Fisher & Zucker
FRANCHISE ALERT - November 1999 Newsletter Article

Arbitration Clause Withstands Challenge

In 1996, the New Jersey Supreme Court held that forum selection clauses requiring litigation outside of New Jersey violated New Jersey public policy and were per se invalid. See Kubis & Perszyk Assoc., Inc. v. Sun Microsystems, Inc., 680 A.2d 618 (N.J. 1996). This holding, however, did not address the enforceability of forum selection provisions within arbitration clauses. As a result, although at least one court has ruled that Kubis does not prevent the enforceability of an arbitral forum selection clause, this issue remains unresolved in the Third Circuit. See Doctor's Associates, Inc. v. Hamilton, 150 F.3d 157 (2d Cir. 1998).

In KKW Enterprises, Inc. v. Gloria Jean's Gourmet Coffees Franchising Corp., 1999 WL 497534 (1st Cir. July 19, 1999), the First Circuit Court of Appeals considered the effect of a state statute, which invalidates forum selection clauses, on the enforcement of an arbitration provision in a franchise agreement. In 1998, a Gloria Jean's franchisee sued its Illinois franchisor in Rhode Island and alleged various claims for breach of contract and misrepresentation, as well as violations of the Rhode Island Franchise Investment Act. The Act states that any franchise agreement provision which restricts jurisdiction or venue to a place outside Rhode Island is void with respect to claims enforceable under the Act.

The franchisor demanded arbitration in Chicago pursuant to the arbitration provisions in the parties' franchise agreements, and filed a motion to stay the state court case. The franchisee then filed a motion to stay the arbitration based upon the Act's invalidation of forum selection clauses. The state court held that the Act invalidated the arbitral forum selection clause with respect to the franchisee's statutory claims. Accordingly, the court concluded that the franchisee's non-statutory claims were arbitrable in Chicago and that the statutory claims should be litigated in Rhode Island. On appeal, the First Circuit reversed. The court held that the Act's provision which requires arbitration to proceed only in Rhode Island violates Section 2 of the Federal Arbitration Act. The FAA provides that arbitration clauses may only be revoked on "grounds as exist at law or in equity for the revocation of any contract." Because the Act's restriction applies to only one type of provision (a venue clause) in only one kind of contract (a franchise agreement), the court held that the statute does not provide a generally applicable contract defense and its invalidation of provisions requiring arbitration outside of Rhode Island is preempted by Section 2 of the FAA. Under this analysis, the court concluded that the parties' choice of arbitral forum should have been honored by the state court despite Rhode Island's statutory restriction.

Given the strong federal policy in favor of arbitration, the application of the U.S. Constitution's Supremacy Clause, and the rationale of the holdings in Hamilton and KKW, it seems likely that the Third Circuit would hold that Kubis does not invalidate forum selection provisions contained in arbitration clauses.

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