Arbitration agreements are increasingly common in commercial contracts, including franchise agreements. However, in the franchise context, state-specific disclaimers in Franchise Disclosure Documents can affect the enforceability of arbitration provisions. CS Anaheim underscores how the specific language used in a state-specific addendum—such as a warning that a forum selection clause may not be enforceable under local law—may influence how courts interpret and enforce arbitration clauses. Careful drafting is essential to ensure that such disclaimers do not inadvertently undermine the parties’ agreement to arbitrate.
Factual Background
This case involves a franchisor’s motion to compel arbitration pursuant to an arbitration clause contained in a franchise agreement. The underlying dispute arose between hotel franchisor Choice Hotels International, Inc. (“Choice”) and franchisee CS Anaheim Hotel Investment LLC (“CS Anaheim”).
On April 15, 2016, the parties entered into a Franchise Agreement. The agreement grants CS Anaheim the right to operate a hotel under Choice’s Cambria Hotels & Suites brand. It also includes an arbitration clause with a delegation provision that requires “any controversy or claim arising out of or relating to [the] Agreement… including any claim that [the] Agreement or any part of [the] Agreement or any related agreements is invalid, illegal, or otherwise voidable or void” to be submitted to final and binding arbitration in Maryland. The agreement also contains a Maryland choice-of-law provision.
Prior to entering the Franchise Agreement, Choice provided CS Anaheim with a Franchise Disclosure Document (“FDD”) that includes a California-specific addendum. The Addendum notes that “[t]he Franchise Agreement requires venue to be limited in Maryland” and that the “provision may not be enforceable under California law.”
Before executing the agreement, CS Anaheim, led by its principal Curtis Olson, conducted thorough due diligence on the FDD and the Franchise Agreement, including negotiation of certain deal- and project-specific terms of the Franchise Agreement. However, the arbitration clause itself was not subject to negotiation and was presented on a take-it-or-leave-it basis.
In December 2019, CS Anaheim opened the franchised hotel. By late 2023, CS Anaheim discovered that Choice had failed to fulfill several material obligations under the agreement, giving rise to the current dispute. Specifically, CS Anaheim claims that:
- Choice allegedly restricted the pool of qualified vendors in exchange for kickbacks, causing franchisees to pay above-market rates and denying them promised volume-discount pricing.
- Choice allegedly used mandatory system fees paid by CS Anaheim for its own internal business development rather than for brand marketing and advertising, contrary to its contractual obligations.
Procedural History
Based on these allegations, CS Anaheim filed suit asserting claims for breach of contract, breach of the implied covenant of good faith and fair dealing, and fraud. It also seeks a declaratory judgment that it may terminate the Franchise Agreement without incurring liquidated damages. In response, Choice filed the present motion to compel arbitration and stay the proceedings.
Court’s Analysis
As a threshold issue, the parties dispute whether Maryland or California law governs. The Court does not resolve this conflict because CS Anaheim waived any argument under Maryland law, having challenged the delegation and arbitration provisions solely under California law. Finding the delegation clause enforceable under California law, the Court declined to address the choice-of-law issue as unnecessary.
In response to Choice’s motion to compel arbitration, CS Anaheim advances three arguments: (1) the arbitration provision is enforceable because the forum selection clause is unenforceable; (2) the delegation clause is unconscionable; and (3) the entire arbitration provision is unconscionable.
Mutuality
CS Anaheim first argued that the arbitration clause is unenforceable due to the lack of mutuality as to the forum selection provision. It pointed to the Addendum to the FDD, which warns that the Maryland venue requirement “may not be enforceable under California law.” According to CS Anaheim, this warning undermines mutual assent to the selected forum, and by extension, to the arbitration clause as a whole. In support, it cited to three cases where courts declined to enforce arbitration clauses under seemingly similar circumstances: Laximi Invs., LLC v. Golf USA, 193 F.3d 1095 (9th Cir. 1999); Winter v. Window Fashions Pros., Inc., 166 Cal. App. 4th 943 (2008); and Nygaard v. Prop. Damage Appraisers, Inc. (Nygaard II), 779 F. App’x 474 (9th Cir. 2019).
