Originally from Dispute Resolution Journal

FRANCHISING

Preemption of State Law

A divided panel of the 9th Circuit held that a Montana law that makes unconscionable arbitration clauses in adhesion contracts unenforceable is not preempted by the Federal Arbitration Act.

James Ticknor and Ticknor Lodging Corporation executed a pre-printed, standard-form franchise agreement drafted by Choice Hotels pertaining to the use of the Econo-Lodge mark on a hotel in Montana. The agreement called for arbitration of all claims relating to the agreement or the breach thereof. But it reserved judicial remedies for claims by Choice against Ticknor for indemnification, to collect money owed under the agreement, and to enjoin trademark infringement. The arbitration clause called for the substantive law of Maryland to apply without reference to its conflict of law rules. The franchise agreement provided for Maryland law to apply to interpret its terms, including Maryland’s conflict of law rules.

After disputes arose, Ticknor ceased to pay the franchise fee. Choice filed a demand for arbitration. Ticknor obtained a temporary restraining order in state court enjoining the arbitration. The case was removed to federal court where Choice unsuccessfully moved to dismiss or to compel arbitration. Choice appealed.

The 9th Circuit upheld the order denying the motion to compel arbitration. First, the court agreed with the district court that under Montana’s choice-of-law rules, Montana had a materially greater interest in the transaction. It also agreed with the lower court’s application of Montana law to determine whether the arbitration clause was unconscionable. Next, the 9th Circuit concluded that Ticknor was forced to accept or reject the franchise agreement without any negotiation. It rejected Choice’s argument that the agreement was negotiated, because Choice provided no business reports that reflected this negotiation. Accordingly, the appeals court found that the franchise agreement was an adhesion contract.

The 9th Circuit found no error in the district court’s ruling that the arbitration clause was one sided because it contained terms unreasonably favorable to the drafter. Thus, it upheld the finding that the clause lacked mutuality of obligation and was unconscionable and unenforceable. Choice argued that Montana’s law on unconscionability was limited to consumer contracts and did not apply to a commercial deal between sophisticated parties. However, the 9th Circuit said that it must take the law as it finds it, and that it would be “entirely speculative” to conclude that the Montana Supreme Court would so conclude.

Finally, the court held that Montana law on unconscionable arbitration clauses did not violate Doctor’s Associates v. Casarroto because it was the result of “the application of general principles that exist at law or in equity for the revocation of any contract.”

The dissent questioned the decision to apply Montana’s law on adhesion contracts to commercial contracts between sophisticated businesses. It also disagreed that the agreement was so one-sided as to be unconscionable.

Ticknor v. Choice Hotels International, 265 F.3d 931 (9th Cir. 2001).