Resolving Franchising Disputes

Despite all best efforts to maintain the “honeymoon” period, there will come time during the relationship where the franchisee and franchisor may not agree or see things differently; this is the “Rough” period… very likely, such period will evolve to a clear disagreement the “Bold” period which, if not managed properly, it can lead down an emotional and costly path.This is the reality in any relationship. 

It may be that franchisee feels that the new items introduced on the menu are not going to do well in the market, or that he lacks support from franchisor, or too much control from franchisor, or that he pays a high fee for the services he receives.

Certainly, when signing the franchise agreement, the last thing the parties want to think about is what happens if the relationship goes bold.

Below, I shall discuss the most common ways to resolving franchising disputes such as Negotiation, Mediation, Litigation and Arbitration, and the considerations to bear in mind when choosing Litigation or Arbitration in a dispute resolution clause.

Negotiation

The simplest and cheapest way to settle a dispute is for the parties to have an open, candid communication with mutual respect for each other. Ideally, each party would approach the dispute objectively and unemotionally, seeking a solution.

In practice, the parties may get too involved emotionally and financially to be able to settle the dispute themselves. However, if each party has gone to a lawyer, letters will have been written, allegations will have been made, and the dispute escalated to a point where goodwill disappears.

Therefore, it is recommended that sensible directors of each party will meet and negotiate. Usually, these directors are far more concerned with reaching a solution based on both parties’ ‘ongoing business interests’ rather than establishing the parties’ legal rights in the dispute.

Reaching amicable settlement has nothing to do with justice; it has to do with looking to the future and not being hung up on the past.

Mediation

If direct negotiation fails, the parties can agree to appoint a neutral third party (a mediator) who will assist the parties to negotiate a sensible agreement to settle their dispute. A mediator doesn’t make decisions for the parties; instead he/ she assists the parties to understand each other’s point of view and come to an agreement.

In practice, the appointed mediator schedule a meeting with both parties to listen to a summary of the dispute and the arguments of both sides, and then, if required, meet in private (‘caucus’) with each side. The mediator’s main objectives are to help the parties defining their points of dispute, identifying areas of agreement, evaluating the strengths and weaknesses of their case, and certainly remind them about the enormous amount of damage in time, money and goodwill which may be caused if they are unable to reach agreement at this stage.

Recently, mediation has become popular as a method of resolving business disputes between the parties, especially of international nature.

In a famous case in England, an English court refused to allow the winning party to recover the costs of litigation because it has refused the losing party’s request to mediate prior to going to court.

It is recommended that you include your franchise agreement a mandatory “Mediation” clause prior to resorting to litigation/ arbitration.

Litigation (state courts)

If the parties fail to reach agreement during either negotiation or mediation, they will resort to litigation or arbitration procedures to settle their dispute. If the parties have failed to include an arbitration clause in their contract, litigation before local courts will be their method of resolving their dispute – unless the parties consent to submit their dispute that has already arisen to arbitration, which in practice is almost impossible to happen after the relation breaks down.

However, in international business relationships (such as in franchising), neither party is eager to trust the resolution of the dispute by the other party’s local court. Each party suspects, correctly or not, that the other party’s home court will offer an advantage, at the very least, familiar procedures, customs, advocates and language. However, by choosing international arbitration, the parties create an equally inconvenient playing field.

Arbitration

Certainly, there are a number of advantages that arbitration can have over litigation. 

Advantages

Arbitration offers substantial advantages, especially in international commercial disputes such as: neutrality, flexibility, privacy/ confidentiality, and most important; enforceability.

Contrary to popular belief, an arbitrator does not (or at least should not) just "cut the baby in half".  They find the facts based on the evidence. They apply the relevant law to those facts. They then determine the parties' legal rights and obligations and resolve the dispute as the law requires, based on those facts.

Selection of your Judge (Arbitrator): in arbitration, the parties are able to select and appoint their Arbitrator (tribunal) who must be neutral and impartial while deciding on the dispute between the parties.

Flexibility: the parties and the Arbitrator shall agree on the procedures, time table and location of hearings which suit the circumstances of the parties and the dispute. In some cases the Arbitrator may decide on the dispute merely on the basis of documents without ever meeting the parties or their lawyers.

Privacy/ Confidentiality: a basic principal before state courts is that proceedings must be carried on in public – justice must be seen to be implemented. Arbitral proceedings are private and confidential.

Enforceability: It is essential to check the enforceability of court judgments and arbitral awards before finalising the dispute resolution clause.  For example, there is currently no agreement between Russia and the UK for the enforcement of court judgments.  This means that a Russian court will generally refuse to recognise an English court judgment, but it will recognise an arbitral award made in England under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.

This convention gives the holder of an arbitration award the right to enforce its award in any of the countries signatories to the NY convention (i.e. 156 countries). The NY Convention is the backbone of international arbitration today.