However, the Court disagreed, finding these precedents distinguishable. In each of these cases, the courts held that the disclaimers precluded a meeting of the minds as to arbitration because the disclaimers explicitly states that binding arbitration would occur in a specific forum, while acknowledging that the provision might not be enforceable under California law. See Laxmi, 193 F.3d at 1096 (“The Franchise Agreement also requires binding arbitration. The arbitration will occur in Oklahoma County, State of Oklahoma … This provision may not be enforceable under California law.” (emphasis added)); Winter, 166 Cal. App. 4th 946 (“The franchise agreement requires binding arbitration. The arbitration will occur at Dallas County, Texas with the costs being borne by the losing party. This provision may not be enforceable under California law.” (emphasis added)); Nygaard v. Prop. Damage Appraisers, Inc. (Nygaard I), No. 16-cv-02184-VC, 2017 WL 8793228, at *2 (E.D. Cal. Dec. 28, 2017), aff’d, 779 F. App’x 474 (9th Cir. 2019) (“The Agreement requires binding arbitration. The arbitration will occur … in Fort Worth, Texas, before a sole arbitrator … This provision may not enforceable under California.” (emphasis added)).
In contrast to Laxmi, Winter, and Nygaard, the Addendum here does not mention arbitration—it only states that the Franchise Agreement requires venue to be limited to Maryland. As such, the Court found that even if mutual assent is lacking as to the forum, the parties still agreed to the broader arbitration provision. Therefore, the potential unenforceability of the forum selection clause does not invalidate the arbitration clause in its entirety.
Unconscionability as to the Delegation Clause
CS Anaheim next challenged the delegation clause as unconscionable. Under California law, a finding of unconscionability requires both procedural and substantive unconscionability, though not in equal measure. California courts apply a sliding scale approach: the greater the degree of substantive unconscionability, the less procedural unconscionability is required to render a provision unenforceable, and vice versa.
CS Anaheim argued that the clause is procedurally unconscionable because it was offered on a take-it-or-leave-it basis. While the Court acknowledged that this could suggest minimal procedural unconscionability, it did not reach that issue. Instead, the Court found no substantive unconscionability and, therefore, upheld the clause.
CS Anaheim advanced two theories of substantive unconscionability. First, it argued there was no meeting of the minds on the venue provision, but the Court had already rejected that contention. Second, it claimed the delegation clause was unconscionable because it allegedly prevented the arbitrator from applying California unconscionability standards, relying on Pinela v. Neiman Marcus Group, Inc., 238 Cal. App. 4th 227 (2015).
In Pinela, the arbitration agreement included a Texas choice-of-law provision and expressly limited the arbitrator’s authority, stating that the arbitrator could not “enlarge, add to, subtract from, disregard or … otherwise alter the parties’ rights under such laws.” The California Court of Appeal found the clause unconscionable because it effectively barred the application of California law to assess the agreement’s enforceability and prevented the arbitrator from modifying the choice-of-law provision to avoid substantial injustice, as required under California law.
The Court found Pinela inapplicable here. Unlike Pinela, the Franchise Agreement between CS Anaheim and Choice contains no language limiting the arbitrator’s authority to apply California law or overriding California’s unconscionability standards. Accordingly, the Court rejected CS Anaheim’s argument and upheld the delegation clause as valid and enforceable.
Because a valid delegation clause exists, any challenge to the enforceability of the arbitration clause as a whole must be decided by the arbitrator. The Court therefore granted Choice’s motion to compel arbitration.
Key Takeaways
CS Anaheim illustrates that when drafting franchise agreements with out-of-state forum selection or arbitration clauses, clarity and precision are essential. Courts may uphold an arbitration clause even if the forum selection provision is deemed unenforceable, provided there is clear mutual assent to arbitrate. If a state-specific disclosure—such as a California Addendum—warns that a forum clause may be unenforceable, the arbitration provision should be clearly and separately stated to avoid conflation. For litigators, CS Anaheim also demonstrates that courts may sever an unenforceable forum selection clause to preserve the parties’ broader agreement to arbitrate, especially when the disclosure does not expressly reference arbitration.
This Case Report was prepared by Shan Wen, an associate in the Franchise and Distribution Practice Group of Mortenson Taggart Adams LLP. Shan can be reached at swen@mortensontaggart.com.