NO. 91-305 

IN THE SUPREME COURT OF THE STATE OF MONTANA 

1992 

JOHN MIKE DOWNEY, PATRICE DOWNEY, THOMAS DOWNEY, AND THE DONUT nom, 

Plaintiffs and Respondents, 

-VSDENVER CHRISTENSEN AND 

BAKER BOY BAKE SHOPS, INC., 

Defendants and Appellants. 

APPEAL FROM: District Court of the Second Judicial District, 

In and for the County of Silver Bow, 

The Honorable Mark P. Sullivan, Judge presiding. 

COUNSEL OF RECORD: 

For Appellants: 

Marshal L. Mickelson; Corette, Pohlman, 

Allen, Black & Carlson, Butte, Montana, 

Michael J. Maus; Howe, Hardy, Galloway & Maus, 

Dickinson, North Dakota. 

For Respondents: 

Curtis Thompson and Sue Ann Love; Jardine, 

Stephenson, Blewett & Weaver, Great Falls, Montana. 

Filed: 

Submitted on Briefs: November 14, 1991 

Decided: January 28, 1992 
Justice John Conway Harrison delivered the Opinion of the Court. 

This is an appeal by Denver Christensen and Baker Boy Bake 

Shops, Inc. (Baker Boy) from a June 4, 1991, Order of the Second 

Judicial District Court, Silver Bow County, denying their motions 

to compel arbitration of the claim filed by John, Patrice, and 

Thomas Downey and The Donut Hole (the Downeys). We reverse. 

Christensen and Baker Boy present the following issue for our 

review: Did the District Court err in failing to compel the 

parties to submit their claims to arbitration? 

Baker Boy is a North Dakota corporation which offers and sells 

The Donut Hole franchises in various states including Montana. The 

Downeys entered into a franchise agreement with Baker Boy on 

February 21, 1987, agreeing to open and operate a The Donut Hole 

franchise in Butte, Montana. Christensen was employed by Baker Boy 

assisting new franchisees in business operations. Christensen 

allegedly helped procure the franchise agreement entered into 

between the Downeys and Baker Boy. 

The Downeys operated The Donut Hole in Butte from 

approximately January of 1988 through December 31, 1990, in a 

building they leased from Baker Boy. The Downeys ceased operations 

after Baker Boy evicted them from the leased premises for nonpayment of rent. 

The Downeys filed a complaint against Christensen and Baker 

Boy on November 1, 1990. The Downeys presented a number of claims 

alleging fraud, breach of the implied covenant of good faith and 

fair dealing, breach of contract, and negligence. These claims 

2 
stemmed from the franchise agreement entered into between the 

Downeys and Baker Boy. 

Immediately upon serving the complaint on Christensen and 

Baker Boy, the Downeys began discovery by serving requests for 

production on Christensen and Baker Boy. Both Christensen and 

Baker Boy responded to the Downeys' first discovery requests. 

Christensen and Baker Boy separately answered the complaint on 

the merits and each asserted the following affirmative defenses: 

As an affirmative defense, Baker Boy alleges that by 

agreement between the parties' [sic] disputes as alleged 

herein must be resolved by arbitration and, therefore, 

the [clourt does not have jurisdiction. 

This court lacks subject matter jurisdiction as the 

franchise agreement requires disputes such as those 

alleged to be resolved by arbitration; 

Baker Boy also filed a counterclaim and amended counterclaim 

against the Downeys alleging breach of the franchise agreement and 

breach of the leasehold agreement. 

After responding to the Downeys' discovery requests, 

Christensen and Baker Boy initiated discovery proceedings. 

Christensen served interrogatories and requests for production on 

the Downeys and Baker Boy served requests for admission on the 

Downeys. The Downeys responded to both requests. During this 

exchange of written discovery, depositions were scheduled and 

noticed but never taken. 

After the Downeys served their second request for discovery on 

Baker Boy, both Christensen and Baker Boy filed motions to compel 

arbitration and stay proceedings. Baker Boy failed to respond to 

the Downeys' latest discovery requests because of these pending 

3 
motions. The District Court denied Christensen's and Baker Boy's 

motions to compel arbitration. Christensen and Baker Boy jointly 

appeal. 

I. 

Did the District Court err in failing to compel the parties to 

submit their claims to arbitration? 

The written franchise agreement governing the parties' 

relationship provides: 

[Tlhe parties agree that any and all disputes between 

them, and any claim by either party that cannot be 

amicably settled, shall be determined solely and 

exclusively by arbitration in accordance with the rules 

of the American Arbitration Association or any successor 

thereof. 

Clearly, this arbitration clause requires the parties to submit the 

instant controversy to arbitration rather than civil litigation. 

However, the District Court concluded that both Christensen and 

Baker Boy waived arbitration by participating in discovery 

resulting in prejudice to the Downeys. Finding waiver, the court 

concluded that the matter was properly before it. We disagree and 

therefore reverse with instructions that the District Court order 

arbitration. 

