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Indiana Federal Court Finds Franchisor’s Arbitration Policy Unenforceable
By Joshua Stevens on December 11, 2013 at 4:32 PM

Recently, the United States District Court for the Southern District of Indiana denied franchisor Steak n Shake’s motions to compel the non-binding arbitration of three consolidated lawsuits filed by three franchisees. The decision highlights the importance of a franchisor carefully monitoring and updating its dispute resolution policies in the context of the legal risks facing its system.

In April and May 2013, three franchisees sued Steak n Shake seeking, inter alia, a declaratory judgment regarding whether a menu pricing and promotions policy of Steak n Shake constitutes grounds for termination of their respective franchise agreements and alleging breach of contract, fraud, and violation of respective state franchise laws based on the same conduct. The franchisees’ agreements with Steak n Shake contain a dispute resolution provision, in which the franchisor “reserves the right to institute at any time a system of nonbinding arbitration or mediation.” At the time the lawsuits were filed, Steak n Shake did not have any such dispute resolution policy. More than a month after the lawsuits were initiated, however, Steak n Shake purported to implement a new policy requiring non-binding arbitration of any claims arising out of a Steak n Shake franchisee agreement, stating: “this policy does not represent a change, but is merely implementing a right previously reserved by the Company in certain of its franchise agreements.” Steak n Shake then moved to compel non-binding arbitration of all the franchisees’ claims and for a stay of the litigation under the Federal Arbitration Act (“FAA”).

The court denied Steak n Shake’s attempt to compel non-binding arbitration on several grounds. First – on an issue subject to a split among many Circuit Courts of Appeals, but not yet addressed by the Seventh Circuit – the court found that because they apply only to “non-binding arbitration or mediation,” the clauses do not constitute an agreement “to settle by arbitration a controversy” under Section 2 of the FAA; therefore, the dispute is not “referable to arbitration.” Second, the court found that the dispute resolution provision in the franchise agreements was illusory, hence unenforceable, because there was no limit on Steak n Shake’s “ability to avoid arbitration and/or its promise to arbitrate on a whim.” Thus, performance by Steak n Shake was entirely optional, which “cannot form the basis for a valid contract.” Third, the court found that, even if the dispute resolution provision was not illusory, the arbitration policy could not be applied retroactively to already pending lawsuits, unless expressly reserving such a right.

The decision highlights that the best practice is for a franchisor to regularly evaluate its dispute resolution procedures in the context of its current legal risk and emerging case law. If the policy does not fit current business and legal objectives, the franchisor should explore ways to change the policy system wide before a dispute occurs. The case is Druco Restaurants, Inc., et al. v. Steak n Shake Enterprises, Inc., et al., 1:13-CV-00560-LJM, 2013 WL 5779646 (S.D. Ind. Oct. 9, 2013). Plaintiffs are represented by Kirsten M. Ahmad, Joshua A. Stevens and Beth M. Conran in the litigation.

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