Awuah v. Coverall North America, Inc.

United States Court of Appeals
For the First Circuit

No. 08-1920

PIUS AWUAH, NILTON DOS SANTOS, GERALDO CORREIA, BENECIRA
CAVALCANTE, DENISSE PINEDA, JAI PREM, ALDIVAR BRANDAO, PHILLIP
BEITZ, RICHARD BARRIENTOS, MARIAN LEWIS, STANLEY STEWART,
and all others similarly situated,

Plaintiffs, Appellees,

v.

COVERALL NORTH AMERICA, INC.,

Defendant, Appellant.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. William G. Young, U.S. District Judge]

Before

Boudin, Stahl, and Howard,
Circuit Judges.

Norman M. Leon with whom Michael D. Vhay, John F. Dienelt,and
DLA Piper U.S. LLP were on brief for appellant.
Hillary Schwab with whom Shannon Liss-Riordan, Harold Lichten,
and Pyle, Rome, Lichten, Ehrenberg, & Liss-Riordan, P.C. were on
brief for appellees.

January 23, 2009
 BOUDIN, Circuit Judge. The question before us is whether

a dispute over the validity of an arbitration agreement should be

decided by a court or by an arbitrator. Appellant is Coverall

North America, Inc., itself the subsidiary of still larger

enterprises. Coverall contracts to provide commercial janitorial

cleaning services to building owners or operators throughout the

United States. It "franchises" other companies or individuals to

do the actual cleaning of the premises and has more than 5,000 such

franchises in place in the United States.

The franchise agreements promise to supply the franchisee

with equipment, training, a quality control program, and billing

and collection services, as well as a set amount of initial

cleaning business per month for buildings whose owners or operators

have contracted with Coverall. In exchange, Coverall receives from

the franchisee up-front fees in the range of $12,000 to $21,500,

and additional payment for each cleaning job a franchisee performs.

Disputes have arisen between Coverall and a number of its

franchisees over whether Coverall made misrepresentations, kept its

contractual promises, wrongly classified franchisees as independent

contractors, and over other aspects of the relationship. On

February 15, 2007, a dozen or so franchisees filed a class action

against Coverall in federal district court in Massachusetts,

alleging fraud, misrepresentation, breach of contract, lost

benefits, improper deductions of earnings, and violations of

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minimum wage, overtime, and consumer protection laws. It appears

from the record that the plaintiffs in many cases are recent

immigrants and persons with limited education.

Among the nearly dozen named plaintiffs, three had

franchise agreements containing arbitration clauses--Pius Awuah,

Denisse Pineda, and Richard Barrientos, who are the appellees in

this court. Apparently Coverall only recently introduced such

provisions into its standard franchise contract. For two of the

three appellees, the franchise agreement states that if required

mediation processes are not successful,

all controversies, disputes or claims between
Coverall, its officers, directors, agents
and/or employees (in their respective
capacities) and Franchisee . . . arising out
of or related to the relationship of the
parties, this Agreement, any related agreement
between the parties, and/or any specification,
standard or operating procedure of Coverall,
including those set forth in the Coverall
Policy and Procedure Manual . . . shall be
submitted promptly for arbitration.

The third contract has a similar provision but also

states that parties agree to submit to arbitration disputes about

the validity of the franchise agreement or related agreements.

However, the agreements signed by all three appellees also provide

that "unless otherwise provided or the parties agree otherwise,

arbitration shall be in accordance with the then current Rules of

the American Arbitration Association." Rule 7(a) of those rules

provides that "[t]he arbitrator shall have the power to rule on his

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or her own jurisdiction, including any objections with respect to

the existence, scope or validity of the arbitration agreement."

Citing these provisions, Coverall filed motions to stay

the district court proceedings as to these three franchisees

pending arbitration. The three franchisees responded that the

arbitration agreements were unconscionable, citing various

provisions of the agreements which they said made arbitration

costly or unfair.1 Coverall responded in turn that, by the terms

of Rule 7(a), a challenge to the validity of the arbitration

provision was itself a matter for the arbitrator to determine.

In a decision dated July 1, 2008, the district court held

that the franchise agreements did not clearly and unmistakably

reflect such an intention, and the district judge referred

plaintiffs' claims of unconscionability to a magistrate judge.

