Kia Franklin

In MoJo: how forced arbitration helps franchises commit fraud

We've written time and again about the dangers of pre-dispute binding mandatory arbitration clauses in contracts between people and corporations. And lately this issue has been gaining ground in larger outlets like The Nation and Huffington Post.

The most recent article comes from Stephanie Mencimer at Mother Jones (Mencimer has covered this topic extensively in the past). She details the horrific experience of a Maryland couple that thought they were entering into an exciting new enterprise, but found themselves sucked into an expensive and energy-draining case of franchise fraud. To make matters worse, the couple couldn't take their alleged defrauder, Coffee Beanery, to court. You got it--arbitration horror. From the article:

Hoping to recoup their losses, Welshans and Williams sued in Maryland federal court. But Coffee Beanery struck back in Michigan; a federal judge there ordered the couple—as required in the fine print of their franchise agreement—to instead take their dispute to a private arbitrator selected by the company. (Such binding arbitration clauses are boilerplate in contracts for everything from cell phones to credit cards.) Welshans had to borrow another $100,000 from his brother-in-law just to proceed with the process, which required steep fees up front.

The arbitrator who handled their case had some serious conflicts of interests:

JoAnne Barron, the arbitrator selected for the case, already knew the company and its lawyer, Karl Fink, who served 20 years as a judge on the state court where Barron has been employed as an attorney. She and Coffee Beanery also shared an accounting firm, a potential conflict given that the case partly involved the company's accounting practices. Barron had overseen at least two previous franchise disputes involving Fink, finding in the company's favor both times.

Surprise, surprise--she ruled against them. Coming out of the process, the couple is in the hole to the tune of hundreds of thousands of dollars, including some seriously steep fees. This includes court reporter/transcription fees of over $35,000 and an arbitrator's fee of almost $17,000. But there is a tie for the most ridiculous fees--they had to pay for the lunch and transportation costs of the other side's lawyers, and for the company's defense against a Maryland state investigation, to which the couple was not even a party.

Most recently, the 6th Circuit Court of Appeals struck down the arbitrator's award, finding that the arbitrator had ignored state law. The company is appealing that decision.

Here's a link to the article. Believe me, it's worth the read. In addition to the above snippets, Mencimer provides a full layout of the fees incurred through arbitration, a discussion of the elements of Coffee Beanery's fraudulent activity, and even a description of how Coffee Beanery used its arbitration victory to send a message (of intimidation?) to other franchisees bringing disputes against the company. Mencimer also describes how this experience has reshaped the couple's lives.

Stories like this get me thinking. Imagine if we each refused to enter into any contract that forces us to sign away our right to sue... Would we have jobs? Cell phones? Homes? Cars? Would we even be reading this blog right now?

Pass the AFA now!

Kia Franklin: Author Bio | Other Posts
Posted at 1:07 PM, Feb 26, 2009 in Arbitration | Corporate Abuse | Corporate Lawsuit Amnesty | In the News | Loser Pays | Mandatory Arbitration
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Yes! Lots of fraud in franchising that, unfortunately, is encouraged and permitted by ineffective federal regulation, i.e. the FTC Rule. The FTC Rule promulgated in late 1979 actually is a subsidy of the FRANCHISORS because it appears to protect the franchisors from any obligation to disclose MATERIAL unit performance statistics of the system to new first-generation buyers of the franchise. Even mature and respectible looking franchisors are able to commit fraud under cover of government regulation when they can sell their franchises without disclosing MATERIAL facts concerning unit performance that are vital to the new buyers of franchises and also to the investors in the paper of the franchisors.

Mandated arbitration seals the "stacked deck" against franchisees who are defrauded in the pre-sale process because once they sign the unbargained, boilerplate, self-serving contract, the franchisors appear to be protected from charges of fraudulent inducement in the sales process in arbitrations and in the courts.

Please read the excellent article with references, etc.. entitled "Franchising Fraud: the continuing need for reform" published by the American Business Law Journal 01 Jan 2003, and on the Internet in mid 2008, for a study of the "Inducement Problem" that leads to so much fraud in the Industry.

Richard Solomon of Franchise Remedies tells the truth. Fraud has been increasing at a rapid pace within the industry and the sharks are out there looking for "severance pay" and proceeds from 40lK's etc.. and other savings to line THEIR pockets at the expense of innocents who invest in pigs and dogs (listed on the SBA Franchise Registry) because they believe that the government wouldn't "license" franchisors with a "disclosure document" if the franchise was a pig or a dog.

Hopefully, the Congress will try to clean up the mess of franchising with better regulation and eliminate mandated arbitration, especially in franchise contracts where failed franchisees lose so much.

Posted by: Carol Cross | June 9, 2009 1:11 PM

When you own or start a franchise business, you’re in business for yourself, but not by yourself. And when you use, you’re setting yourself up for a franchise opportunity.

Posted by: FranchiseExpo | September 16, 2010 4:17 PM