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.
21 July 2009
Franchise agreements often contain a graduated system of dispute resolution. At the first stage, the franchisor and franchisee might agree to resolve their dispute by mediation. If this method proves unsuccessful, the matter may then be decided independently either through arbitration or by the state courts.
The desire of parties to resolve matters as speedily as possible often means that arbitration is chosen as the dispute reolution method. This has the advantage that individuals with a highly specialized understanding of the particular business at the centre of the dispute can be selected as arbitrators. Furthermore, the fact that once a dispute has been arbitrated neither party can appeal to the higher courts increases the attractiveness of arbitration. Finally, it is advantageous for businesses involved in disputes that arbitration proceedings – unlike state court proceedings – are conducted in private. Thus, for example, in a dispute in which a product is shown to be defective or little goodwill has been displayed in dealing with franchisees, the public, other franchisees and competitors will not find out.
The choice of arbitration tribunal is at the free discretion of the parties, as is the applicable law. A franchisor based in the United States can accordingly agree with a German franchisee that the franchise agreement will be subject to the law of a certain US state and that disputes will be decided by a US arbitration tribunal.
The award of a foreign (eg, US) arbitration tribunal must, however, still be declared enforceable by a German court. State courts have a monopoly on execution. An award is executed in accordance with the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. State courts are very careful about refusing execution of arbitration awards:
"even if they appear to be erroneous in fact or law, with the result that it is inherently more difficult to upset an award than it is to reverse a judge on appeal."(1)
In two recent cases before the higher regional courts concerning Subway franchises in Dresden and Bremen, execution of US arbitration tribunal awards was refused because the franchise agreements with a German franchisee provided for arbitration in New York.
The facts of the two cases involving the Subway fast food restaurant franchise were similar.(2) The franchisor was based in the Netherlands, the parent company of the franchisor in New York. The franchisor concluded franchise agreements with its German franchisees subject to the law of Liechtenstein. According to the franchise agreement, disputes were to be decided by an arbitral tribunal based in New York. Clause 10c of the agreement states the following:
"The parties will arbitrate any dispute the parties do not settle under the discussion procedures above, and any dispute which this agreement provides will be submitted directly to arbitration… the arbitration will be held in accordance with the United Nations Commission on International Trade Regulations and Law (UNCITRAL) Arbitration Rules administered by an arbitration agency, such as the International Centre for Dispute Resolution, an affiliate of the American Arbitration Association, at a hearing to be held in New York."
Because of financial difficulties, the franchisees at the centre of both cases owed franchise fees. The franchisee in Dresden 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 should take account of this situation and temporarily suspended payment of the franchise fees. The franchisee in Bremen was also in financial difficulties and in default of royalty payments.
The franchisor obtained arbitral awards in the United States in both cases, ordering the franchisees to pay the outstanding franchise fees. The franchisor's applications in both cases for declarations that the awards were executable were rejected by the courts because the arbitrations, in the view of the courts, were invalid according to Article 5(1)(a) of the New York Convention.
The New York Convention lists in Article 5 a total of seven cirumstances in which the recognition and execution of a foreign arbitration award can be refused. Problems with the declaration of enforceability usually arise on grounds of public policy.(3) Public policy provides that foreign arbitration awards need not be recognized and executed if they breach important principles of the law of the state where recognition and enforcement is sought.(4) However, the awards were denied recognition not on the ground, that they breach public order, but because the arbitration agreements, according to Article 5(1)(a), breached the law chosen by the parties.(5)
The law initially stated to be applicable was that of Liechtenstein, which referred to Austrian law. Section 879(3) of the Austrian Civil Code, which therefore applies in Liechtenstein as civil law, reads as follows:
"A contractual provision contained in general conditions of business or form contracts which does not determine one of the main mutual performances, is in any event void if, considering all the circumstances of the case, it is grossly unfavourable to one of the parties."
In the agreements concerned, the courts found that the franchisees had been unreasonably disadvantaged.
