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Ice cream headache

Cold Stone case challenges arbitration clauses


Everybody thought Lesa Meyers would gain weight when she bought a Cold Stone Creamery franchise two blocks from her Long Beach, Calif., home in 2005.

Instead, Meyers lost 12 pounds those first few weeks as she contended with a host of issues for which she hadn’t bargained. She had equipment problems, staff problems, and she had to repair relationships with both customers and vendors. “Working ‘pretty hard’ is an understatement,” she said.

That hard work finally earned the store a modest profit one year later, and still Meyers lost her business thanks to one other problem she didn’t foresee: Her store lost its lease.

Meyers quickly sued, claiming that Cold Stone and its area developer, Conehead Investments, didn’t inform her when she bought the franchise for $375,000 of the lease problems started under the previous owner. Now the case is setting up to be a test of the enforceability of arbitration clauses in the nation’s biggest state, and the ultimate decision could impact numerous franchise companies.

A Los Angeles judge in April denied Cold Stone’s motion to compel arbitration, based on Meyers’ franchise agreement with the company. Cold Stone has filed an appeal, which could take a year to resolve.

If Cold Stone loses, that could solidify a decision by the U.S. Ninth Circuit Court of Appeals this past December giving courts in California the right to overturn arbitration clauses in certain cases.

That case involved a former MailCoups franchisee out of Contra Costa, Calif., Connie Nagrampa, who owned a franchise with the direct mail company before terminating her franchise agreement in 2000. She claimed she lost money, contrary to the company’s promises of big profits. MailCoups then tried to compel arbitration.

The court ruled for Nagrampa. It gave three reasons for saying that the arbitration clause was invalid: The franchisor gave the franchisee no choice but to accept the clause; the franchisor reserved for itself the right to litigation in certain cases even while requiring that the franchisee go to an arbitrator; and the franchisee could only file in the franchisor’s hometown.

The decision meant that “just because you have an arbitration provision doesn’t mean that it will be enforceable,” said Kevin Murphy, a San Francisco franchise law expert who served as a consultant for Nagrampa. As a result, legal experts believe that Meyers’ case against Cold Stone will be the first among many challenges of arbitration clauses based on the Nagrampa case.

Arbitration is a legal technique designed to settle disputes outside the courtroom. An arbitrator hears arguments between two parties. Neither party can appeal the arbitrator’s ruling.

Most franchise agreements include a clause requiring arbitration, rather than litigation, to settle legal issues, said Murphy. “They’re the de facto standard in settling franchise disputes,” Murphy said. “Franchisors use them because they don’t create legal precedent, they’re very private and they tend to favor franchisors in many cases.”

But they often discourage franchisees from filing any complaints, Murphy said. Arbitration costs more to file than litigation. The decision is final, and the frequent requirement that franchisees file in the franchisor’s hometown requires them to spend thousands on travel on top of the attorney costs, Murphy said.

Yet a growing number of franchisors are beginning to question the wisdom of arbitration clauses, said Barry Heller, a Washington D.C.-based franchise attorney with DLA Piper who has studied the Nagrampa case. Part of that is due to concerns about some recent arbitrators’ decisions, which went against the franchisors. Companies are also concerned that some franchisees can band together and demand arbitration as a class.

Legal experts don’t believe that the California cases will spell the end of arbitration, even in that state. But franchisors, including national companies, will need to reconsider their provisions if they want arbitration to survive a court challenge there—especially if Meyers wins her case.

“If I’m a franchisor and I have a lot of franchisees based in California and I want this arbitration clause to be enforced, then I am going to write my arbitration clause so it avoids defects,” Heller said. Experts said the result of the California cases could have a more national impact by causing some regional or national companies to rethink their arbitration clauses.

Yet Heller doesn’t believe many courts in other states will follow California’s example. “A lot of courts have traditionally viewed California as doing things that are ‘way out there.’”

As for Meyers, even if she does succeed in challenging arbitration, that is hardly a guarantee she will win her case against Cold Stone.

A 47-year-old attorney, Meyers bought the Long Beach store because she thought it was a “once-in-a-lifetime opportunity.” Cold Stone was an increasingly popular opportunity among franchisees—the number of stores more than doubled between 2003 and 2005, from 541 to 1,223, as did company revenues, according to Cold Stone’s uniform franchise offering circular, or UFOC.

Meyers negotiated with the previous owners to buy the store. She also signed Cold Stone’s thick franchise agreement and went on an 11-day trip to the company’s Ice Cream University. She closed on the sale July 13, 2005.

Meyers quickly found out, however, that she was inheriting a store with numerous problems. It had a bad reputation for customer service. She had to replace a water heater and a freezer floor and the ballast in the ceiling. She even struggled to convince a vendor that it was OK to sell her store nuts. To top things off, her store was burglarized and an employee took money from the company safe.

One week after taking over the store, Meyers found out that the previous owner lost his franchise rights and was forced to sell. “I just don’t know that I ever really recovered from that,” she said. “To me, that was significant information that would have had me look at everything differently.”

That fall Meyers considered selling the store, but she persisted. Then in December 2005, she received word that there were problems with the store’s lease. According to Meyers’ complaint, the previous owner was late making rent several times between 2003 and 2005, prompting the owner of the building to inform Cold Stone that it didn’t plan to renew the lease the following summer. “That knocked me to my knees,” she said. “That was it. I was so stunned. I was physically sick.”

Negotiations failed between the landlord and Cold Stone, which manages its franchisees’ leases. Meyers was informed the following July that she had to close her store on July 31, 2006.

According to her complaint, Meyers said that Cold Stone didn’t tell her of the lease problems, even though it knew about them when she bought the franchise.

Cold Stone officials would not comment on the case, saying it was pending litigation, but according to legal documents the company believes that Meyers’ complaint isn’t with them but with the previous owner—who is not mentioned in the lawsuit. The company says that Meyers’ purchase contract with the previous owner was contingent upon the landlord agreeing to waive all previous defaults.

Meyers said she tried to get the company to repay her fees or pay for her to move to another location, but that the company refused. Though she continued to work full-time as an attorney, Meyers said she couldn’t take on the debt the $100,000-plus move would require.

So Meyers no longer owns a Cold Stone, yet she is still paying off the loan she received when she bought the franchise. She has $350,000 remaining on the debt and is paying $3,200 a month. “Let’s be honest, I’m into my savings now,” she said. “This has completely impacted my entire life.

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