In Casa del Caffe Vergnano S.p.A. v. ItalFlavors, LLC, the US Court of Appeals for the Ninth Circuit held that an arbitration agreement was unenforceable because it was part of a sham contract. Although the parties signed a franchise agreement containing the arbitration provision, they also signed a second "hold harmless" agreement, which, in essence, declared the franchise agreement invalid. The parties entered the sham contract so that it could be used to support a nonimmigrant visa application. ( (9th Cir. Mar. 15, 2016).)

In 2010, Cesar and Hector Rabellino formed ItalFlavors, LLC, planning to use the business to open an Italian-style coffee shop in the US. The Rabellinos met with a representative of Caffe Vergnano in Italy to discuss opening a US Caffe Vergnano franchise. At the time of the meeting, Hector Rabellino lived in Argentina, but he planned to immigrate to the US to run the franchise.

During the meeting, the parties signed a franchise agreement that contained an arbitration clause requiring any disputes under the agreement be resolved by arbitration held in Geneva, Switzerland. The parties also signed a second "hold harmless" agreement, which provided that the franchise agreement "does not have any validity or effectiveness between the parties." The hold harmless agreement stated that the franchise agreement was prepared solely to assist Hector Rabellino in obtaining a visa to work in the US. The hold harmless agreement further provided that the parties "will sign a future contract which will regulate their commercial relationship," but the parties did not sign any subsequent agreements.

ItalFlavors opened a Caffe Vergnano franchise in San Diego, California in April 2011. The business failed, and the franchise closed in December 2011. ItalFlavors subsequently sued Caffe Vergnano in the US District Court for the Southern District of California under California's Franchise Investment Law and Business and Professions Code.

Caffe Vergnano filed a petition to compel arbitration under the franchise agreement. The district court stayed ItalFlavors's suit and granted Caffe Vergnano's petition, holding that the issue of whether the arbitration clause in the franchise agreement survived the hold harmless agreement should be submitted to the arbitrator. ItalFlavors appealed.

The Ninth Circuit reversed the district court, holding that the arbitration clause was unenforceable because the hold harmless agreement demonstrated that the franchise agreement was a sham created only to help Hector Rabellino obtain a US visa.

The court initially considered whether the court or the arbitrator should determine the validity of the arbitration clause. The court emphasized that because arbitration is a matter of consent between parties, if a party has not agreed to submit a dispute to arbitration, it cannot be required to do so. Citing United Steelworkers of Am. v. Warrior & Gulf Navigation Co, the Ninth Circuit explained that a dispute concerning contract formation is generally an issue for the court (363 U.S. 574, 582 (1960)). In this case, the threshold issue was whether the franchise agreement was a binding contract, and therefore the issue was for the court to decide. Because the case arose under Chapter 2 of the Federal Arbitration Act, the Ninth Circuit examined the franchise agreement under federal common law.

The Ninth Circuit held that the parties did not manifest their intent to be bound by the franchise agreement because they also signed the hold harmless agreement. The hold harmless agreement expressly declared that the franchise agreement was not binding. Additionally, the court held, the provision that the parties would sign a future contract to regulate their commercial relationship would not make sense if the franchise agreement was binding. Because there was no mutual intent to be bound, the franchise agreement was not a valid agreement, and the arbitration clause within the franchise agreement was unenforceable.

It is unclear whether Caffe Vergnano argued that any issue of the contract's validity must be heard by the arbitrator under the separability doctrine because the issue is not addressed in the court's opinion. Under that doctrine, a challenge to the validity of a contract as a whole, and not specifically to the arbitration clause within it, must go to the arbitrator, not the court (see Practice Note, Separability of Arbitration Agreements in International Arbitration: US Law of Separability).

This case also provides guidance to organizations or investors, or their counsel, considering E-2 treaty investor nonimmigrant visa status. Among other requirements, investors applying for this visa category must prove that a substantial investment has been made in an active and operating business. The types of arrangements seen in this case likely stem from the pressure to create the documents, relationships, or enterprises that satisfy the visa requirements and speed visa issuance. Ultimately, however, the arrangements must be legal to support a new or continuing request for visa status. For more information on the E-2 visa category, see Article, Executive Relocation: Immigration Law Issues and Key Nonimmigrant Visa Classifications Chart.