In a franchise dispute involving a sushi restaurant in the Chicago suburbs, the First District in Kim v. Kim, 2016 IL App (1st) 153296-U examines the scope of contractual arbitration clauses and when arbitration can be insisted on by non-parties to a contract.
The franchisee plaintiff sued the two principals of the franchisor for fraud. He alleged the defendants tricked him into entering the franchise by grossly inflating the daily sales of the restaurant. The plaintiff sued for rescission and fraud when the restaurant’s actual sales didn’t match the defendants’ pre-contract projections.
The court dismissed the suit based on an arbitration clause contained in the franchise agreement and the plaintiff appealed. He argued that since the defendants were not parties to the franchise agreement (the agreement was between plaintiff and the corporate franchisor), the defendants couldn’t use the arbitration clause as a “sword” and require the plaintiff to arbitrate his claims.
Affirming the case’s dismissal, the appeals court first discussed the burden-shifting machinery of a Section 2-619 motion to dismiss. With such a motion, the movant must offer affirmative matter appearing on the face of the complaint or that is supported by affidavits. Once the defendant meets this initial burden, the burden then shifts to the plaintiff who must establish that the affirmative matter is unfounded or requires the resolution of a material fact. If the plaintiff fails to carry his burden, the motion to dismiss can be granted. (¶ 23)
The court then zeroed in on whether the defendants – non-parties to the franchise agreement – could enforce the agreement’s arbitration clause against the plaintiff. Generally, only parties to a contract can enforce its terms. By contrast, non-parties cannot. An exception to this rule is equitable estoppel: where a party is estopped or prevented from avoiding a written contract term because the party trying to enforce it isn’t technically a party to it.
For equitable estoppel to apply and subject a contracting party to arbitration against a non-party, (1) the signatory must rely on terms of a contract to make its claims (or presumes the existence a written agreement that contains an arbitration provision) against the nonsignatory, (2) the signatory must allege concerted misconduct by the nonparty and one or more contracting parties, and (3) where there is a close nexus between the alleged wrong and the claims against the non-party and where plaintiff’s claims against a defendant are factually intertwined with or based on written contract terms. (¶¶ 44-45)
Here, the crux of plaintiff’s lawsuit was that the defendants induced him into signing the franchise agreement and related restaurant lease. Since the plaintiff’s claims were premised on and presumed the franchise agreement’s existence, and the franchise agreement contained a broad arbitration clause, the court held that the plaintiff was subject to the arbitration clause and the defendants could enforce the clause.
A third party generally cannot enforce contract provisions since the third party, by definition, is not a signatory to the contract.
But where a plaintiff’s claim against a non-party relates to or is factually intertwined with a written contract, the terms of that contract can govern and be enforced by the non-party.