Awuah v. Coverall N. Am., Inc., 563 F. Supp. 2d 312 (D. Mass.

2008). Coverall then appealed to this court, which stayed

proceedings before the magistrate judge pending this appeal.

Coverall's interlocutory appeal to this court is pursuant

to the Federal Arbitration Act ("FAA"), 9 U.S.C. § 16(a)(1)(A)

1
These included the agreement's cost-sharing provisions,
prohibition of punitive and exemplary damages, bar on class action
arbitration, "no-modification clause," a requirement that the
losing party pay the prevailing party's attorney costs, a
prohibition on a claimant using the results of another arbitration
proceeding in his own proceeding, and a provision allowing Coverall
alone to initiate suit in court in certain circumstances. See
Articles 21(A)(11), 22.

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(2000), which entitles a party to appeal a refusal to stay court

proceedings pending arbitration. Fit Tech, Inc. v. Bally Total

Fitness Holding Corp., 374 F.3d 1, 5 (1st Cir. 2004).2 Although

the district court has not yet definitively rejected arbitration on

the merits of the three appellees' claims, it has rejected

arbitration on the issue--which Coverall claims to be committed to

the arbitrator--as to whether the arbitration clause itself is so

unconscionable that an interlocutory appeal is permitted. Madol v.

Dan Nelson Automotive Group, 372 F.3d 997, 998-99 (8th Cir. 2004).

The FAA provides that where "the making of the agreement

for arbitration or the failure to comply therewith is not in

issue," arbitration should be ordered. 9 U.S.C. § 4. Based on

this language, the Supreme Court has determined that whether an

issue is subject to arbitration under an agreement containing an

arbitration clause is itself presumptively a matter for the court

to decide before ordering arbitration. First Options v. Kaplan,

514 U.S. 938, 943-44 (1995). However, this general rule can be

qualified by agreement of the parties.

Thus, where the parties have themselves "clearly and

unmistakably agreed" that the arbitrator should decide whether an

issue is arbitrable, the Supreme Court has held that this issue is

2
The franchise agreements provide that they are subject to the
FAA but are otherwise governed by the substantive law of the state
in which the franchisee is located: here, the three appellees are
respectively residents of Massachusetts (Awuah), New Jersey
(Pineda), and Pennsylvania (Barrientos).

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to be decided by the arbitrator. E.g., Howsam v. Dean Witter

Reynolds, Inc., 537 U.S. 79, 83 (2002). Additionally, a challenge

to the validity of the contract itself is subject to arbitration

and that allocation of authority to the arbitrator will also be

respected by the court. Buckeye Check Cashing v. Cardegna, 546

U.S. 440, 443-45 (2006).

Yet where the parties merely agree that the validity of

the contract should be subject to arbitration, this does not commit

to the arbitrator a dispute about whether the arbitration clause is

valid. Id. at 445-46; Prima Paint Corp. v. Flood & Conklin Mfg.

Co., 388 U.S. 395, 404 (1967). Unfortunately, the Supreme Court

has not said definitively whether the arbitrator gets to decide the

latter question where, as here, arbitration rules incorporated in

the contract say that the arbitrator should decide whether the

arbitration clause is valid.

How the Court would decide such a case is not entirely

clear. On the one hand, one might think that Howsam's principle of

party autonomy might extend to such a case. On the other, Buckeye

did not cite Howsam and conceivably the Court might regard the

validity of the arbitration clause as a special case in which

challenges should be decided by the judge, either as a matter of

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policy or because of statutory language.3 If the matter were

completely open in this circuit, we are not certain of the outcome.

However, this court has said expressly that the validity

of an arbitration clause is itself a matter for the arbitrator

where the agreement so provides. In Apollo Computer v. Berg, 886

F.2d 469 (1st Cir. 1989), the parties had consented to

International Chamber of Commerce rules, which stipulate that

challenges to the "validity of the arbitration agreement" shall be

decided by an arbitrator. Apollo said:

These provisions clearly and unmistakably
allow the arbitrator to determine her own
jurisdiction when, as here, there exists a
prima facie agreement to arbitrate whose
continued existence and validity is being
questioned. The arbitrator should decide
whether a valid arbitration agreement exists.
. . .

Id. at 473-74.

