FranCast

Have you ever been required by a state franchise regulator to include in your franchise agreement or disclosure document a provision that you believe he or she does not have the legal right to require? This issue often arises when a state franchise law imposes an obligation that may be preempted by federal law. For example, several states – such as Michigan, North Dakota, Rhode Island, Washington, Wisconsin, and Maryland – have franchise laws that arguably impose restrictions dealing with arbitration that would violate the Federal Arbitration Act. What do you do when faced with a regulator who insists that you include the provision though you believe that federal law would not require that?

A recent action by the US Supreme Court denying review of a court of appeals’ decision provides at least one answer, though perhaps not a satisfactory one for franchisors.

State law v. contractual provision

In Dickey’s Barbecue Restaurants, Inc. v. Chorley Enterprises, Inc., the franchisor (Dickey’s) sought to register to sell franchises in the State of Maryland. The Maryland Franchise Law Regulations provide that a franchisor would be in violation of the law if it required a franchisee to “waive the franchisee’s right to file a lawsuit alleging a cause of action arising under the Maryland Franchise Law in any court of competent jurisdiction in this State.” Dickey’s franchise agreement provided that all claims (with exceptions not relevant here) be arbitrated. However, because of the Maryland Regulation noted above, Dickey’s was required by the state regulators to include a provision that “the provisions of this Agreement shall not require you to waive your right to file a lawsuit alleging a cause of action arising under Maryland Franchise Law in any court of competent jurisdiction in the State of Maryland.”

When, years later, a dispute arose with some franchisees who asserted a claim under the Maryland Franchise Law, Dickey’s argued that those claims should be arbitrated because the requirement that those claims be in court was preempted by the Federal Arbitration Act, which provides that arbitration agreements be enforced.

The court of appeals’ decision

The Fourth Circuit Court of Appeals rejected that argument, stating that the clause in the franchise agreement allowing the franchisee to file these claims in court was a contractual provision and that preemption applies only to the “state law” itself. The court noted that when “a party to a contract voluntarily assumes an obligation to proceed under certain state laws, traditional preemption doctrine does not apply to shield a party from liability for breach of that agreement.” (Emphasis added) When Dickey’s argued that it did not “voluntarily” include that clause in the agreement, the court disagreed, stating that Dickey’s “was not forced to do anything” because it could have (i) declined to do business in the State of Maryland or (ii) filed a declaratory judgment action challenging the state administrator’s position before including that clause in its agreement.

Review by the Supreme Court

Dickey’s sought to have the decision reviewed by the US Supreme Court. Because we at DLA Piper recognized the dilemma that the Court of Appeals’ decision creates for franchisors – either not sell in a particular state or commence what would most likely be a lengthy court proceeding against the administrator whose approval the franchisor would need in the future to become registered – we filed an amicus brief on behalf of the International Franchise Association arguing that the decision to include such clauses should not be considered “voluntary.”

After the petition for review was filed, the franchisee decided to waive responding; the Supreme Court requested a response from the franchisee; and the case was conferenced by the Justices twice. During the pendency of the petition, Justice Antonin Scalia passed away, and the remaining Justices denied the petition for review. Accordingly, the decision of the Fourth Circuit remains the law, at least in that circuit.

What this means for franchisors

If you are faced with a situation in which a state law or regulator requires you to include a provision in your franchise agreement, disclosure document or any addenda, which you contend is barred by other laws, you should of course first try to convince the regulator of the soundness of your position. If the regulator continues to insist on inclusion of that contractual clause, you should attempt to add to the clause a statement indicating that you believe the clause is not enforceable. The purpose of that addition is to enable you, in the context of a dispute later with a franchisee, to argue that you should not be bound by the contractual provision (and that the franchisee was on notice that you would challenge its enforcement).

If you and the regulator cannot agree on any satisfactory additional language, then based on the Dickey’s decision, if the issue is important to you, you should either refrain from selling future franchises in that state or file for a declaratory judgment or injunction to enjoin the regulator from requiring inclusion of that clause in the agreement.

While these options are certainly not ideal, that unfortunately is the result of the Dickey’s decision.