Holmes v. Coverall North America, Inc.

• Decision Date: 01 September 1994
• Docket Number: No. 10,10
• Citation: 336 Md. 534,649 A.2d 365
• Parties: Ronald T. HOLMES et al. v. COVERALL NORTH AMERICA, INC. et al. ,
• Court: Maryland Court of Appeals

Page 534

336 Md. 534

649 A.2d 365

Ronald T. HOLMES et al. v. COVERALL NORTH AMERICA, INC. et al.

No. 10, Sept. Term, 1994.

Court of Appeals of Maryland.

Nov. 4, 1994.

Eliot G. Striar, Columbia, for petitioner.

C. Torrence Armstrong (Frederick P. Helm, McGuire, Woods, Battle & Boothe, Alexandria, VA, Morton A. Sacks, McGuire, Woods, Battle & Boothe, Baltimore, all on brief), for respondent.

Argued before MURPHY, C.J., and ELDRIDGE, RODOWSKY, CHASANOW, KARWACKI, BELL and RAKER, JJ.

CHASANOW, Judge.

In this appeal, we are called upon to determine whether a claim for breach of contract damages based on fraudulent inducement and violations of the Maryland Franchise Registration and Disclosure Act may be resolved in court rather than submitted to an arbitrator, as required by an arbitration clause contained in the franchise contract.

I.

The underlying dispute in this case involves the validity of an arbitration clause in a franchise agreement between Ronald T. Holmes ("Holmes"), Holmestar Corporation ("Holmestar"), and Coverall North America, Inc. ("Coverall"). Coverall is a janitorial supplies franchise with its principal place of business in California. In October of 1987, Holmes sought information from Coverall after seeing an advertisement for Coverall franchises. After receiving this information, Holmes engaged in prolonged discussions with Alex Roudi, ¹ who was the sole stockholder, director, president, and chief financial officer of Coverall.

On February 22, 1988, Holmes signed a franchise agreement for a Coverall franchise. Paragraph 20 of the franchise agreement contained a broad arbitration clause which stated:

"Any claim or controversy arising out of or relating to this Agreement or the breach thereof shall be settled by arbitration, in accordance with the rules then prevailing of the American Arbitration Association."

Although operations of the Holmes's franchise were to begin on May 23, 1988, the site was not ready on time and the opening was delayed until July 1, 1988. On July 12, 1988, while Roudi was in Baltimore training Holmes in the franchise operations, Roudi represented to Holmes that, because of the delayed opening, a new franchise agreement should be signed to ensure that billing arrangements under the franchise agreement began at the proper time. Based on Roudi's representations, Holmes signed a second franchise contract on July 12, 1988 which Roudi dated May 12, 1988. Although Holmes alleged that the second contract contained material alterations from the first contract, the arbitration clause was identical to the arbitration clause in the February 22, 1988 franchise contract. Approximately one year after having signed the second franchise agreement and commencing franchise operations, Holmes discovered that Coverall had not, at the time Holmes signed the first franchise contract, been authorized under Maryland law to sell franchises.

Under the Maryland Franchise Act, Maryland Code (1957, 1988 Repl.Vol.), Article 56, §§ 345 et seq. (now entitled the Maryland Franchise Registration And Disclosure Law and codified in Md.Code (1992, 1994 Cum.Supp.), Business Regulation Art., §§ 14-201 et seq.), ² Coverall was required to obtain approval of its offering prospectus by the Maryland Securities Commissioner in order to be authorized to sell franchises in Maryland. This approval was not received by Coverall until May 6, 1988 and Coverall was therefore not registered to sell franchises in Maryland at the time the first franchise contract was entered into. Nonetheless, Holmes continued to carry on franchise operations and did not seek a rescission of the contract. On August 3, 1989, Coverall informed Holmes that the franchise agreement was terminated due to Holmes's alleged mismanagement and his default under the agreement. On August 14, 1989, after receiving Coverall's termination letter, Holmes and Holmestar informed Coverall by letter that because of violations of the Franchise Act, they were rescinding the franchise agreement.

Petitioners Holmes and Holmestar subsequently filed a complaint in the Circuit Court for Howard County against Coverall, Roudi, their attorney and other officers, directors and employees of Coverall. The complaint alleged various violations of the Franchise Act, fraud in the inducement, negligent misrepresentation, and professional malpractice, and sought punitive and compensatory damages. Coverall subsequently filed a petition for arbitration and for a stay of Holmes's action pending arbitration. The petition for a stay pending arbitration was granted.

