Whether you are a new franchisor who must make decisions about the terms of your Franchise Agreement or a prospective franchisee who must consider the relative importance of various provisions of a Franchise Agreement, several clauses of a typical Franchise Agreement, often appearing toward the end of a lengthy contract, should be carefully analyzed. These terms concern how any disputes between the franchisor and the franchisee must be resolved. While dispute resolution is probably down the list of concerns at the outset of a franchise relationship, the agreements made at the beginning can affect what happens at a later, more stressful, time.

Whether to mediate, arbitrate, or litigate: Mediation is a tool used to try to resolve disputes before formal proceedings move forward. The parties to the dispute agree on a mediator, often provided, at a fee, by a commercial alternative disputed resolution ("ADR") company, who then attempts to assist the parties to resolve their dispute by agreement. Mediators can be retired judges, attorneys, persons with industry experience, or others. If the matter is not resolved by agreement at the conclusion of the mediation, more formal proceedings can commence or, if already begun, proceed. Mediation is often advisable if the franchisor-franchisee relationship will continue or if the parties desire to try to avoid the substantial cost of moving forward with an arbitration or litigation proceeding. Most mediators are not inexpensive, usually charging many hundreds of dollars per hour. However, the parties’ agreement can specify the length of the mediation-such as one day=and that can limit the mediator and ADR service’s charges, costs usually shared between the parties to the mediation.

Many Franchise Agreements contain a provision that specifies that any dispute will be resolved by arbitration under the auspices of a designated ADR provider. If the Franchise Agreement contains an arbitration clause, in all likelihood filing a suit in court will not be allowed since under the Federal Arbitration Act arbitration is a preferred method of dispute resolution and, except in very limited circumstances, will prevent a party from looking to the courts to deal with the matter unless both sides agree otherwise. Arbitration, like mediation, is a creature of contract. The contract provisions specifying arbitration can set most of the terms of the arbitration, such as the number of arbitrators-usually one or three, the rules under which the arbitration proceeding will take place, the venue (location) of the arbitration hearing, any special experience to be possessed by the arbitrator or arbitrators, who bears the costs of the arbitration, the availability of or limits on discovery- pre-hearing depositions and other fact-finding procedures, and so forth. Arbitration awards are normally not subject to appeal and are, as a result, final, even if the arbitration panel made serious errors.

A series of court cases has allowed arbitration provisions to be set aside or limited if the arbitration clause is too one-sided, as was often the case in early Franchise Agreements. One of the grounds for setting aside an arbitration clause is unconscionability. An arbitration provision may be found to be unconscionable if, for example, one side is required to arbitrate but the other side can go to court if it wants, the location of the arbitration is extremely inconvenient to one of the parties, one party must bear the costs of the arbitration even if it wins, or similar provisions, especially if they are forced on a party with significantly less bargaining power on a "take it or leave it" basis or are buried in the small print "boilerplate" in the contract. Some recent court decisions have required the franchisor to initially pay the arbitration fees if the franchisee is unable to and the claims involve public policy issues, such as franchise law violations.

The advantages often attributed to arbitration are that arbitration takes less time than a lawsuit, is less expensive than a court proceeding, and leaves the parties better able to continue their relationship since it is a less formal proceeding. However, we have seen arbitration proceedings that result in great expense- the cost of the ADR administrator, the high filing fees, and the cost of the arbitrator or arbitrators at many hundreds of dollars per hour each—in addition to the cost of the parties’ attorneys and related expenses. Often an arbitration provision will specify that the arbitrators can decide that one of the parties is the "prevailing party" and require the other party to pay the costs of the arbitration and, if the contract contains a clause allowing it, some or all of the other party’s attorneys’ fees. Of course, if the party who loses has no money, those awards are rather meaningless. Arbitrations with complicated facts, multiple witnesses, extensive briefing, expert testimony, etc., can take a great deal of time and result in substantial cost, as well as a long time before reaching a result. Scheduling extensive hearings can result in delay since the schedules of each of the parties’ lawyers, the arbitrator or arbitrators, the witnesses, and the parties must be coordinated in finding convenient times for day-long or partial day hearings. While the hearings are usually less formal, taking place in a conference room rather than a courtroom and normally with loosened rules of evidence, the adversarial nature of the proceedings usually irrevocably damages the relationship of the parties.

Litigation-a lawsuit filed in court-can be initiated with a reasonably low filing fee. However, the cost of preparing a complaint to initiate the action can be substantial. Extensive pre-trial depositions and other methods of fact-finding allowed in such a proceeding, can take a great deal of time with resulting expense. In a complex matter, motions and the court’s busy calendar can delay a trial for months, and sometimes years. As a result, attorneys’ fees can be greater in litigation, although the judge and the matter’s administrators are paid by the government and not the parties, as in arbitration. A jury trial is usually available in a lawsuit although some states still allow the parties’ contract to waive trial by jury. The rules of evidence are enforced in litigation, limiting such things as hearsay, nonexpert opinion, and other items sometimes allowed in an arbitration proceeding. Serious errors can serve as grounds for an appeal to a higher court, permitting the correction of miscarriages of justice. Attorneys’ fees provisions are also enforceable in litigation as they are in arbitration if the contract at issue allows the prevailing party to recover fees and costs. While the contract can attempt to specify where the matter will be heard-"forum selection", state jurisdictional statutes can often override the contract provisions, especially in states which have franchise registration or relationship laws that require litigation involving those laws to be in the home state of the franchisee. The forum selection clause in an arbitration provision has a greater chance of being enforced.

We are often asked whether it is preferable to have an arbitration clause in a Franchise Agreement or whether allowing litigation to be used to resolve disputes is more advisable. As you can see, each method of dispute resolution has advantages and disadvantages. Each method has its steadfast advocates as well as its critics. Many lawyers like the built-in protections of court proceedings: discovery to clarify the facts before trial, rules of evidence to control what is put before the judge and jury, the right of appeal to correct serious errors that may have caused a bad result, and the possibility of lower costs because no arbitrators or ADR administrators have to be paid. On the other hand, arbitration has its champions, citing the easier initiation of proceedings, the less formal atmosphere, the absence or limits on discovery which takes time and can be costly, the ability to choose one’s arbitrator or arbitrators, the ability, if allowed by the contract, to specify the special skills or experience to be possessed by the arbitrator or arbitrators, and the possibility of a quicker decision.

There is clearly no perfect method of dispute resolution otherwise every Franchise Agreement would have the same provisions. However, knowing the nature of the specified proceedings and the ramifications of an attorneys’ fees clause and forum selection and venue provisions should help both franchisors and franchisees make an informed decision about which method to specify in the event of a dispute between the parties which they cannot resolve between themselves using less formal means.