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Business Law by Tom Ramsey

Can’t Afford Arbitration? Too BadTom Ramsey - Business Law

November 6th, 2012 – Although certainly not everyone’s favorite dispute resolution method, the requirement that disputes be resolved by private (for profit) arbitration appears in many contracts. Of course, unlike a trial, the cost, including hefty filing and arbitrator fees, and facility and administrative charges, is borne entirely by the parties.

Would a dispute be resolved by a court, instead of the use of arbitration as required by the provisions of a contract, if any of the parties is truly unable to pay for an arbitration?

Before continuing, two words need explanation. First, a “stay” is a court order prohibiting the process that is the object of the “stay” from continuing. Second, if a stay is ended by a subsequent court ruling, the stay is “lifted.”

MJKA, Inc., and about five others (collectively, MJKA), as franchisees, entered into franchise agreements with 123 Fit Franchising, LLC, the franchisor. A provision in each of the franchise agreements required all of the claims based on them to be arbitrated.

September 2006: MJKA initiated a single lawsuit in a San Diego County trial court against 123, alleging that they were fraudulently induced to enter into the agreements and that 123 failed to provide them with the operational support that 123 was obligated to provide pursuant to the terms of the agreements.

November 2, 2006: 123 filed a petition in a Colorado court seeking an order compelling arbitrations of the claims of MJKA.

November 7, 2006: 123 filed a motion in the San Diego County trial court to stay the lawsuit in that court and allow the arbitration to move ahead because all disputes had to be resolved by arbitration, not by court trial.

In response, MJKA asked the San Diego County trial court to declare that the arbitration requirement is unenforceable. The court stayed the lawsuit before it. It also refused to find that the arbitration requirement was unenforceable because it did not have jurisdiction to make such a determination. It stated that MJKA could make that argument in the Colorado court.

October 2007: The Colorado court granted 123’s motion to compel arbitration. MJKA then attempted to initiate arbitration, but determined that the costs of arbitration would be prohibitive.

September 2008: This time MJKA asked the San Diego County trial court to stay the arbitration and allow the court trial to move ahead. The trial court denied this request. It stated that it was “concerned that the arbitration has not yet occurred, and that the plaintiffs [MJKA] may be financially unable to proceed with the arbitration. The plaintiffs are obviously entitled to have their dispute heard on the merits in some forum, whether in arbitration or otherwise. However, the Court is not persuaded, on the present record, that it would be appropriate for this Court to lift its stay . . . when a Colorado court has ordered the matter to arbitration and the plaintiffs have not returned to the Colorado court for relief . . .”

August 2009: MJKA again asked the San Diego County trial court to stay the arbitration and allow the court trial to move ahead. Probably in response to the court’s comments in September, MJKA cited the anticipated costs, per case ($38,500- $42,500), consisting of the following: A $6,000 arbitration filing fee; a $2,500 case service fee; between $10,000 and $14,000 for the arbitrator; travel and lawyer fees of about $20,000. They pointed out that about six franchisees are making the claims against 123, resulting in six arbitrations ($231,000-$255,000). They also explained that the arbitrator will not permit consolidation of the claims, requiring a separate arbitration for each. Additionally, the arbitrator will not waive or defer any fees. They also made it clear to the court that they have incurred substantial personal debt (in the range between $208,000 and $320,000 per franchisee, totaling between $1,248,000 and $1,920,000) with regard to the establishment of the businesses to operate the franchises. This time the trial court lifted the stay. It also determined that the arbitration provisions are unenforceable and/or unconscionable. The next step would have been a court trial in San Diego, not an arbitration.

Instead, 123 appealed the trial court’s ruling.

The breadth of the power of the trial court to lift the stay of the trial was the center of the appeal. A California Civil Code section provides that if any court with appropriate power, regardless of its location (including one outside California), has ordered arbitration of a controversy which is also an issue involved in a case before a California trial court, the California trial court shall, upon the motion of a party, stay the trial until the arbitration is had “or until such earlier time as the [trial] court specifies.” The power deals with the trial court to stay the trial, not to stay the arbitration.

As outlined above, initially, the San Diego County trial court stayed the lawsuit before it, in accordance with the statute. However, 123 was unhappy about this result and appealed the subsequent order of the San Diego County trial court that stayed the arbitration.

The Court of Appeal explained that the purpose of the stay of a lawsuit is to protect the jurisdiction of the arbitrator by not proceeding with any trial in the trial court until arbitration is resolved. In the absence of a stay, the continuation of the trial court proceedings would disrupt the arbitration proceedings and could render them ineffective. Although the trial court can stay the trial proceedings before it, beyond that its power to interfere in the pending arbitration is strictly limited. 

MJKA argued that the statute allows the trial court to stay the trial until such earlier time as it specifies. However, the Court of Appeal could find no case that addressed the circumstances under which a trial court can lift a stay of a case before it prior to the completion of an arbitration regarding the same issues.

The Court of Appeal decided that the power of a trial court to lift a stay of a trial “merely upon a determination that a party cannot afford arbitration” would be beyond the very limited scope provided in the California statute. In all likelihood, the fact that a Colorado court actually ordered arbitration probably didn’t help MJKA.

Finally, the Court of Appeal decided that since the trial court had improperly lifted the stay, it could not declare the arbitration provisions to be unenforceable and/or unconscionable.

The stay order of the San Diego County trial court was lifted, allowing the arbitration to somehow proceed.
The next chapter is unknown…

This case is entitled MJKA, Inc., et al, v. 123 Fit Franchising, LLC. It was decided in 2011.

(Tom Ramsey is a Long Beach attorney who has specialized in business law for more than 40 years. He may be reached at bizlawwiz@aol.com.)