The Franchise Memorandum

The Sixth Circuit Court of Appeals has taken the relatively rare step of vacating an arbitration award on the grounds of “manifest disregard for the law.” In Coffee Beanery, LTD. v. WW, L.L.C., 2008 WL 3838010 (6th Cir. Aug. 8, 2008), an unsuccessful franchisee sued its franchisor alleging, among other claims, fraud, negligent misrepresentation, breach of contract, and violation of several franchise disclosure laws. The franchisor successfully moved to dismiss the court action and compel arbitration, based on the franchise agreement’s arbitration clause. At arbitration, the franchisee presented undisputed evidence that the franchisor had failed to disclose its vice president’s prior felony conviction for grand larceny.

The Maryland Franchise Registration and Disclosure Law (which the parties agreed applied to the case) requires franchisors to disclose whether any person identified in Item 2 “has been convicted of a felony…if the felony…involved fraud, embezzlement, fraudulent conversion, or misappropriation of property.” The arbitrator, however, found in favor of the franchisor on all counts, concluding that grand larceny is not the type of felony conviction required to be disclosed under the Maryland law. The arbitration decision was confirmed by the United States District Court for the Eastern District of Michigan. The Sixth Circuit, however, found that the statute “could not be any more clear” that felony convictions involving misappropriation of property must be disclosed. By definition, grand larceny is a felony involving misappropriation. Moreover, the arbitrator’s conclusion that the non-disclosure did not directly cause damages to the franchisee was of no import, because the technical violation of the disclosure law itself entitled the franchisee to rescission. Finally, because the franchisee’s execution of the franchise agreement was preceded by a defective franchise disclosure, the franchisee was not bound by the terms of the franchise agreement—including the arbitration clause. Therefore, the franchisee could not be compelled to arbitrate its claims on remand.