The recent 1st Circuit case Fantastic Sams Franchise Corp. v. FSRO Association Ltd. pitted the hair salon chain against owners of regional franchises. The franchisees claimed that the Fantastic Sams corporation was depressingthe sale price that they could obtain for the businesses by failing to issue legally required disclosure statements— a document similar to a prospectus a franchisee must obtain before selling his business.
The parties had contractually agreed to arbitrate disputes arising under their franchise agreements. The franchisees wanted to arbitrate their claims in an association action—essentially meaning that an association of franchisees would represent the interests of the individual franchise owners collectively in a single case.
“An association action was desirable for its precedential value,” says W. Michael Garner, a Minnesota attorney who represented the franchisees in the case. “We wanted Fantastic Sams to be bound as to all of the members of the association, rather than have multiple, possibly conflicting, decisions.”
But Fantastic Sams fought back, arguing that the corporation could not be bound to arbitrate the cases on a class basis because some of the franchisees’ agreements were silent about whether class arbitration was permitted. Fantastic Sams thought it had strong support in the 2010 U.S. Supreme Court case Stolt-Nielsen v. AnimalFeeds International Corp., in which the court held that “imposing class arbitration on parties whose arbitration clauses are ‘silent’ on that issue is not consistent with the Federal Arbitration Act [FAA]. … A party simply may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.”
But in rejecting the franchisor’s position, the 1st Circuit joined a growing group of appellate courts that are narrowing the reach of Stolt-Nielsen and making it more difficult for companies to avoid class arbitration.
The 1st Circuit decided that Stolt-Nielsen should be limited to the specific circumstances of that case. In Stolt-Nielsen, the parties, a shipping company and a supplier of liquid components used in livestock feed, had stipulated during the litigation that they had not agreed to arbitrate claims on a class basis. The 1st Circuit distinguished that from the Fantastic Sams franchise agreement. While the agreement was silent on the issue of class claims, the parties disagreed about whether they’d understood that class arbitration would be permitted. The court found that silence regarding class arbitration in the agreement—standing alone—doesn’t automatically mean class arbitration cannot be imposed. Rather, the court found that the arbitrator has authority to determine and give effect to the parties’ intent.
“Some courts have said unless the agreement expressly provides for class arbitration, then you cannot have a class action,” says Liz Kramer, a shareholder at Leonard, Street and Deinard. “Now a number of circuit decisions have said that’s not the right interpretation of Stolt-Nielsen. Courts are now saying that arbitrators have to analyze these agreements as a contract and determine the parties’ intent based on the agreement and the surrounding circumstances.”
The decision gives leverage to proponents of class arbitration. For many small consumer cases, the question of whether class proceedings will be permitted is the determining factor in whether the case will be brought in the first place. For instance, if consumers allege that a credit card issuer improperly charged cardholders $10 per month, each individual customer’s damages are likely too small to be of interest to attorneys. On the other hand, if class members can pool their claims and their resources, then the collective amount of damages may be high enough to merit hiring an attorney.
“If you’re a large potential defendant, you want to take away that leverage,” Kramer says. She also points out that companies face other risks if they are forced to arbitrate class claims.For instance, the American Arbitration Association (AAA) rules do not have the procedural safeguards of Federal Rule of Civil Procedure 23 for certifying class actions, nor is the AAA well-equipped to manage notice procedures in a large class.
Reconciling a Split
The 1st Circuit decision is consistent with the 2nd Circuit decision in In Re American Express Merchants’ Litigation and the 3rd Circuit decision in Sutter v. Oxford Health Plans. However, the 5th Circuit in Reed v. Florida Metropolitan University Inc. interpreted Stolt-Nielsen to bar class arbitration unless the parties’ agreement explicitly provides for it.
The conflicting decisions create uncertainty about whether class arbitration will be imposed in the event that the agreement does not address the issue. Diane Saunders, a shareholder at Ogletree Deakins, advises that companies can mitigate that risk by being specific in drafting their arbitration agreements.
“Include an express class arbitration waiver in the arbitration agreement,” she advises. “Then there cannot be any argument. Think about the types of disputes that may arise, and be explicit about those.”
The issue may still return to the Supreme Court to resolve the question of how far Stolt-Nielsen should extend. However, that is unlikely to occur in the coming term, given that the circuit courts have had limited time to interpret and apply Stolt-Nielsen and the law is still developing in the majority of circuits.
Fantastic Sams, for one, isn’t a candidate for Supreme Court review. According to Garner, the parties settled shortly after the 1st Circuit decision.
Fantastic Sams counsel did not respond to requests for comment.