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Superior Bargaining Power Loses in ‘Zounds’ Decision

October 3, 2017Articles The Legal Intelligencer

In franchise agreements, the choice of law, venue and dispute resolution provisions have critical importance because of nationwide branding and development. The franchisor desires the convenience of having disputes resolved in its selected forum, and the benefit of having consistent law and decisions applied. Despite the express agreement by the parties, however, these provisions may be invalidated if violative of a fundamental policy of the franchisee's state.

In Zounds Hearing Franchising v. Bower, 2:17-cv-00728, the U.S. District Court for the District of Arizona invalidated the Arizona choice of law, and with it, the Arizona venue and mediation provision in favor of the application of Ohio law and transferred the case back to Ohio. The decision provides several lessons on procedure and conflicts of law which every franchise practitioner should learn.

The procedural posture and disposition of the case was unusual. The franchisees are located in Ohio and they filed suit in Ohio state court under the Ohio Business Opportunities Purchasers Protection Act. Zounds, an Arizona based hearing aid service franchisor, immediately removed the case based on diversity jurisdiction to the district court in Ohio. Zounds then moved to stay or dismiss the case in Ohio, claiming that Arizona was the venue choice in the franchise agreement. The Ohio court as a matter of discretion and convenience transferred the Ohio case to Arizona under 28 USC Section 1404(a) Zounds had also filed duplicative actions in Arizona, overlapping the franchisees cases previously filed in Ohio. Based on the decision by the Arizona court, all of the cases were transferred back to Ohio.

The outcome determinative question posed in the case is whether the choice of law, venue and mediation were to be governed by Arizona law as expressed in the contract, or by the Ohio investor protection law, which expressly provides that the law is not waivable and is a fundamental policy of the state of Ohio. At oral argument, the parties acknowledged that if Ohio law applied, then the franchisees claims would prevail and would fail under Arizona law.

The court held that under choice of law principles, the parties could not circumvent by contract investor protections a state provides to those within its boundaries. In the absence of a choice of law provision, the site of the franchises in Ohio would suggest that Ohio has the most significant relationship to the transaction and parties. The district court relying on Restatement (Second) of Conflict of Laws Section 187 cmt. G found that the fundamental policy of the Ohio investor protection law overcomes the contractual choice of law because Ohio has a materially greater interest in the outcome of the case and waiver of the Ohio protections are expressly prohibited by the statute. The district court specifically found that Ohio is the state with the most significant relationship to the transaction and parties, that the contractual choice of the less protective Arizona law is contrary to the fundamental policy of Ohio and therefore invalid, and that the choice of law and venue provisions are invalid based on Ohio law.

The franchisees claim under Ohio law is that Zounds failed to provide a five-day right of cancellation under an Ohio regulation and that Zounds made false, misleading and inconsistent representations in connection with a sale of a franchise. Under Arizona law, none of these claims was actionable but were viable under Ohio law. Ohio law also provides for voiding any provision in an agreement restricting jurisdiction or venue to a forum outside of Ohio. Based on the fundamental policy of Ohio as expressed in the investor protection statute, the Arizona district court transferred the case back to the district court in Ohio.

The Arizona district court additionally held that the venue requirements for pre-suit mediation violates the franchisees' rights to an Ohio venue. The franchise agreement provides that at Zounds' election the franchisees must mediate their disputes in Arizona before commencing litigation. The court held the venue restriction for mediation was invalidated by the Ohio prohibition on venues other than in Ohio. Further, any contractual limitation on joiner of several franchisees or class treatment for mediation or litigation were also voided and collective action.

As the Arizona district court answered all outstanding procedural questions that arose in the Ohio case, the district court entered judgment in favor of the franchisees. Zounds then requested counsel fees, and although the franchise agreement did not provide for prevailing party counsel fee awards, Arizona law did so in these circumstances. The district court held " ... it would be a presumptive abuse of discretion not to award attorney fees against an unsuccessful party who used its superior bargaining power to impose such a term." The court invited the franchisees to submit their own bill of costs and application for counsel fees for consideration.

The case is a good example of a court remedying the overreaching by a franchisor. The Ohio act is not a well-known statute and snags franchisors frequently because of its subtleties. But once violated, it effectively has no statute of limitations, so a franchisor must deal with it directly. It took a jurist of the franchisor's forum to assess the entire situation and apply justice.

Reprinted with permission from the October 3 issue of The Legal Intelligencer. (c) 2017 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.