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Feb022012

Case Study: Franchise Dispute Arbitration

Major “bet-the-company” business disputes don’t happen that often.  Fortunately.  In fact, for most small and medium-sized companies, bet-the-company litigation may happen only once in a career.  But precisely because these disputes are not common occurrences, most business owners have little or no experience with them.  This post will examine one such bet-the-company case, including frank discussions of cost, timing, and other lessons, with the goal of raising the business owner’s awareness of these realities before they occur.  All business litigation is unique, but many of these same themes and concerns run through most complex business litigation.

Overview:  This firm represented a dental franchisee in a dispute with its franchisor.  Our clients (a partnership of two dentists) purchased a dental franchise and simultaneously signed a 10-year lease for a dental office owned by the same individual who owned the franchise company.  Our clients were skilled dentists but had little business experience and felt that the franchise was a good choice because it specifically promised hundreds of hours of training in clinic operations, a detailed franchise manual, and the loan of a handful of pre-trained employees, as well as participation in the franchise system’s advertising program.  Unfortunately, very little of what was promised was ever provided.  Our clients’ requests for these training and materials were refused, and when our clients’ eventually sent a written demand it was the franchisor that responded by terminating the franchise.  This placed our clients in a particularly precarious position because termination of the franchise placed them in breach of their 10-year lease and caused hundreds of thousands of dollars in personal guarantees for building improvements and equipment to become immediately due.

Arbitration:  After two months of investigation and efforts to negotiate a resolution, our clients began an arbitration proceeding through the American Arbitration Association on March 11, 2011.  Arbitration was required by the franchise agreement.  Our clients asserted claims of breach of contract and fraud.  Additionally, because the franchisor itself had very little assets, we also asserted an alter ego claim against owner of both the franchise company and the office building as an individual in order to ensure that, if we prevailed, we could collect against the owner’s personal assets.  After written discovery, disclosures of expert witnesses on the topic of franchise operations and financial damages, and five depositions, a two-week arbitration hearing was held from November 8-17.  The arbitrator issued an award overwhelmingly in favor of our clients on December 30th.  Our clients prevailed on their claims of breach of contract and fraud as well as on their alter ego claim, resulting in the entire award being enforceable against the owner of the franchisor and office building individually.  The arbitrator awarded $400,000 in damages, required the respondent to pay all of our client’s arbitration costs including attorneys’ fees and expert witness fees, required the respondent to pay off an equipment loan of approximately one hundred thousand dollars, and released our clients from their lease and personal guarantee.  Additionally, the arbitrator found in our clients’ favor and rejected a $4 million counter-claim filed by respondents.

Costs:  Complex business litigation is expensive.  Here, the case involved numerous entities, thousands of pages of documents, several interrelated contracts, required the deposition of 5 witnesses, and concluded with an 8-day hearing with 12 witnesses.  The fees paid by our clients to the AAA for management of the case and the arbitrator’s time totaled $23,750.00.  We also worked with a highly regarded expert witness to provide key testimony of franchise practices and financial damages, whose total fees for his analysis, report, critique of the opposing expert’s report, deposition, and trial testimony were $28,093.00.  Attorney’s fees from this firm for the entire matter totaled $73,732.00.  Including miscellaneous expenses and deposition costs, the case cost our clients a total of $129,255.72—all of which was awarded back to our clients by the arbitrator.  Without a doubt, this is a large expense for any business.  However, in light of the complexity of the case we believe these costs are significantly lower than what most firms would have charged -- and the results speak for themselves.  While it can be difficult to compare legal fees between different cases, here there is at least one clear comparison:  the Respondents’ total costs and fees on this very same matter were $190,161.40 -- 47% higher than our clients’ costs, despite the fact that respondents lost on all claims.

Comparisons with court proceedings:  one of the questions most commonly raised by business owners concerns the differences between litigation in courts and through binding arbitration.  Here, because this case was handled under the AAA’s large case commercial arbitration rules, there were relatively few differences between this arbitration and a court case.  Perhaps the largest advantage of arbitrating this matter was that it was resolved quickly:  a hearing was held less than 8 months from the initiation of the arbitration, with the award issued less than two months after the hearing.  Depending on the venue, this case could have easily taken 18 months or more to complete in the courts.  Another advantage of arbitration is that it is very difficult to appeal and prevail – the arbitrator’s award is essentially the last word.  One notable disadvantage of arbitration in this case was the cost—an additional $23,750 our clients had to pay for the arbitration itself.  In comparison, the expenses paid to the court are normally only a few hundred dollars in filing fees and jury fees.   There are numerous other differences between court and arbitration.  For example, while I often prefer to have a case decided by a jury, here it may have been useful to have the case decided by an arbitrator with extensive experience in franchise law.

There are a few important take-aways to highlight in this case.  First, while this arbitration represented a significant cost to our clients (about 10% of their annual revenue), their only other option was bankruptcy, both personal and for their business.  Bet-the-company litigation is rarely cheap, but it is often a bargain compared to the alternatives.  Second, some of the best money a business can spend is to engage a trial attorney as early as possible in a dispute.  Businesses often wait until they’re in over their heads before hiring an attorney, at which point many options are no longer available.  Even if you’re already working with your existing attorney who specializes in business formation or transactions, engaging litigation counsel long before a dispute actually turns into litigation will help you evaluate the true risks and costs of litigation in your decision making.

If you are currently involved in a business dispute and would like to discuss obtaining a case evaluation specific to your circumstances, contact us at (303) 800-8237 or jvail@vail-law.com

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