The Franchise Memorandum

In Awuah v. Coverall North Am., Inc., 2009 WL 159423 (1st Cir. Jan. 23, 2009), several franchisees filed a class action against the franchisor in Massachusetts federal district court alleging fraud, breach of contract, and violations of various minimum wage, overtime, and consumer protection laws. In response to the lawsuit, the franchisor moved to compel arbitration and stay the pending litigation, based upon arbitration provisions contained in three of the applicable franchise agreements. The franchisees responded that the arbitration clauses were unconscionable and that the court should decide whether the agreements to arbitrate are enforceable.

Relying on the rules of the American Arbitration Association, which rules had been incorporated by reference into the arbitration agreements, the franchisor argued that the franchisees’ challenge to the validity of the arbitration provisions was a matter for the arbitrator to decide. The federal district court disagreed with the franchisor and held that the franchisees’ claims of unconscionability should be addressed by the court because the applicable franchise agreements “did not clearly and unmistakably” state that claims challenging the validity or unconscionability of the arbitration clause should be heard by an arbitrator.

On appeal to the First Circuit, the appellate court disagreed with the lower court and determined that the AAA rules requiring the arbitrator to decide the validity of an arbitration agreement were clear and unmistakable and that the rules had, unequivocally, been incorporated into the franchise agreements. Notwithstanding that determination, the appeals court expressed concern that if the terms for getting an arbitrator to decide the issue of unconscionability are unduly burdensome due to the expense associated with arbitration, then the arbitration remedy becomes “illusory” and arbitration is no longer a valid alternative to litigation. Based upon this concern, the First Circuit remanded the issue to the district court to determine whether, under the facts of the case, the arbitration clause effectively deprived the franchisees of a remedy.