Arbitration clauses are to be enforced as written. Certainly a badly drafted arbitration clause leads to disputes and wasted time and costs.

Below we shall examine some of the main points which the parties need to consider when drafting an arbitration clause in a franchising contract.

2. Reference to a Recognized Arbitral Institution

It is crucial that the parties select a clear and unambiguous language in referring to an existing arbitral institution. Below are examples on ambiguous and incorrect references to arbitral institution.

Ambiguity: “Any dispute arising from or relating to this Contract will be settled under the Rules of Arbitration of “the International Arbitral Centre of the Chamber of Commerce and Industry in Paris” Would this be the CMAP (Centre for Mediation and Arbitration of Paris founded by the Chamber of Commerce and Industry) or ICC?

Reference to Non-Existing Institution: “Any dispute arising from or relating to this Contract will be settled under the rules of procedure of the “International Commercial Arbitration Association”.There no such institution.

3. Scope of the Arbitration Clause

Wording Must Have a Broad Scope: Each of the leading arbitral institution provides a sample arbitration clause for inclusion in international contracts. For example, The London Court of International Arbitration’s (LCIA) suggested clause states:

“Any dispute arising out of or in connection with this contract, including any question regarding its existence, validity or termination, shall be referred to and finally resolved by arbitration under the LCIA Rules, which rules are deemed to be incorporated by reference into this clause.”

This clause has been said to contain the key expressions: “Any dispute”…“in connection with”…“finally resolved by arbitration”. The term “all disputes” encompasses all types of controversies, without exception. The language, “in connection with”, creates a broad form clause that will cover non-contractual claims such as tort and fraud.

The word ‘arbitration’ must be mentioned:

In AIG Europe v QBE International Insurance (2001), the English court had to interpret the following clause headed ‘Arbitral Procedure’:

“In case of dispute between the insured and the insurers the parties will apply to the tribunal de Commerce in Paris who will appoint an Arbitrator. The latter, with the possible collaboration of two further Arbitrators appointed by the parties, will have the task of proposing an agreement acceptable to both parties.”

The court held that although the clause referred to the appointment of one or more Arbitrators, their duty was merely to act as conciliators proposing an agreement and there was no arbitration agreement.

Appointment of Arbitrators

One or Three… Odd Number: It is advisable that an arbitration clause to specify the number of the Arbitrators which should be either one or three Arbitrators (even number will risk deadlock).

The Parties should consider whether the value of the contract and of any potential disputes justifies the selection of three Arbitrators, which will be more expensive and normally longer (coordinating space in three Arbitrators' diaries will take more time).

However, the parties may agree not to specify the number in advance and to decide in accordance with the size and complexity of the dispute if one arises. The disadvantage of this is that proceedings may be delayed if the parties disagree on the number of Arbitrators once relations have broken down. If institutional arbitration is used, the institution will decide the number of Arbitrators.

Excessive Requirements as to Arbitrator qualifications: All disputes arising out of this Contract shall be decided by one Arbitrator. The Arbitrator shall be a Romanian national who is fluent in English and Spanish with a degree in business, and at least 10 years of experience as a CEO of an international brand.”

Although this clause may sound to drafters the best ever clause to select the suitable arbitrator in the event of a dispute, but when you set this into motion, probably you will run into a serious problem to find arbitrators who are matching the requirements

Signing Arbitration Clause

Capacity: You shall need to check that person signing the franchise agreement has authority to enter into the agreement. Bear in mind that in some jurisdictions a special power of attorney will be needed to sign over an arbitration clause, like in Turkey.

Conclusion

Disputes are often a part of any long term relationship. It is essential that your franchise contract includes a clear mechanism for resolving disputes. However, a dispute resolution clause is often seen as “mid-night” provision – no more than a "footnote" to the agreement, and far less important than the commercial terms of a deal.

Business people and lawyers should carefully consider the kinds of disputes which are likely to arise under the contracts, and select a dispute resolution mechanism (or combination of mechanisms) which is best suited to resolve those kinds of disputes. If they don't chose wisely, they may end up being committed to a mechanism which is inappropriate for the disputes which do arise. If they don't chose at all, then by default they chose litigation before state courts.

However, open communication and candid discussions, with respect, between the parties will often resolve many issues.

About the Author

Ashraf El Motei heads the Dispute Resolution practice in Motei & Associates, a Dubai based law firm since 2002. His practice encompasses a broad spectrum of substantive areas of the law with specific focus on civil, commercial and family disputes.

In addition to his civil litigation practice, Ashraf has represented clients in numerous arbitration cases under the rules of the International Chamber of Commerce (ICC) and the Dubai International Arbitration Centre (DIAC). He has also served as arbitrator and co-arbitrator in several significant arbitrations. He has specific expertise in enforcement of foreign arbitral awards under the New York Convention.

For more information about M&A, please visit http://www.motei.com/