Resolving franchising disputes: to litigate or arbitrate?

There is a natural sense of optimism at the start of all business relationships, and the prospect of future conflict can feel remote. However, when entering into new contracts (either as franchisee or franchisor) it is important to at least recognise the possibility of a future dispute, and in doing so ensure that express wording is included in the contracts to confirm how disputes will be resolved should they arise.

Most franchise agreements will include a "dispute resolution" clause, outlining how disputes will be managed as well as a clause setting out the "applicable law" of the contract. When considering a dispute resolution clause, one of the most important decisions will be whether to opt for litigation or arbitration. As we explain below, the best approach will often vary case by case.

Litigation

Litigation is the process of resolving disputes through a national court system. It is (generally) a public process and in England and Wales we have highly experienced judges deciding on cases. As far as costs are concerned, the general rule is that the loser pays the winner’s costs, or at least most of them.

If your contract is an international one and you may have to enforce any judgment overseas, it’s worth thinking about whether a judgment of England and Wales (or whichever jurisdiction is involved) would be readily enforced there.

Arbitration

Arbitration follows a similar process to the courts, but instead of being assigned a judge, the parties choose their own arbitrator(s). The arbitration is usually conducted under a set of rules published by an arbitral body (such as the International Chamber of Commerce or LCIA). When picking an arbitrator, it is tempting to choose someone who has sector knowledge relevant to the dispute. However, as the opportunities to appeal an arbitrator’s decision are very limited, more important is the arbitrator’s understanding of the legal process and the law that the parties have chosen to apply to the contract.

The advantages of arbitration include:

• Speed and flexibility: Parties to arbitration can select their own arbitrator and procedural rules (preferably those of an institution such as the ICC or LCIA). Whilst the procedure followed in practice is not dissimilar to court proceedings, the parties can often agree to make it quicker.
• Enforcement overseas: An arbitral award can, in principle, be enforced in any of the (currently) 172 countries that have signed up to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. This makes enforcement simpler than the judgment of a national court.
• Neutrality: If the parties are based in different locations, then they can choose a “neutral” location. However, this decision will affect the law applicable to the process of the arbitration, and therefore legal advice should be sought on this.
• Confidentiality: Arbitration is confidential. This is particularly important in the franchising context where protecting the reputation of the brand, and the integrity of the network, is key to the continued success of the business. It also has great advantages if information considered to be confidential is relevant to the dispute; parties can exchange such information without the threat of it being in the public domain.
• Finality: Appealing an arbitral award is generally more difficult than a court judgment. Whether it can be challenged is governed by the law of the seat, but in England there are very limited grounds on which an arbitration award can be appealed.  This can be an advantage or disadvantage of arbitration, depending in whose favour any award is made.
• Third parties: In court litigation we are seeing a rise of group claims being pursued by groups of franchisees against a franchisor. This is more challenging in an arbitration context as group claims are not straight forward; this is another potential advantage to agreeing to arbitration.

Arbitration is not, however, suitable for every dispute, particularly smaller disputes as it can be an expensive process. Further, it may not be suitable where there are several parties to a dispute.

Dispute resolution clauses: additional considerations

In addition to deciding between litigation or arbitration, it is also important to consider:

• Whether any steps should be taken before commencing proceedings: A clear procedure to handle disputes before resorting to litigation or arbitration can minimise costs and prevent unnecessary damage to the franchise relationship. For example, contracts may first require a face-to-face discussion and / or mediation of the dispute, using an independent mediator (such as through the British Franchise Association).
• Who the parties would like to resolve their dispute: Litigation v arbitration – see above.
• Which law would the parties like to apply to both the contract and any dispute: This is particularly important where the contract is between parties in different countries. The agreement should spell this out.
• When should a dispute be resolved? The choice of law will determine the parties’ default statutory time limit for bringing a claim (for example, English law requires a breach of contract claim to be brought within 6 years of the breach). However, the parties might also want to agree a bespoke limitation period; for example, a requirement to bring claims within 1 year can reduce uncertainty when a dispute arises.

Final thoughts

The decisions made about dispute resolution when negotiating a contract are some of the most important that parties can make. They can give one party a significant advantage over another if a dispute ever arises, and the repercussions of making the wrong decision could be costly in both time and money. It is therefore worth investing time and thought into the worst case scenario of a dispute right at the beginning of a relationship, to put you on the best possible footing.