We would like to ensure that you are still receiving content that you find useful – please confirm that you would like to continue to receive ILO newsletters.
20 January 2009
Franchise agreements often contain a graduated system of dispute resolution. At the first stage the franchisor and franchisee agree to resolve their dispute by mediation. If this is unsuccessful the matter must be decided independently, either through arbitration or by the state courts.
The wish to have the matter resolved as speedily as possible is often the reason for deciding on arbitration, which also offers the advantage of allowing the parties to choose arbitrators with a highly specialized understanding of the particular business. The fact that the dispute will be decided in a single instance is also an advantage of arbitration (ie, neither party can appeal to higher courts). Finally, the fact that, unlike state court proceedings, arbitration is conducted in private is a significant factor for businesses.
The choice of arbitral tribunal is at the discretion of the parties, as is the choice of applicable law. Accordingly, a franchisor based in the United States can agree with the German franchisee that the franchise agreement be subject to the law of a certain US state and that disputes be decided by a US arbitral tribunal. However, the arbitral award of a foreign (eg, US) arbitral tribunal must still be declared enforceable by a German court. As a recent judgment by the Higher Regional Court of Dresden shows, this can lead to considerable problems.
The franchisor - fast-food restaurant chain Subway - concluded franchise agreements with its German franchisees subject to Liechtenstein law. The franchisor was based in the Netherlands and its parent company in New York. According to the franchise agreement, disputes were to be decided by an arbitral tribunal based in New York.
A dispute over the payment of franchise fees arose between the franchisor and a German franchisee that was in financial difficulties because access to his Subway restaurant was hindered by road construction work in the immediate vicinity. The franchisee was of the view that the franchisor must take account of the situation and temporarily suspended payment of the franchise fees. The franchisor sued before the agreed US arbitral tribunal for payment of the franchise fees. The arbitral tribunal found in favour of the franchisor, which then applied to the Higher Regional Court of Dresden for a declaration that the arbitral award was executable.
The court refused to recognize and execute the arbitral award.(1) In the court's view, the arbitration clause was unreasonably unfavourable to the franchisee according to the law of Liechtenstein applicable to the franchise agreement. The franchisor had no ascertainable legitimate interest in compelling the franchisee to participate in an oral hearing in New York. The franchisor was active worldwide and therefore any place of jurisdiction in the locality of the franchisee would have been convenient. The franchisor has a network of staff in Germany and a lawyer whom it continuously instructed. It was inequitably more difficult for the franchisee to take part in a hearing in New York and to instruct a US lawyer who could appropriately represent him. In addition, all contractual performance took place in Germany. Apart from the convenience of the franchisor's parent company, there were no understandable grounds for the franchisee, which sold sandwiches and salads in the city of Meißen, Saxony, to have to travel to New York to have its dispute with the franchisor decided.
The applied test of reasonableness - which is nothing other than a fairness test - gives a court wide scope for interpretation of the arbitration clause in question. Thus, the judgment in this case is unsurprising.
The problem lay in the drafting of the agreement, because when Subway made the agreement subject to Liechtenstein law, it (probably unintentionally) chose a jurisdiction which - in comparison to German law - recognizes a fairness test for general conditions of business. If a jurisdiction which did not provide for such a fairness test had been chosen, the court's judgment would probably have been different.
Three practical lessons can be drawn from the judgment:
For further information on this topic please contact Karsten Metzlaff or Karl Rauser at Nörr Stiefenhofer Lutz by telephone (+49 30 20 94 20 00) or by fax (+49 30 20 94 20 94) or by email (firstname.lastname@example.org or email@example.com).
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription.