International Law

Arbitration and Statutory Franchise Fraud

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Fascinating case from the US 6th Circuit Court of Appeals concerning the relationship between the validity of an arbitration clause and the statutory failure to disclose all material information in the Franchise Disclosure Document.

The case is Coffee Beanery, Ltd v. WW LLC, and the Appeals Court Decision is here.

Here is the head note which explains the decision:

"At issue is whether the Arbitrator showed a manifest disregard of the law when she issued her award. Because we conclude that the failure to disclose a prior felony conviction for grand larceny violates the Maryland Franchise Registration and Disclosure Law ("Franchise Act"), Md. Bus. Reg. Code Ann. § 14-216(8)(i), and because the

Arbitrator showed a manifest disregard of the law in concluding otherwise, we REVERSE the judgment of the district court and VACATE the Arbitrator's award."

Of course the puzzle is that arbitrators are free to disregard stare decisis, or legal precedent.  So, exactly what is a manifest disregard of the law?

The US 7th Circuit Court in George Watts & Son v. Tiffany and Company described the resolution to the puzzle this way:

"There is, however, a way to understand "manifest disregard of the law" that preserves the established relation between court and arbitrator and resolves the tension in the competing lines of cases. It is this: an arbitrator may not direct the parties to violate the law. In the main, an arbitrator acts as th parties' agent and as their delegate may do anything the parties may do directly."

An arbitrator essentially can compromise the parties legal claims, and need not arrive at a decision consistent with published law on the same facts.  Presumably each party signed up for arbitration to reach this sort of result.  Compromise instead of a fight to the death.

But as part of the compromise, the arbitrator cannot direct parties to agree to violate the law.  Violation means acting in disregard of a statute or regulation.   

The 6th Circuit decided that the Arbitrator could not simply ignore the failure to disclose statutory required information, in order to obtain jurisdiction of the dispute.  

Much effort, time and money were wasted here by both parties because the initial District Judge failed to give a clear signal to the Arbitrator that a) the violations of Maryland law were clear, and b) these violations would likely void the agreement to arbitrate.

After numerous email conversations with the plaintiff's counsel, I came to the conclusion that I never did understand either the initial District Court order or how the Arbitrator came to the conclusion that the dispute was hers and not the Maryland Court's to adjudicate.

I think her mistake was to misunderstand the significance of the undisclosed felony.  Had it been disclosed, there may have been no difference to the purchaser's decision, and it is certainly hard to see this felony as a proximate cause of any loss.

But the undisclosed felony removes her jurisdiction to hear the dispute; it voids the arbitration clause because as a part of the franchise agreement, it was procured by a statutory fraud.

Full post as published by Misleading Advertising Law on August 21, 2008 (boomark / email).