to draft in such a way as to make associational standing highly problematic?

Stay tuned.

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