A recent Washington Supreme Court decision, concerning a Subway sandwich shop franchise dispute, although unrelated to construction, sheds some light on how courts will view future arbitration disputes.[i] Many construction contracts require that construction disputes be resolved in arbitration, rather than in court, and thus, the Washington Supreme Court’s ruling in this case, will have an impact on the arbitration of construction disputes.
Between 2004 and 2006, two enterprising entrepreneurs (“owners”) entered into three franchise agreements to operate Subway sandwich shops in Pierce County. The franchise agreement provided that the owners agreed “not to own or operate, or assist another person to own or operate any other business . . . which is identical with or similar to the business reasonably contemplated by this agreement.” A manager at one of restaurants advised the Subway franchisor (the entity from whom the entrepreneurs purchased the shops) that the two owners had opened another restaurant and that he rarely saw the owners at the Subway shops. Based on that assertion, the franchisor commenced an arbitration against the two entrepreneurs. The franchise agreement’s choice of laws provision read as follows:
This Agreement will be governed by and construed in accordance with the substantive laws of the state of Connecticut, without reference to its conflicts of law, except as may be otherwise provided in this Agreement. The Parties agree any franchise law or business opportunity law of the state of Connecticut, now in effect, or adopted or amended after the date of this Agreement, will not apply to the franchises located outside of Connecticut.
The franchisor indicated it would allow the two owners to cure the alleged violation of the non-compete clause by selling the Subway restaurants within 60 days. The two entrepreneurs found a buyer who offered to purchase the three stores for $1,180,000, however, when the buyer was told of the pending arbitration, he withdrew the offer. The entrepreneurs then filed a lawsuit in Pierce County contending that the franchise agreement violated Washington law and that they were entitled to damages under the Washington Consumer Protection Act. They asked the judge to enjoin the Connecticut arbitration.
The trial judge found that the arbitration’s forum selection clause (that the arbitration had to take place in the state of Connecticut) was “unconscionable and unenforceable” and ordered that the dispute between the parties be arbitrated in Washington under Washington law. The franchisor did not seek discretionary review of this decision, and as it turns out, that was a major tactical error and the arbitration went forward.
The arbitrator denied all of the franchisor’s claims and ruled for the two entrepreneurs, awarding them substantial damages and attorneys’ fees. The franchisor moved to vacate the arbitration award based on the trial court’s original order directing that the arbitration take place in Washington, rather than in Connecticut. First, the court affirmed that it has limited authority concerning arbitrations. The courts, not the arbitrators, determine the threshold matter of whether an arbitration clause is valid and enforceable. If a party challenges the validity of an arbitration clause, rather than the validity of the contract as a whole, the question of “arbitrability” is for the court to decide, not the arbitrator. Since the franchisor was requesting that the court determine whether the dispute resolution provision of the franchise agreement was enforceable, and not challenging the contract as a whole, the question was one for the court to decide.
The franchisor then challenged the court’s ruling, which failed to strictly enforce the venue, choice of law and damage limitations in the franchise agreement (there was a damage limitation that limited the damages to $100,000). The court in conducting its analysis, first held that it was following the “emergent consensus of courts” and ruled that a “party who fails to seek discretionary review of an order compelling arbitration, must show prejudice as a condition of relief of the arbitration award.” In other words, because the franchisor failed to appeal the trial court’s decision mandating that the arbitration take place in Washington, the franchisor, to prevail on appeal, had to show more than an error occurred; it had to show that the ruling prejudiced the franchisor.
The franchisor was unable to show that the outcome of the arbitration would have been different under Washington law than it would have been under Connecticut law, and “demonstrated no prejudice.” The trial court’s ruling was affirmed because the franchisor could not demonstrate prejudice, even though the trial court may have arguably made an error. As far as the limitation on damages was concerned, (there was a limit of $100,000 damages under the franchise agreement) because three stores were involved, three franchise agreements were involved with a $100,000 limit each, the aggregate limit was $300,000. Since the damages awarded to the entrepreneurs was $230,000, there again, the franchisor was unable to show any prejudice and the ruling was affirmed.
Finally, the franchisor argued it was prejudiced when the trial court refused to enforce the choice of law provision in the franchise agreements when the arbitrator employed Washington law, rather than Connecticut law. The court noted that the Franchise Investment Protection Act does not demand in state adjudication of disputes, but the Washington State Department of Financial Institutions has indicated that franchise agreements which require out of state arbitration of disputes may be unfair. The court rejected this argument because the franchisor was unable to show it was prejudiced by the case going forward in Washington, rather than in Connecticut. The Washington arbitrator’s decision was affirmed.
Comment: The take away from this case is that if there is a dispute concerning the enforceability of an arbitration provision and the court rules in favor of compelling arbitration, that decision should immediately be appealed if the prejudice standard is to be avoided. Justice Madsen, who concurred in the opinion, but criticized the mandate that the party who fails to seek discretionary review of an order compelling arbitration must show prejudice as a condition of relief from the arbitration award, points out that the majority’s new prejudice standard encourages motions for interlocutory discretionary review, which is contrary to the expeditious resolution of disputes which is at the core of arbitration’s purpose. Discretionary review of arbitration orders will be costly and take time, which will slow down the arbitration process. Such appellate review will cause delay contrary to the policy favoring arbitration, which “places a burden on one party that does not accord with the standard courts use providing for de novo review of orders to compel arbitration.”[ii]
[i] Saleemi v. Doctor’s Assocs. Inc., __ Wn.2d __, 292 P.3d 108 (2013).
[ii] Id., __ Wn.2d __, 292 P.3d at 118.