Apollo accords with the views of at least one other

circuit, see Terminix Int'l Co. LP v. Palmer Ranch Ltd., 432 F.3d

1327, 1332-33 (11th Cir. 2005), and has been taken at face value by

3
In a number of cases, including ones where AAA rules were
cross-referenced in the contract, courts have examined arbitration
clauses for unconscionability, but without any indication that
anyone argued that the issue should have gone to arbitration based
on the cross-reference. See Davis v. O'Melveny & Myers, 485 F.3d
1066 (9th Cir. 2007), cert. dismissed, 128 S.Ct. 1117 (2008);
Nagrampa v. Mailcoups, Inc., 469 F.3d 1257 (9th Cir. 2006); Gemini
Ernst & Young v. Nackel, 346 F.3d 360, 365 (2d Cir. 2003);
Alexander v. Anthony Int'l, L.P., 341 F.3d 256 (3d Cir. 2003);
Burden v. Check Into Cash of Kentucky, LLC, 267 F.3d 483 (6th Cir.
2001), cert. denied, 535 U.S. 970 (2002).

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a district court within our own circuit. Morris v. Regis Corp.,

No. 08-68-P-H, 2008 U.S. Dist. LEXIS 56612, at *3 (D. Me., July 25,

2008). Morris held that district court should adjudicate the

validity of the arbitration clause only because the contract at

issue contained ambiguous language with respect to whether a court

or arbitrator should decide this gateway dispute. Morris, 2008

U.S. Dist. LEXIS 56612, at *6, *9-10.

Admittedly, the precise controversy in Apollo involved

the question whether one party had authority to bind the other to

arbitrate rather than (as here) a question of unconscionability.

Still, the language quoted above, although perhaps broader than

necessary to resolve the controversy, did constitute the rationale

for the decision. Given that the Supreme Court has not clearly

spoken, the interests of predictability are served by respecting

our own prior language unless either the Supreme Court or an en

banc panel say otherwise. United States v. Holloway, 499 F.3d 114,

118 (1st Cir. 2007).

The district court did not disagree with Apollo's

premise--that the parties can contract for the arbitrator to decide

challenges to his own authority--but the court held that the

parties in this case had not clearly and unmistakably committed to

the arbitrator the question whether the arbitration clause itself

was valid. This would be a hard position to defend if one looked

only to the language of Rule 7(a), since it appears explicitly to

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affirm the arbitrator's authority to decide challenges to the

"validity of the arbitration agreement."

The district court's answer was that allowing the

arbitrator to decide the validity of the arbitration clause would

entail his striking the clause if it were invalid; yet the

arbitration clause provides that "the arbitrator . . . shall not

alter or otherwise reform the terms of this agreement" and other

language to the same effect. By contrast, the agreements have a

severability clause allowing other provisions to survive if "a

court of competent jurisdiction" invalidates a provision.

With respect, this is too thin a basis for concluding

that the agreements' language "evinces an intent to allow questions

of arbitrability to be decided by a court." Awuah, 563 F. Supp. 2d

at 315. Rule 7(a) says plainly that the arbitrator may "rule on

his or her own jurisdiction" including any objection to the

"existence, scope or validity of the arbitration agreement." This

is about as "clear and unmistakable" as language can get, meeting

the standard we have followed. E.g., Rosenberg v. Merrill Lynch

Pierce, Fenner & Smith, Inc., 170 F.3d 1, 20-21 (1st Cir. 1999);

Skirchak v. Dynamic Research Corp., 508 F.3d 49, 60-61 (1st Cir.

2007).

Of course, a larger question, or perhaps several, lie

behind this controversy. It is doubtful that many people read the

small print in form contracts, let alone the small print in

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arbitration rules that are cross-referenced by such contracts,

however explicit the cross-reference. While one might expect more

in a commercial setting, Coverall franchisees are (it is alleged)

often far from sophisticated business men and women. In all events

whether "knowledge" is the real issue may be doubtful.

Franchise agreements are often contracts of adhesion

offered to those with little bargaining power; probably few would

go unsigned even if Rule 7(a) were printed in bold type on the

front page.4 Further, courts have no general power to relieve

parties of bad bargains except in extreme cases, i.e., where the

contract is unconscionable. The question here is simply who should

decide the unconscionability issue, and the arbitration clause said

in effect that this was for the arbitrator.

