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Catch 22: No “Day In Court”

From the Blog of Phyllis G. Pollack.

As I do not conduct arbitration hearings, I normally do not pay close attention to court decisions on the subject. But one issued on January 4, 2011 by the Fourth Appellate District of the California Court of Appeal caught my attention. In MKJA, Inc. v. 123 Fit Franchising, LLC, Case No. D055967, the appellate decision may well have placed plaintiffs in a “no-win” situation denying them their day in court and justice.

Plaintiffs are franchisees who signed health club franchise agreements with defendant franchisor. Claiming that defendants failed to provide plaintiffs with the operational support required by the agreements, plaintiffs sued the franchisor and others for violation of the California Franchise Investment Law (Corp. Code §3100 et seq.), breach of contract, unfair business practices (Business and Professions Code §17200 et seq.) and fraudulent inducement. (Id. at p.3).

In November 2006, the defendants moved the California trial court to stay the action because the franchise agreement provided that the parties would arbitrate such disputes before an arbitrator with the American Arbitration Association (AAA) in Denver, Colorado. In response, the plaintiffs moved to have the provision deemed unenforceable. In January 2007, the trial court, noting that under California Code of Civil Procedure §1281.4, it was required to stay the action, did so. Staying the action, the court stated it did not have jurisdiction to decide whether the provision was enforceable.

From January 2007 to September 2008, nothing occurred in the California court in this matter. Then in September 2008, plaintiffs filed a motion to lift the stay and for a declaration that the arbitration provision was unconscionable. In support of their motion, plaintiffs noted that the Colorado court had granted the defendants’ motion to compel arbitration in October 2007 but when they attempted to arbitrate, they found the cost to arbitrate to be prohibitive, including a $6,000 filing fee, a $2,500 case service fee, an estimated cost of $10,000-$14,000 in arbitrator fees and an estimated $20,000 in attorney’s fees bringing the total to $38,000-$42,000 per case. (Id. at p.6). As plaintiffs had already incurred hundreds of thousands of dollars in debt in connection with this franchise, plaintiffs claimed that they simply could not afford to arbitrate. They did not have the money, and the AAA would not agree to waive its fees. (Id. at p.7).

After a hearing, the trial court lifted the stay of litigation and declared the arbitration provision to be unenforceable and/or unconscionable. (Id. at p. 9).

The appellate court reversed finding that there was no provision in California’s arbitration statute authorizing the trial court to lift a stay of the litigation on the grounds that plaintiffs cannot afford the costs of arbitration. (Id. at pp. 15-23). Reviewing the case law and the purpose behind the stay, the appellate court noted that the reason for the stay:

“. . . is to protect the jurisdiction of the arbitrator by preserving the status quo until the arbitration is resolved (citations omitted). Preserving the arbitrator’s jurisdiction through a stay of related litigation is essential to the enforceability of an arbitration agreement since, in the absence of such a stay, a party could simply litigate claims that it had agreed to arbitrate. Given the purpose of the statute, the most reasonable interpretation of the stay provision is that it grants a trial court discretion to lift a stay prior to the completion of arbitration only under circumstances in which lifting the stay would not frustrate the arbitrator’s jurisdiction.” (Id. at pp. 20-21).

As might be surmised, the appellate court also held that the trial court lacked jurisdiction to determine whether the arbitration provision was unenforceable and/or unconscionable. (Id. at p. 23).

In sum, the appellate court reversed. On first blush, it might seem that plaintiffs were left without a remedy or a way to litigate their claims. But two questions come to mind: (1) didn’t plaintiffs spend a lot of money litigating this case and is this perhaps the reason why they were broke? (2) Why didn’t they file this motion in the Colorado court since the franchise agreement indicated that Colorado had the jurisdiction?

The more important issue involves drafting of alternative dispute resolution (“ADR”) clauses. While in recent years, arbitration has been touted as a favorable alternative to trials, given the latter’s expense in time and money, this decision highlights the dangers of not paying close attention to an arbitration (or mediation and/or any other type of ADR) clause and/or failing to negotiate it in detail. Arbitration (or any other ADR procedure) can be very expensive- if not carefully managed – more so than a trial and, as here, leave a plaintiff without a “remedy” or means to obtain “justice.” No doubt, the plaintiffs here read the franchise agreement with its arbitration provision requiring the use of the American Arbitration Association but did not investigate the cost and so did not realize how expensive an arbitration can be. As a result, they did not even attempt to negotiate this clause. But this, too, begs the question! Even if they did investigate and realize the costs, did they really have the leverage or bargaining power to negotiate a more favorable or streamlined, less expense incurring provision with the franchisor? Who knows? The morale of the story, though, is to pay attention to what you are agreeing to.

While this appellate court may have “properly” interpreted the statutes, did it do “justice”? Did the court lose sight of the forest for the trees, or be so myopic that it left the plaintiffs without remedy at all? Or, did plaintiffs bring it upon themselves by not doing their due diligence into the nature and expense of ADR and then negotiating a streamlined less expensive ADR procedure?

U.S. Supreme Court Justice Black noted in Griffin v. Illinois, 351 US 12,19 (1956) “There can be no equal justice where the kind of trial a man gets depends on the amount of money he has.”

. . .Just something to think about!


Phyllis Pollack

Phyllis Pollack with PGP Mediation uses a facilitative, interest-based approach. Her preferred mediation style is facilitative in the belief that the best and most durable resolutions are those achieved by the parties themselves. The parties generally know the business issues and priorities, personalities and obstacles to a successful resolution as… MORE >

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