The Franchise Memorandum

In Bencharsky v. Cottman Transmission Systems, LLC, 2008 WL 5411500 (N.D. Cal. Dec. 29, 2008), the United States District Court for the Northern District of California enforced an arbitration clause in a franchise agreement, but with some significant limitations. The franchisee had filed the lawsuit alleging breach of contract, fraud, negligent misrepresentation, interference with contract, and violation of the California Franchise Investment Law (CFIL). The factual basis for the action was that, among other things, the franchisor had refused to renew the franchise agreements at their current locations under the Cottman brand name. When Cottman moved to dismiss and to compel arbitration, the franchisees contended that the arbitration clause was unconscionable and thus unenforceable under California precedent.

In granting Cottman’s motion, the court found that it (rather than the arbitrator) would determine the validity of the arbitration clause because the franchisee was merely challenging the arbitration provision instead of seeking to invalidate the entire franchise agreement. The court then held that the franchise agreements’ choice of law provision (which would have applied Pennsylvania law to the question the enforceability of the arbitration provision) was invalid because California law affords greater protections to franchisees than Pennsylvania law—especially because the CFIL gives franchisors a narrower range of defenses to misrepresentation claims than Pennsylvania recognizes. 

The court then determined that the arbitration clause was substantively unconscionable in that it only allowed Cottman to seek injunctive relief in court, even for trademark infringement claims; that it barred punitive and exemplary damages and set out a one-year limitations period on filing the arbitration; and that it limited the power of the arbitrator to alter or modify any provision of the franchise agreements. The court, however, noted that the arbitration clause was not significantly unconscionable procedurally because the franchisees had been the ones to initiate contact with Cottman about becoming part of the system, that they had consulted with an attorney before signing the franchise agreement, and that the arbitration was distinctly identified in the text of the contract.

Concluding that it would uphold the arbitration provision while severing the unconscionable portions, the court granted Cottman’s motion to dismiss the action and compel arbitration. The court also held that it did not have jurisdiction to compel the parties to arbitrate in their contractually-selected forum state of Pennsylvania.