Hepler Broom, LLC

COMMERCIAL CLEANING FRANCHISOR SWEEPS UP RICO CLAIMS — Arbitration Provision and Class-Action Waiver Clause Valid and Enforceable by Nonsignatories

February 4, 2014

Stratus Building Solutions faced a business challenge on a bet the company scale.  Despite winning many franchise awards, five franchisees charged that its entire system imposed a fraud on franchisees.   The plaintiffs sued 179 defendants, including the system franchisor, master (regional) franchisors, and over 70 individuals associated with the franchise system of violating §§ 1962(c) & (d) of the Racketeer Influenced and Corrupt Organizations Act (“RICO”).  They claim the Defendants collectively operate the Stratus franchise system through a massive, but vaguely alleged scheme to defraud all unit franchisees across the country.  They spread misinformation on the web about Stratus and solicitations to join the cause celebre through channels such as unhappyfranchisee.com.

But Plaintiffs ignored their contractual obligation to arbitrate their claims under their Franchise Agreements, on an individual rather than class basis.   Stratus moved to dismiss the complaint and compel arbitration of the claims on an individual basis in accord with the broad form arbitration provision in the franchise agreements.

In accordance with the Federal Arbitration Act (“FAA”), 9 U.S.C. § 1 et seq., Chief Judge Catherine D. Perry of the U.S. District Court for the Eastern District of Missouri found that the arbitration provision and class-action waiver clause contained in Plaintiffs’ Unit Franchise Agreements are valid, irrevocable, and must be enforced according to their terms.   Judge Perry rejected the argument that the arbitration agreement was unenforceable as procedurally or substantively unconscionable and concluded the agreement applied to non-signatories who were connected with the Franchise system. “Because plaintiffs’ RICO claims allege that they were defrauded, in part, by the operation of the unit franchise agreement, the arbitration agreement encompasses those claims…. Any arbitration must be conducted on an individual basis in accordance with the terms of the arbitration agreement.”

Chief Judge Perry also found “that plaintiffs have not carried their burden of showing, through specific evidence, that the arbitration agreements foreclose pursuit of any remedy.”  Noting that the applicable AAA rules the parties adopted allows the arbitrators discretion to award costs and fees among the parties, the Court reasoned the limited evidence in the record could not support unconscionability.  And the FAA “prohibits a judge from weighing the cost of arbitration against a claimant’s potential recovery.  Am. Express Co. v. It. Colors Rest., 133 S. Ct. 2304, 2312 (2013).”

But what about the named non-signatory owners, operators, agents, employees or officers of the regional master franchisors or Stratus?   The Court, interpreting the arbitration agreement and Missouri law, found they are all intended third-party beneficiaries of the arbitration agreement itself.  “Because the arbitration agreement reflects the signees’ intent to benefit some third parties and the unit franchise agreement clearly confers benefits upon Stratus Franchising and the other master franchises, those parties may enforce the arbitration agreement.”

This important decision for our clients effectively ends over a year of significant disruption to Stratus’ business reputation and eliminates a potential for multi-million dollar, treble damage system-wide exposures.  The important lesson of the case, however, lies in the drafting and enforcement of the arbitration provision.  Absent an arbitration agreement that is broad enough to encompass the dispute and the parties to the case, enforcement is complicated. In particular, the clarity of the class action waiver is important.  In this context the key provision read:

“iv.      We and you agree that arbitration will be conducted on an individual, and not class-wide basis and that an arbitration proceeding between us and our affiliates, and our and their respective members, officers, managers, agents, and/or employees, and you (and/or your owners, managers, guarantors, affiliates, and/or employees) may not be consolidated with any other arbitration proceedings between us and any other person.”

The case is Jose Torres, et al. v. Simpatico, Inc., et al., No. 4:12CV2373 CDP (E.D. Mo. 2/3/14).   It provides an excellent resource for parties evaluating enforcement of arbitration agreements under the FAA in the Eighth Circuit, non-signatory enforceability, and substantive and procedural unconscionability defenses.

See the Court’s Full Memorandum and Opinion.