Non-Signatory Owner-Operator Bound to Franchise Agreement
Earlier this month, in Everett v. Paul Davis Restoration, Inc., Nos. 12-3407, 13-1036, 2014 U.S. App. LEXIS 21059 (7th Cir. Nov. 3, 2014), the United States Court of Appeals for the Seventh Circuit held that an owner-operator of a property damage restoration services franchise was bound to the terms of a franchise agreement she had never executed because she received a direct benefit from the franchise agreement. Everett follows the trend in other jurisdictions to bind non-signatories to contractual provisions under the doctrine of equitable estoppel.
In Everett, the franchisor entered into a franchise agreement with Matthew Everett and EA Green Bay, LLC (“EAGB”). EAGB was owned, controlled, and operated by Matthew Everett and his wife, Renee Everett. At the time of signing the franchise agreement, Matthew Everett indicated he was the 100% owner of EAGB, and the franchise agreement required consent from the franchisor before ownership in EAGB could be transferred. Six years into the franchise relationship, the franchisor terminated the franchise agreement for cause. Matthew Everett then transferred his 50% ownership interest to Renee Everett and an EAGB employee. Renee Everett then continued to operate EAGB under a new assumed name and continued to serve the same customers from the same location, in spite of a provision in the franchise agreement prohibiting the operation of a competitive business for a period of two years after the termination of the franchise. The franchisor responded by initiating arbitration to enforce its covenant not to compete, resulting in the issuance of a unanimous award against Renee Everett. The district court, however, vacated the arbitration award finding that Renee Everett could not be bound to the arbitration provision as a non-signatory under a theory of direct benefits estoppel. The Seventh Circuit Court of Appeals reversed.
In finding Renee Everett was bound to the arbitration provision in the franchise agreement, and therefore the arbitration award, the Court of Appeals noted that ordinary principles of contract and agency may bind a non-signatory party to an arbitration agreement, including under the doctrine of direct benefits estoppel. Under this doctrine, a non-signatory is estopped from avoiding arbitration if she “knowingly seeks the benefits of the contract containing an arbitration clause.” Here, Renee Everett obtained the benefits of the franchise agreement, namely owning and operating the franchise and trading upon the name, goodwill, and reputation of the franchisor.
While the holding in Everett supports franchisor controls of brand reputation by supporting the enforcement of post-termination contractual provisions, franchisors are advised to take steps to ensure the proper persons are bound to covenants not to compete and other contractual provisions from the onset of the relationship. Requiring individual shareholders or members of a franchisee entity to execute personal guaranties, and including provisions that prohibit the unauthorized transfer of the franchise agreement, may be effective tools to ensure contractual terms can be enforced against the proper offenders. It is always easier to have all proper persons sign the franchise agreement and any ancillary documents at the onset of the franchise relationship than relying on the doctrine of equitable estoppel afterwards in the event of a dispute.