The Federal Arbitration Act governs the arbitration clause at 

issue in this case since the transaction between Baker Boy and the 

Downeys was one involving commerce. 9 U.S.C. § 2; Vukasin v. D.A. 

Davidson & Co. (1990), 241 Mont. 126, 785 P.2d 713. The underlying 

motions to compel arbitration were properly before the Second 

Judicial District Court, Silver Bow County, Montana, because state 

district courts have jurisdiction under the Federal Arbitration Act 

4 
to order arbitration. Passage v. Prudential-Bache Sec., Inc. 

(1986), 223 Mont. 60, 727 P.2d 1298; Southland Corp. v. Keating 

(1984), 465 U.S. 1, 104 S.Ct. 852, 79 L.Ed.2d 1. When a district 

court denies a motion to compel arbitration based on the premise 

that one party waived arbitration, this Court reviews such 

determination de novo. Fisher v. A.G. Becker Paribas Inc. (9th 

Cir. 1986), 791 F.2d 691, 693. 

When parties have contracted to settle disputes through 

arbitration, the party asserting waiver bears a heavy burden of 

proof. Britton v. Co-op Banking Group (9th Cir. 1990), 916 F.2d 

1405, 1412; Fisher, 791 F.2d at 694. That party must demonstrate: 

(1) knowledge of the existing right to compel arbitration; (2) acts 

inconsistent with the right to arbitrate the dispute; and (3) 

prejudice to the party resisting arbitration. Britton, 916 F.2d at 

1412; Fisher, 791 F.2d at 694. 

In the case at bar, the parties do not dispute that 

Christensen and Baker Boy knew of their existing right to 

arbitrate. However, the Downeys assert that Christensen and Baker 

Boy acted inconsistently with their right to arbitrate to the 

Downeys' prejudice constituting waiver. 

Christensen and Baker Boy seek reversal of the District 

Court's order denying their motions to compel arbitration for the 

following reasons: (1) each asserted its right to arbitration as 

an affirmative defense in its answer; (2) neither waived its right 

to arbitrate the dispute by participating in discovery; and (3) the 

Downeys were not prejudiced by Christensen's and Baker Boy's 

5 
participation in discovery. 

The Downeys allege the following inconsistencies demonstrating 

waiver: (1) Christensen's and Baker Boy's filing of formal answers 

rather than motions to dismiss or stay proceedings; (2) Baker Boy's 

filing of a counterclaim; (3) Christensen's and Baker Boy's 

participation in preparing a discovery schedule: and (4) 

Christensen's and Baker Boy's participation in discovery before 

they filed motions to compel arbitration. The Downeys contend that 

these acts prejudiced them since Christensen and Baker Boy 

benefitted from the Downeys' substantial compliance with 

Christensen's and Baker Boy's discovery requests without affording 

similar benefits on the Downeys. 

The Downeys were on notice of Christensen's and Baker Boy's 

intent to rely on the arbitration clause in the franchise agreement 

from the outset because they explicitly included this right to 

arbitrate in their answers as affirmative defenses. This factor 

alone sufficiently defeats a claim of waiver. G.B. Michael and 

Genossenschaftkraftfutterwerk, Corp. v. SS Thanasis (N.D. Cal. 

1970), 311 F.Supp. 170, 181. However, further discussion is 

warranted since the Downeys claim prejudice via Christensen's and 

Baker Boy's use of discovery. 

First, to succeed in proving waiver, the Downeys were required 

to prove Christensen and Baker Boy acted inconsistently with their 

right to arbitrate. Since the Downeys complained of fraudulent 

inducement of the franchise agreement, it was not unreasonable nor 

inconsistent with its right to arbitrate, for Baker Boy to engage 

6 
in discovery to determine whether the Downeys contested the 

validity of the entire agreement or merely the arbitration clause 

in the agreement. It is well settled that the district court has 

jurisdiction only if fraud in the inducement of the arbitration 

clause is in issue. If the validity of the entire agreement is in 

issue, the dispute must be submitted to arbitration. Vukasin, 241 

Mont. at 132, 785 P.2d at 717; Prima Paint corp. v. Flood & Conklin 

Mfg. Co. (1967), 388 U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270. 

Proceeding under this authority, Baker Boy's engagement in 

pre-arbitration discovery seeking information regarding specific 

details of the Downeys' claims was legitimate and cannot be 

considered inconsistent with its right to arbitrate. Hilti, Inc. 

v. Oldach (1st Cir. 1968), 392 F.2d 368, 371. Answering on the 

merits, asserting a counterclaim, and participating in discovery, 

without more, is insufficient to constitute waiver. Demsey & 

ASSOC. v. S.S. Sea Star (2d Cir. 1972), 461 F.2d 1009, 1018. 

Christensen engaged in broader discovery than did Baker Boy by 

submitting extensive interrogatories and requests for production to 

the Downeys which sought more information than necessary to 

determine the existence of the right to arbitrate. This discovery 

was excessive and inconsistent with Christensen's right to 

arbitrate since he sought more information than necessary to 

determine the extent of the Downeys' claims. 

