The Federal Arbitration Act Cannot Preempt the California Franchise Relations Act if the Arbitration Provision Is Not Enforceable

California protects in-state franchisees from the expense, inconvenience, and possible prejudice of having to litigate outside of California. Although forum selection clauses are presumptively valid, Section 20040.5 of the California Franchise Relations Act voids out-of-state forum selection clauses in franchise agreements. However, Section 20040.5 has a limited application where there is an arbitration provision in a franchise agreement. One possible workaround to ensure your case can be filed in California is to argue that the arbitration provision is not enforceable.

Does an Arbitration Clause Mean You Have To Litigate Outside of California?

The Ninth Circuit previously found in Bradley v. Harris Research Inc., 275 F.3d 884 (9th Cir. 2001), that the Federal Arbitration Act (the “FAA”) preempted Section 20040.5 in agreements to arbitrate. As the following case shows, one way to avoid this preemption is by arguing that the arbitration provision is not enforceable and that therefore Bradley is not controlling.

In Fleming v. Matco Tools Corp., 2019 WL 1980696 (N.D. Cal. May 3, 2019), the court considered whether the FAA preempted section 20040.5 because of the presence of an arbitration provision in the parties’ distribution agreements. The case involved a putative class and allegations that distributors were misclassified as independent contractors rather than employees. Not surprisingly, Matco wanted the forum selection clause enforced and the case moved to Ohio.

Matco argued that the validity of the agreement could not be considered in determining the applicability of a forum selection clause. However, the court found that Matco’s case law only supported the “proposition that generally, it is inappropriate to analyze the validity of the contract as a whole when determining the applicability of a forum selection clause.” But here, the Court was not considering the validity of the contract as a whole so much as the validity of just the arbitration provision.

If an Arbitration Provision Is Not Valid, the California Franchise Relations Act Voids the Forum Selection Clause

The arbitration provision contained a class action waiver specifically stating that the distributor waived any right to arbitrate or litigate as a class action or in a private attorney general capacity. The Private Attorneys General Act or PAGA authorizes an employee to bring an action for civil penalties against his employer for Labor Code violations. The arbitration provision further included a severability clause which stated that “if the provision prohibiting class-wide or private attorney general arbitration is deemed invalid, then the provision requiring arbitration of breaches between the parties shall be null and void and there shall be no obligation to arbitrate such breaches.”

The court noted that in Sakkab v. Luxottica Retail N. Am., Inc., 803 F.3d 425, 430 (9th Cir. 2015), the Ninth Circuit had found pre-dispute agreements to waive PAGA claims to be unenforceable. Following Sakkab, the court found that since PAGA claims could not be waived, the parties’ arbitration provision was not valid. Combined with the severability clause, this meant that the entire arbitration provision was not enforceable. The court did not need to address the plaintiffs’ unconscionability argument but that represented an additional ground for voiding the arbitration provision.

Having lost its arbitration provision, Matco made the “long shot” argument that section 20040.5 violated the dormant commerce clause. Matco claimed that section 20040.5 placed a substantial burden on interstate commerce because it deprived out-of-state franchisors of the assurance that the same laws, court rules, and regulations would apply to their franchise agreements. The court rejected this argument, noting that the very purpose of diversity jurisdiction “is to provide a federal forum for out-of-state litigants where they are free from prejudice in favor of a local litigant.” Further, the court said that the federal courts in California were equally equipped to interpret California and Ohio law.

After rejecting the dormant commerce clause argument, the court also denied a transfer of the action under 28 U.S.C. § 1404(a) “[f]or the convenience of parties and witnesses [or] in the interest of justice.” Thus, the motion to dismiss and motion to transfer were both denied. Matco was forced to answer the complaint in California.

* Originally published in shorter form in the California Lawyers Association, Business Law Section, Franchise Law Committee, Case Report, June 2019

Work With an Experienced Franchise Lawyer

The case is illustrative of a strategy for ensuring that your claims can be filed in California. California courts are often sympathetic to challenges to arbitration provisions and by voiding that provision a party can argue that section 20040.5 is applicable. In addition to looking for arguments such as the PAGA one here, parties can argue that arbitration provisions are unconscionable and therefore unenforceable. By doing so, a franchisee can keep its case in California. If you need an experienced California franchise lawyer to analyze or litigate the issue of whether you can file your case in California, contact Luther Lanard, PC, to schedule a consultation.