What is the most potent concern is an argument embedded,

although not stressed, in appellees' brief, namely, that

arbitration in this case may itself be an illusory remedy. In

principle, having the arbitrator decide questions of validity may

be fine if the parties so agreed; but if the terms for getting an

arbitrator to decide the issue are impossibly burdensome, that

outcome would indeed raise public policy concerns. If arbitration

4
Although pertinent on certain issues, the fact that an
agreement is a contract of adhesion or includes documents by cross-
references does not alone make the document invalid or nullify the
cross reference. E.g., Am. Bankers Mortgage Corp. v. Fed. Home
Loan Mortgage Corp., 75 F.3d 1401 (9th Cir. 1996); Level Export
Corp. v. Wolz, Aiken & Co., 305 N.Y. 82, 87 (1953); Farnsworth, §
4.28 n.33; Williston on Contracts, § 49:22 (4th ed. 2008).

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prevents plaintiffs from vindicating their rights, it is no longer

a "valid alternative to traditional litigation." Kristian v.

Comcast Corp., 446 F.3d 25, 37 (1st Cir. 2006)

In this instance, appellees' allegations do raise claims

that the arbitral forum is illusory. In particular, they assert

that the amounts likely to be recovered by each of the individual

franchisees may be modest and that the costs of arbitration itself-

-independent of counsel fees, which can be contingent--would be

overwhelming. Of course, court litigation can also be expensive,

but at least one does not need to pay the judge. Appellees

asserted in the district court that franchisees

could be liable for substantial administrative
fees payable up front to the American
Arbitration Association, half of all the
arbitration fees to the neutral arbitrator
(who, at a reduced hourly rate of $300.00 per
hour, would still cost $2,400 per day for both
hearings and writing) and in addition would
have to pay the whole fee for an additional
arbitrator.

They also submitted the report of a franchise law

attorney, which states that he has been involved in arbitrations

that have cost $100,000 and $150,000 (for one arbitrator) and

$300,000 and $400,000 (for a three-person arbitration panel). This

concern about fees is the most prominent but not necessarily the

only basis for appellees' claim that in practical effect they have

no real opportunity to get issues, including unconscionability,

resolved in arbitration.

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 In Green Tree Fin. Corp. v. Randolph, the Supreme Court

observed: "It may well be that the existence of large arbitration

costs could preclude a litigant . . . from effectively vindicating

her federal statutory rights in the arbitral forum." 531 U.S. 79,

90 (2000). Several circuits have agreed that where a plaintiff

asserts that excessive arbitration costs deprive the plaintiff of

an arbitral forum, a threshold issue is presented for consideration

by the court. See, e.g., Faber v. Menard, Inc., 367 F.3d 1048,

1052-55 (8th Cir. 2004); Musnick v. King Motor Co., 325 F.3d 1255,

1259 (11th Cir. 2003).

Yet, despite the failure of Coverall's brief to respond

to these contentions, how burdensome arbitration would be is

uncertain. Given the franchise fees, the individuals may have

substantial but not excessively large claims--the complaint

specifies amounts of $4,740, $8,500 and $46,064, respectively, but

says these are bare minimums. And the American Arbitration

Association rules have provisions for expedited treatment and

lesser procedures in cases where the amount in controversy is

$75,000 or less. Whether access to the arbitrator is really a

colorable defense is not clear on this record.

Our concern here is not with unconscionability--

essentially a fairness issue, Farnsworth, supra, § 4.28, at 584-

88,--but more narrowly with whether the arbitration regime here is

structured so as to prevent a litigant from having access to the

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arbitrator to resolve claims, including unconscionability defenses.

The standard for such a showing of illusoriness would also be high-

-all formal dispute resolution involves costs and inconvenience.

But if the remedy is truly illusory, a court should not order

arbitration at all but decide the entire dispute itself.

Accordingly, although our view of the district court's

initial role is narrower, we agree that the appellees are entitled

to a ruling by that court as to whether the arbitration remedy in

this case is illusory. Our current stay will terminate when the

mandate issues in the case. Subject to the district court's

wishes, we see no reason why the magistrate judge cannot proceed

with the inquiry, refocused in accordance with this decision.

The district court's refusal to order arbitration at this

time is affirmed on the grounds set forth above, and the matter is

remanded to the district court for proceedings consistent with this

decision.

It is so ordered.

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