The Franchise Memorandum

The United States District Court for the Southern District of Ohio recently enforced a franchise agreement’s arbitration provision, rejecting a franchisee’s claim of unconscionability. In Rodriguez v. Tropical Smoothie Franchise Development Corp., 2012 U.S. Dist. LEXIS 750 (S.D. Ohio, Jan. 4 2012), a franchisee brought suit against the franchisor of the Tropical Smoothie chain alleging that Tropical Smoothie violated state franchise disclosure laws, resulting in failure of the franchisee’s business. Tropical Smoothie moved to dismiss or stay the proceedings and compel arbitration, noting that the franchise agreement required all disputes to be submitted to binding arbitration in Atlanta, Georgia. In response, the franchisee asserted that the arbitration clause was “unconscionable.”

To be invalidated as unconscionable, an arbitration clause must be found both procedurally and substantively unconscionable. Substantive unconscionability looks to whether the actual terms of the arbitration clause are “outrageously unfair” so as to “shock the judicial conscience.” Here, the plaintiff argued that the arbitration clause was substantively unconscionable because it was mandatory, it required arbitration in Atlanta (he lived in Ohio), it required three arbitrators with experience in franchise law, it excluded class actions and punitive damages, it placed a one-year limit on claims, and it required the party seeking arbitration to initially pay the arbitrator fees and costs. The court found none of these provisions troubling or unusual, save the last one. The court held that, in light of the franchisee’s dire financial circumstances and an initial estimate of arbitrator’s fees and costs ranging between $20,000 and $40,000, the requirement that the initiating party front all arbitration costs would in effect prevent the plaintiff from asserting any claims. This was true even though the arbitration clause ultimately gave the arbitrator freedom to award costs to the prevailing party.

Procedural unconscionability looks to the manner in which the arbitration agreement was entered. For example, an arbitration provision “hidden in a maze of fine print” has been found procedurally unconscionable. The plaintiff admitted that it had not read the franchise agreement (or the arbitration clause) before signing, which is typically a bar to a claim of procedural unconscionability. The plaintiff argued, however, that because we live in a society in which consumers frequently are required to sign various user and license agreements without reading them, his failure to read the franchise agreement should not be dispositive. The court rejected this reasoning, noting that the franchise agreement was a business contract, not a consumer agreement, and that the plaintiff was a college-educated businessperson. Because both parts of the unconscionability test were not met, the franchisor’s motion to dismiss the court action was granted.