Second, as the party resisting arbitration, the Downeys 

possessed the burden of proving that any such inconsistent actions 

by Christensen or Baker Boy were prejudicial to demonstrate waiver. 

7 
Demsey & Assoc., 461 F.2d at 1018. Inconsistent acts are examined 

on a case by case basis to determine if they are prejudicial. 

Stifel, Nicolaus & Co. Inc. v. Freeman (8th Cir. 1991), 924 F.2d 

157, 159. The Downeys have failed to demonstrate prejudice from 

Christensen's or Baker Boy's actions. 

The Downeys base their plea of prejudice on the fact that they 

have complied with Christensen's and Baker Boy's discovery requests 

in full, while Christensen and Baker Boy have not afforded a 

similar benefit. Since Baker Boy's discovery requests were not 

inconsistent with its right to arbitrate, prejudice is not in issue 

as to this appellant. In any event, Baker Boy's refusal is 

harmless since Baker Boy agrees to answer the Downeys' latest 

discovery requests if this case is submitted to arbitration. 

We have examined Christensen's discovery request and the 

answers given the Downeys. We have concluded that no information 

prejudicial to the Downeys in their arbitration proceeding was 

obtained by those discovery requests. The Downeys base their 

entire claim of prejudice on Baker Boy's failure to respond to 

discovery. In contrast, the Downeys have not presented any factual 

basis to demonstrate prejudice as to Christensen. 

Throughout these proceedings Christensen and Baker Boy have 

reminded the Downeys of their intention to rely on the arbitration 

provision of the franchise agreement as a defense to remove the 

instant case from the jurisdiction of the District Court. 

Christensen's and Baker Boy's participation in discovery did not 

cause prejudice sufficient to constitute waiver since Christensen 

8 
and Baker Boy gave timely notice to the Downeys. Benoay v. 

Prudential-Bache Sec., Inc. (11th Cir. 1986), 805 F.2d 1437. The 

Downeys were on notice from the outset and, as a result, any 

actions they took regarding discovery were taken at their own risk. 

Since the Downeys have failed to demonstrate that both 

Christensen and Baker Boy acted inconsistently with their right to 

arbitrate or that any inconsistent actions constituted prejudice, 

waiver does not apply. Therefore, the order of the District Court 

denying Christensen's and Baker Boy's motions to compel arbitration 

is reversed. This case is remanded to the District Court with 

directions to order all arbitrable claims submitted to arbitration. 

We concur: / 

9 
Justice William E. Hunt, Sr., dissenting. 

I dissent. 

The defendants waived their right to arbitration because their 

actions were inconsistent with their right to arbitrate. The 

defendants knew they had a right to arbitrate, but elected to 

proceed through the judicial system. Upon filing of the complaint, 

defendants could have made a Rule lZ(b) motion to dismiss or to 

stay the proceedings pending arbitration pursuant to 9 U.S.C. 5 3 

(1987). Instead, the defendants elected to file an answer, with 

Baker Boy also filing a counterclaim, thereby voluntarily 

subjecting themselves to the judicial forum. 

In addition, the defendants also chose to engage in the 

discovery process for over six months. They participated in the 

setting of a discovery schedule, as well as agreeing that the court 

could set a trial date upon filing a notice of issue. Christensen 

sent a 48 page set of discovery requests to the Downeys. The 

Downeys responded to all 76 interrogatories and delivered 

approximately 950 pages of records and documents. The defendants 

also began scheduling depositions. All of these actions taken by 

the defendants were inconsistent with their right to arbitrate. 

I also believe the Downeys will be prejudiced by removing the 

case to arbitration where discovery is not available. While 

proceeding through the judicial forum, defendants availed 

themselves of the privileges and protections of Montana's Rules of 

Civil Procedure relating to discovery. By removing this case to 

10 
arbitration, the Downeys will not be afforded the same luxury. The 

defendants have refused to respond to the Downeys' discovery 

requests and only moved for arbitration after the Downeys initiated 

their discovery. This places the Downeys at an extreme 

disadvantage. These actions not only prejudice the Downeys, they 

also represent an abuse of the judicial system. I would affirm the 

order of the District Court. 

I i the f r i issent of Justice Hunt. 

11 
January 28, 1992 

CERTIFICATE OF SERVICE 

I hereby certify that the following order was sent by United States mail, prepaid, to the 

following named: 

Marshall Mickelson 

CORE'ITE, POHLMAN, ALLEN, BLACK & CARLSON 

P.O. Box 509 

Butte, MT 59703 

Michael J. Maus 

Howe, Hardy, Galloway & Maus 

P.O. Box 370 

Dickinson, ND 58601 

Sue Ann Love and Curtis G. Thompson 

JARDINE, STEPHENSON, BLEWE'IT & WEAVER, P.C. 

P.O. Box 2269 

Great Falls, MT 59403-2269 

ED SMITH 

CLERK OF THE SUPREME COURT 

Y .