In the view of the Dresden Higher Regional Court, the arbitration clause was unreasonably unfavourable to the franchisee. The franchisor had no ascertainable legitimate interest in compelling the franchisee to participate in an oral hearing in New York. For the franchisor, which was active worldwide, 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 German lawyer continuously instructed by it. For the franchisee, it was inequitably more difficult 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 parent company of the franchisor, there were no understandable grounds for the franchisee, who sold sandwiches and salads in the city of Meissen in Saxony, to have to travel to New York to have his dispute with the franchisor decided. Therefore, on December 7 2007 the court refused to recognize and execute the arbitral award.
The Higher Regional Court in Bremen ultimately shared the view that there were no grounds, other than the convenience of the parent company, for the franchisee (who sold sandwiches and salads in Bremerhaven) to be obliged to fly to New York in order to conduct litigation with a Dutch franchisor. The franchisee would in that case be burdened unilaterally because there was no discernibly similar burden on the franchisor. The burden was considered 'gross' because it would have been easy for the franchisor based in the Netherlands not to have the dispute heard in New York.
The impression is unavoidable that the franchisor exploited its overwhelming structural and financial power in order to impose an extremely unfavourable court jurisdiction agreement on its contractual partner. The arbitration agreement was therefore void according to the applicable Liechtenstein (ie, Austrian) law, and for that reason the arbitration award could not be declared executable under Article 5 New York Convention.
The problem for the franchisor was that in the cases concerned, a jurisdiction which imposed a test of fairness on general conditions of business was chosen. That jurisdiction was chosen because a branch of the non-US headquarters was situated in Liechtenstein for tax reasons and the choice of law was therefore practical. The formation of the company in the Netherlands was due to other tax reasons. The franchisor could have avoided the consequence of the arbitration awards not being recognized or executable by choosing the applicable law more carefully. If a jurisdiction had been chosen which did not review general conditions in the manner provided for in Section 879(3) of the Austrian Civil Code, or limited such a review at least to consumer agreements, the franchisor would have had no problem with the recognition and execution of the arbitration award. The public policy reservation of Article 5(2)(b) of the New York Convention would have made no difference since the agreement would not have been subject to any breach.
The judgment of the Dresden Higher Regional Court has also been criticized (6) since no unreasonable disadvantage in the meaning of German law (ie, Section 307(1) of the German Civil Code) arose, as the franchisee's orientation difficulties in instructing a US lawyer or participating in a court hearing in New York were not adequate to constitute such disadvantage. According to the logic of the court, therefore, any remote foreign place of arbitration in the general terms and conditions of agreements runs the risk of being considered inadmissible. This risk may be realized where there are incomparably significant difficulties and costs connected with a hearing on another continent. However, this may be different in arbitration cases in neighbouring European states.
It remains the case that when agreeing on the jurisdiction that is to apply to a franchise agreement, a review must be made as to whether that law recognizes a fairness test for general conditions of business. If that is the case, a remote place of arbitration should not be agreed, so as to avoid problems with the recognition and execution of arbitration awards.
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), fax (+49 30 20 94 20 94) or email (email@example.com or firstname.lastname@example.org).
(1) Goode, "Usage and its Reception in Transnational Commercial Law", in: Ziegel (ed), New Developments in International Commercial and Consumer Law, Oxford (1998).
(2) Dresden Higher Regional Court, judgment of December 7 2007, 11 Sch 8/07; Bremen Higher Regional Court, judgment of October 30 2008, 2 Sch 2/08.
(3) "Article 5(2): Recognition and enforcement of an arbitral award may also be refused if the competent authority in the country where recognition and enforcement is sought finds that… the recognition and enforcement of the award would be contrary to the public policy of that country."
(4) In German law this principle is contained – among other things – in Section 328(1) of the Code of Civil Procedure, Article 27(1) of the Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters and Article 34(1) of the Convention on Jurisdiction and the Recognition and Enforcement of Judgments in Civil and Commercial Matters.
(5) "Article 5(1): Recognition and enforcement of the award may be refused, at the request of the party against whom it is invoked, only if that party furnishes to the competent authority where the recognition and enforcement is sought, proof that... the parties to the agreement referred to in article II were, under the law applicable to them, under some incapacity, or the said agreement is not valid under the law to which the parties have subjected it"
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.