Does Michigan Law Provide A Blueprint For California To Revise Its Franchise Relations Act To Avoid Out-Of-State Arbitration Forums?
By Kevin A. Adams on September 12, 2015
Section 20040.5 of the California Franchise Relations Act was enacted by the California legislature to keep disputes involving California franchisees in the State by voiding out-of-state forum selection clauses in franchise agreements. This statutory contractual limitation reflects California’s strong public policy to protect in-state franchisees from the expense, inconvenience, and possible prejudice of having to litigate in a non-California venue.
Despite the strong public policy behind Section 20040.5, the effect of the statute was later significantly reduced by the Ninth Circuit’s decision in Bradley v. Harris Research Inc., 275 F.3d 884 (9th Cir. 2001), finding that the Federal Arbitration Act (the “FAA”) preempted Section 20040.5’s limitation on out-of-state forum selection clauses in agreements to arbitrate.
By its terms, the FAA was enacted “[t]o make valid and enforceable written provisions or agreements for arbitration of disputes arising out of contracts, maritime transactions, or commerce among the States or Territories or with foreign nations.” 68 P.L. 401 (emphasis added).
Bradley’s finding of FAA preemption, followed by several U.S. Supreme Court opinions – including AT&T Mobility v. Concepcion, 131 S.Ct. 1740 (2011) – abruptly changed the individual State’s ability to legislate terms contrary to those contained within an otherwise valid agreement to arbitrate.
This brings us to the unique pre-sale, pre-contracting disclosure requirement of the Michigan Franchise Investment Law (the “MFIL”) that appears to avoid the FAA preemption problem faced by Section 20040.5 and other similar state franchise statutes.
As background, the MFIL was enacted in 1974 for the stated general purpose of protecting the rights of franchisees. See General Aviation v. Cessna Aircraft Co., 13 F.3d 178, 181 (6th Cir. Mich. 1993). Among its various limitations on franchisor rights, the MFIL contains two separate provisions – Section 8 and Section 27 – that seek to restrict arbitrations involving Michigan franchisees to the State of Michigan.
Section 27(f) – much like that of Section 20040.5 – expressly renders “void and unenforceable” any provision in a franchise agreement “requiring that arbitration or litigation be conducted outside of [Michigan].” MCLS § 445.1527. As recently as 1991, Michigan courts relied upon Section 27(f) to void out-of-state arbitration provisions in franchise agreements. See Hambell v. Alphagraphics Franchising Inc., 779 F. Supp. 910, 911 (E.D. Mich. 1991)(Holding “that the provision in the franchise agreement requiring that all arbitrations be conducted in Tucson, Arizona is void and unenforceable pursuant to Michigan law.”).
More recently, however, courts have uniformly found Section 27(f) to be preempted by the FAA to the extent it invalidated contractual provisions that required arbitration outside the state. See Flint Warm Air Supply Co. v. York Int’l Corp., 115 F. Supp. 2d 820 (E.D. Mich. 2000)(contractual provision in distributor sales agreement requiring disputes to be arbitrated in Pennsylvania found to be enforceable); Binder v. Med. Shoppe Int'l, Inc., 2010 U.S. Dist. LEXIS 72614, 16-17, 2010 WL 2854308 (E.D. Mich. July 20, 2010)(Section 27(f) “is preempted by the Supremacy Clause of the United States Constitution, Art. VI, cl. 2, and the FAA.”); see also, Alphagraphics Franchising v. Whaler Graphics, 840 F. Supp. 708 (D. Ariz. 1993)(finding that the FAA requires arbitration agreements to be enforced according to their terms, thus, preempting Section 27(f)).
For the reasons stated above, judicial precedent finding Section 27(f) to be preempted by the FAA has grown stronger over the years. Now, Section 27(f) – like that of Section 20040.5 – has virtually no effect on out-of-state arbitration provisions in franchise agreements.
Section 8, on the other hand, seeks the same result as Section 27(f) but through a different route. Section 8 requires the franchisor to attach to its franchise disclosure document a special notice “on a separate sheet of paper immediately following the cover sheet.” MCLS § 445.1508(3). Among other things, the special notice must list “an exact copy of the items prohibited by section 27” – including the out-of-state arbitration venue prohibition contained within Section 27(f). MCLS § 445.1508(3)(ii). In effect, Section 8 compels the franchisor to announce to a prospective franchisee, as part of the notice, that any provision in the franchise agreement “requiring that arbitration or litigation be conducted outside this state” is “void and unenforceable.”
While both Section 8 and Section 27 seek the same result – to restrict arbitrations involving Michigan franchisees to the State of Michigan – the timing of the restrictions imposed by these sections differ dramatically.
Section 27 is a post-contract venue restriction that is designed to void portions of existing agreements to arbitrate. Alternatively, Section 8 is a pre-sale, pre-contracting disclosure requirement that (1) precludes the franchisor from including an out-of-state venue provision as part of the franchise agreement in the first instance, or (2) conceivably compromises any “meeting of the minds” the parties’ reached with respect to any out-of-state venue clause in the franchise agreement.
Because Section 27 seeks to invalidate a portion of an otherwise valid and enforceable agreement to arbitrate, the FAA – protecting existing “written provisions or agreements for arbitration of disputes” – is triggered. However, Section 8 applies to the disclosure period of the parties’ relationship and before the existence of any written agreement to arbitrate.
This begs the question: “does the FAA preempt state legislation that is intended to hinder the parties’ right to freely agree and enter into an otherwise valid and enforceable agreement to arbitrate?”
Unfortunately, Michigan jurisprudence is not helpful in this regard. The few cases that do address Section 8’s out-of-state venue prohibition do so in the context of out-of-state court actions – not out-of-state arbitral forums. See, e.g., Buist v. Digital Message Sys. Corp., 2002 Mich. App. LEXIS 2271 (Mich. Ct. App. Dec. 27, 2002)(court enforces Section 8 to void out-of-state court action).
The Ninth Circuit does provide some guidance on this issue in its decision in Laxmi Invs., L.L.C. v. Golf USA, 193 F.3d 1095, 1097 (9th Cir. Cal. 1999). As later explained by the Bradley Court:
- Laxmi held that the forum selection clause in that franchise agreement was unenforceable because the parties never clearly agreed on the venue in which arbitration was to take place […] based on the fact that the franchisor had given the franchisee a UFOC that stated in part that the franchise agreement required binding arbitration in Oklahoma, but that the requirement “may not be enforceable under California law,” a reference to § 20040.5. Because there was no evidence that the franchisor “ever indicated that it would insist upon an out-of-state forum despite the contravening California law” referred to in the UFOC, and the franchisee had no reason to expect that it had agreed to an out-of-state forum, we held that there was no “meeting of the minds on the forum selection provision.”
Bradley, 275 F.3d at 891 (9th Cir. Cal. 2001)(internal citations omitted).
While informative, the Laxmi and Bradley decisions addressed contract formation and not any potential conflict between the FAA and the state’s power to limit its citizens’ ability to freely enter into agreements to arbitrate.
Although judicial precedent has ingrained in lawyers the notion that the FAA preempts all restrictions on arbitration, the FAA was enacted to validate parties’ existing agreements to arbitrate. There is no indication in the legislative records to suggest that the FAA was intended to preempt state legislation limiting the parties’ ability to contract as to the terms of the arbitration.
Because the FAA only governs written agreements to arbitrate, California can (and should) look to Section 8 of the MFIL as a means to again enforce its strong public policy to protect in-state franchisees from having to travel to foreign jurisdictions to litigate franchise-related disputes.