Holmes and Holmestar then filed an appeal of the stay pending arbitration to the Court of Special Appeals. Coverall filed a motion to dismiss the appeal, arguing that the trial court's order granting a stay pending arbitration was not a final appealable order. The Court of Special Appeals granted Coverall's motion to dismiss the appeal by order dated April 17, 1992. We then granted Holmes's petition for certiorari, vacated the order of the Court of Special Appeals and remanded the case to that court for consideration of the appeal on the merits. See Holmes v. Coverall North America, 330 Md. 114, 622 A.2d 744 (1993) (per curiam).

On remand, the Court of Special Appeals heard argument and rejected Holmes's contention that rescission of the contract was a threshold issue to be resolved by the court prior to arbitration. It affirmed the trial court's order for arbitration and stay of the action. See Holmes v. Coverall, 98 Md.App. 519, 526, 633 A.2d 932, 935 (1993), cert. granted, 334 Md. 263, 638 A.2d 778 (1994). In so doing, the Court of Special Appeals relied on the Maryland Uniform Arbitration Act (Maryland Arbitration Act), Maryland Code (1974, 1989 Repl.Vol.), Courts and Judicial Proceedings Article, §§ 3-201 et seq. ³ Holmes, 98 Md.App. at 526, 633 A.2d at 935. Section 3-206(a) of the Maryland Arbitration Act states:

"A written agreement to submit any existing controversy to arbitration or a provision in a written contract to submit to arbitration any controversy arising between the parties in the future is valid and enforceable, and is irrevocable, except upon grounds that exist at law or in equity for the revocation of a contract."

Section 3-207(b) of the Maryland Arbitration Act provides that where a party opposing an order to arbitrate denies the existence of an arbitration agreement, "the court shall proceed expeditiously to determine if the agreement exists." In making such a determination:

"If the court determines that existence of the arbitration agreement is in substantial and bona fide dispute, it shall try this issue promptly and order a stay if it finds for the petitioner. If the court finds for the adverse party, it shall order the parties to proceed with arbitration."

§ 3-208(c).

Recognizing the strong legislative policy of the Maryland Arbitration Act to enforce valid arbitration agreements, the Court of Special Appeals noted that in a suit to compel arbitration, the court's function is:

" 'the resolution of a single issue--is there an agreement to arbitrate the subject matter of a particular dispute. Where the language of the arbitration clause is clear, and it is plain that the dispute sought to be arbitrated falls within the scope of the arbitration clause, arbitration should be compelled.' "

Holmes, 98 Md.App. at 525-26, 633 A.2d at 935 (quoting Gold Coast Mall, Inc. v. Larmar Corp., 298 Md. 96, 104, 468 A.2d 91 (1983) (citations omitted)). Thus, the court noted that, in determining whether an agreement to arbitrate exists, the dispute often falls into two categories:

"(1) issues relating to the formation of the arbitration agreement, which should be decided by the court, such as a claim of novation, or an allegation that the agreement is void for lack of mutual consent ...; and,

(2) issues arising after the formation of the arbitration agreement, which should be referred to arbitration, such as rescission, fraud in the inducement, waiver, and termination of the contract."

Holmes, 98 Md.App. at 530, 633 A.2d at 937 (citing Goebel v. Blocks & Marbles Brand Toys, Inc., 568 N.E.2d 552 (Ind.Ct.App.1991)).

The intermediate appellate court noted that under § 365(b) of the Franchise Act, if violations of § 365(a) of the Franchise Act are found, "[t]he court may order the franchisor or subfranchisor to rescind any franchise and to make restitution...." 98 Md.App. at 531, 633 A.2d at 938 (citing § 365(b)) (emphasis omitted). Thus, the contract in question was voidable and not void ab initio. 98 Md.App. at 531-32, 633 A.2d at 938. The court noted that an order of arbitration was proper because the petitioners' claims were not threshold issues, but rather "relate[d] to events extrinsic to the formation of the contract; the parties to the Agreement clearly intended that the arbitration clause apply to the Appellants' claims for rescission ... and damages." 98 Md.App. at 531, 633 A.2d at 937 (emphasis in original). The court stated that:

"If we were to adopt Appellants' position, any party to a contract containing an arbitration agreement could attempt to avoid the binding nature of the arbitration agreement by merely alleging that the formation of the entire contract was faulty. Such a rule of law would wreak havoc on well-settled principles of arbitration law. The Legislature clearly intended that only issues relating to the existence of the arbitration agreement, and not the underlying contract, be decided by the trial court in the first instance."

98 Md.App. at 532, 633 A.2d at 938.

We granted certiorari to address the issue of whether allegations of fraudulent inducement and violations of the Franchise Act in a franchise agreement containing a broad arbitration clause are sufficient to permit the franchisee to avoid arbitration of the dispute.

II.

The Maryland Arbitration Act has been called the "State analogue ... to the Federal Arbitration Act." See Regina v. Envirmech, 80...