Franchise Class Actions and Arbitration – Are They Compatible?

Updated from an article originally published on on April 17, 2015.

Can a franchisor avoid the possibility of a franchisee class action by including an arbitration clause in its franchise agreements?  In a 2014 decision the Ontario Superior Court stayed a proposed class action in a case commenced by Pillar to Post franchisees alleging that the franchisor had made fundamental changes to its home inspection franchise system without complying with the statutory disclosure obligations under the Arthur Wishart Act (Franchise Disclosure), 2000 (the “AWA”).  The franchisees claimed damages of $25 million.

The franchisor sought a stay of the proposed class action on the basis that the parties had agreed to in the standard franchise agreement that “all controversies, claims or disputes between Franchisor and Franchisee…[will] be resolved by arbitration before a sole arbitrator”. The franchisees argued that the right of franchisees to associate in the AWA extends to their right to participate in class actions and overrode the mandatory directive for a stay contained in the Arbitration Act. 

The Court held that in the absence of a clear statement of legislative intent to protect a party’s right to litigate or the application of one of the few exceptions found in the Arbitration Act, court actions should be stayed in favour of arbitration. The Court held that a “clear intervention by the legislature to override an agreement to arbitrate” was required and that the arbitration provision in the franchise agreement did not “deny the franchisee any forum for access to justice.”

The Court also stated that class proceedings are not always preferable to arbitration for group claims because class actions are procedural in nature and do not create substantive rights, modify existing rights or enhance the court’s jurisdiction. Also, the Court decided that the stay was not to be denied on public policy grounds because enforceability of an arbitration agreement relates to whether the right to arbitrate must be enforced as opposed to whether arbitration is a preferable procedure.

The case clarified that the exceptions to enforcement of an arbitration agreement are confined to clear statements in other legislation that the jurisdiction of the courts is to be preserved.  This finding is consistent with the “contemporary approach” of “a policy supporting the resolution of disputes outside of court proceedings where parties have agreed to arbitrate their disputes.” 

In 2019 the Supreme Court of Canada released its reasons in TELUS Communications Inc. v. Wellman, reversing the Ontario Court of Appeal decision which had refused to stay certain claims covered by a class action based on an arbitration clause. 

The class representative filed a proposed class action for damages against TELUS on behalf of Ontario residents who had mobile phone service contracts during a specific period. The class included both consumers and business customers. The standard terms and conditions included an arbitration clause stipulating that all claims arising out of or in relation to the contract, apart from the collection of accounts, must be determined through mediation and, failing that, arbitration. However Ontario’s Consumer Protection Act invalidates such clauses to the extent that they prevent consumers from pursuing claims in court. Because business customers are not covered by this exception, TELUS applied for a stay with respect to the business customer claims, relying on the arbitration clause. The motions judge dismissed the motion and certified the action. She determined that Ontario’s Arbitration Act grants a court discretion to refuse a stay where it would not be reasonable to separate the matters dealt with in the arbitration agreement from the other matters, thereby allowing all of the matters to proceed in court. The Court of Appeal dismissed the appeal.

In a 5-4 split decision, the SCC held that the appeal should be allowed and the claims of the business customers should be stayed. The Arbitration Act does not give a court discretion to refuse to stay claims dealt with by an arbitration agreement. Business customers remain bound by their agreements.

In 2020 the Supreme Court of Canada released its decision in Heller v. Uber Technologies Inc. upholding the Ontario Court of Appeal’s 2019 finding that an arbitration clause contained in Uber’s standard Ontario driver contracts was unconscionable. The plaintiff sought a declaration that Ontario Uber drivers are subject to the Employment Standards Act (“ESA”) and that arbitration provisions contained in Uber’s service agreements are void and unenforceable. The plaintiff also sought $400 million in damages on behalf of the class.

The arbitration clause required drivers to submit to the arbitral jurisdiction of the International Chamber of Commerce in Amsterdam, Netherlands to resolve any dispute with Uber. ICC rules require parties to pay approximately $14,500 in administrative fees.  By way of contrast, the plaintiff earns $400 to $600 per week based on 40 to 50 hours of work.

Uber’s initial motion to stay the proposed class action in favour of arbitration succeeded. The Ontario Court of Appeal overturned the motion judge’s decision, finding that the arbitration clause was both unconscionable and an unlawful attempt to contract out of the ESA.

A majority of the Supreme Court agreed with the Court of Appeal that Uber’s arbitration clause is unconscionable by applying a two-part test: (i) whether there is an inequality of bargaining power between the parties and, (ii) whether that inequality led to the weaker party accepting an “improvident bargain.” The majority found that there was an inequality in bargaining power because Uber used a standard form “contract of adhesion” that could not be modified and because the plaintiff would not appreciate the implications of the arbitration clause. The majority then found that the plaintiff had accepted an improvident bargain because the cost of arbitration – at least $14,500 in fees simply to initiate an arbitration claim – would make enforcing the contract all but impossible.

The Supreme Court’s application of the doctrine of unconscionability may make enforcing arbitration clauses more challenging in the franchise context because of the court’s reference to unequal bargaining power which is commonly referred to in franchise decisions involving the application of the duty of fair dealing. 

The Supreme Court noted that a clause can be unconscionable even if the stronger party is not willingly taking advantage of its position. Franchisors seeking to include an arbitration clause in a franchise agreement should consider whether doing so risks binding a franchisee to an “improvident bargain.”

In summary, generally a presumption exists in Canadian law and arbitration statutes that when an arbitration clause exists, challenges to the jurisdiction of the arbitrator are first referred to the arbitrator rather than a judge. This presumption was confirmed by the Supreme Court of Canada in the Uber case. However, there are exceptions as discussed in the TELUS case: the court can rule on arbitral jurisdiction when it is (i) a pure question of law, or (ii) a question of mixed fact and law requiring only “superficial consideration” of the evidentiary record. The Supreme Court of Canada added a third narrow exception in the Uber case, that courts should not refer challenges to an arbitrator if there is a real prospect that if the court does not hear determine the jurisdiction issue, the challenge will never be resolved.

These cases emphasize the need for franchisors to give consideration in drafting franchise agreements as to whether they wish to include an arbitration clause precluding the initiation or participation in class proceedings.  If so, the clause must be clearly and carefully drafted.  Further, if the franchisor wishes to preclude submission of all claims to the courts and utilize arbitration as the preferred means of dispute resolution, the arbitration clause must use broad language to ensure that it includes all potential disputes that may arise between any parties. However, courts will now consider such doctrines as unequal bargaining power and unconscionability in determining whether such clauses may be unenforceable.

Arbitration clauses and arbitration agreements in franchising require detailed knowledge of arbitration law and procedure as well as specific knowledge of franchise law and legislation, and should only be prepared by lawyers who have expertise in both areas.

© Frank Zaid 2021