Alert - Everett v. Paul Davis Restoration, Inc.: Will the Doctrine of Direct Benefits Estoppel Soon Spread to California Franchisees?

February 12, 2015

Applying the doctrine of “direct benefits estoppel,” the Court of Appeals for the Seventh Circuit held that a non-signatory spouse to a franchise agreement may nevertheless be bound by the terms of that agreement if she directly benefited from the franchise relationship.  In Everett v. Paul Davis Restoration, Inc., EA Green Bay, LLC entered into a franchise agreement with Paul Davis Restoration, Inc., to provide water, fire and mold clean-up services.  In the franchise agreement, Matthew Everett identified himself as the “100%” owner of EA Green Bay, LLC.  In reality, his wife, Renee Everett, held a 50% interest in the company.  Only Matthew Everett signed the franchise agreement, notwithstanding the fact that the agreement required all owners of EA Green Bay, LLC to do so.  Renee Everett never signed the franchise agreement. 

After operating as a Paul Davis Restoration franchise for almost six (6) years, EA Green Bay defaulted under the franchise agreement, and the agreement was terminated.  Following termination, Matthew sold his interest in EA Green Bay to his wife, making her the sole owner.  Renee changed the company’s name and began to operate as a water, fire and mold remediation company.  Had Matthew engaged in such activity, he would have stood in breach of the post-termination non-competition clause of the franchise agreement. 

Paul Davis Restoration petitioned for arbitration under the franchise agreement. Simultaneously, Renee sought a declaration in state court that she was not bound by the franchise agreement.  The state court held that Renee was subject to the franchise agreement, under the “direct benefits estoppel” theory.  The case was arbitrated and Paul Davis Restoration prevailed.  Yet, when Paul Davis Restoration attempted to enforce its arbitrated award, the district court reversed its earlier decision and held that Renee did not receive a direct benefit from the franchise agreement.  Any benefits that she received were indirect, because they “flowed through her ownership interest in EA Green Bay” and her status as Matthew’s spouse, but not to her directly.  

On appeal, the Everett Court addressed whether Renee was subject to the post-termination non-competition covenant in the franchise agreement, notwithstanding the fact that she never signed the agreement.  The Court held that Renee was subject to the restrictive covenant, because she “directly benefited” from the franchise agreement.  The Seventh Circuit explained that under the doctrine of “direct benefits estoppel,” “a non-signatory party is estopped from avoiding arbitration if she knowingly seeks the benefits of the contract containing the arbitration clause.”   The Court held that Renee obtained a direct benefit from the franchise agreement based on her ownership interest in EA Green Bay, and therefore she was bound by the arbitration agreement and resulting award.  The Court explained that it would be inequitable to hold otherwise.

California law recognizes that a non-signatory to an arbitration agreement may nevertheless be bound by its terms (or may enforce the same agreement), provided that he/she received a benefit from the agreement in question, or was involved directly in the transaction at issue.  Although there are no reported California state court cases directly applying the direct benefits estoppel theory in the context of franchise agreements, it is not a stretch to suggest that the theory may be applied in a similar context by a California court. 

Franchisees and franchisors who operate in California should take note of the Everett case, as it may affect the manner in which the franchise agreements are drafted.  Franchisors should take care to require that the spouses of franchisees who participate in the franchise sign and agree to be bound by any franchise agreement.  Franchisees who have a non-participating spouse may wish to take steps to ensure that the franchise agreement provides clearly that it does not apply to the non-participating spouse.  Admittedly, this may be difficult, given the franchisor’s superior bargaining power in a traditional franchise relationship.  Nevertheless, it is important for franchisors and franchisees to be aware of the fact that whenever a spouse of a franchise’s principal benefits directly from a franchise agreement, such spouse may remain bound by the terms of the subject franchise agreement.