LAWorld
INTERNATIONAL NETWORK OF INDEPENDENT LAW FIRMS
international business briefing Vol 16 • September 2004
Holly Whatley

Think you’ll be arbitrating employment and consumer claims in California?
Not without careful planning

Here’s the scenario: Your company has done everything it can to avoid facing a jury in the United States. It has incorporated arbitration clauses into its contracts. The clauses incorporate the rules of a neutral arbitration forum for resolving any disputes, such as the American Arbitration Association. You think you are covered for any dispute arising out of that contract. But are you? It may boil down to whether your company is employing individuals or selling to consumers located in the world’s fifth largest economy — California. In both of those contexts, as set forth below, the court will enforce the agreement only if it meets certain criteria not required in other contexts.

Generally, the laws of the United States, as well as of the individual states, favor enforcement of arbitration agreements. Written arbitration agreements in interstate and foreign commercial transactions, except employment agreements, are enforceable under the Federal Arbitration Act (“FAA”), 9 U.S.C. §§ 1 et seq. The FAA, when applicable, also preempts state laws that conflict with it, including state laws that purport to limit arbitration. In fact, one of the main purposes of the FAA was to curtail a state’s ability to enact state laws that undercut the enforceability of agreements to arbitrate. As a result, the policy favoring enforcement of arbitration agreements has become entrenched in both federal and state laws over time.

So what happened? A tension developed between enforcing arbitration agreements and protecting individuals from what some courts view as oppressive and non-negotiable agreements to arbitrate. The tension has arisen as a result of efforts by companies to enforce pre-dispute arbitration agreements against employees and consumers, two groups of individuals that California courts have deemed deserve additional safeguards in arbitration agreements.

Arbitration clauses in employment contracts

In the employment context, the California Supreme Court in Armendariz v. Foundation Health Psychcare Servs., 24 Cal. 4th 83 (2000), ruled that an arbitration agreement entered into by an employee, as a non-negotiable condition of employment, is only enforceable to resolve statutory discrimination claims if it provides for each of the following: 1) a neutral arbitrator; 2) more than minimal discovery; 3) the same relief otherwise available in court; 4) a written decision by the arbitrator; and 5) a limit on costs of the arbitration to the employee. Any imposition of costs on an employee that are greater than he or she would pay for asserting a claim in court is prohibited.

The arbitration agreement at issue in Armendariz did not meet these requirements because it attempted to limit the employee's remedies for wrongful termination claims, which would include any statutory discrimination claims, only to lost wages. The court found that such a limitation was contrary to public policy, unconscionable and unenforceable. Importantly, the court found that this unconscionable provision could not be severed from the remainder of the arbitration agreement and declared the entire arbitration agreement unenforceability.

The court also found that the agreement was unenforceable because arbitration was imposed by the employer, the stronger party, on the employee, the weaker party, and: 1) required arbitration of claims by the employee, but permitted the employer to choose which forum it could use to pursue claims against the employee: and, 2) purported to limit the employee's recovery of damages, but placed no such restriction on the employer. The employer provided no business justification for such a one-sided agreement, and the court found it unconscionable and unenforceable.

The lesson here is that an employer cannot use its superior bargaining power to extract concessions from employees that are contrary to public policy. Agreements to arbitrate in the employment context, at least in California, must include additional specific terms that are not required in other arbitration agreements to guard against employer abuses. And unless the limitations imposed in the arbitration agreement also apply to the employer as well, courts are unlikely to enforce the clauses against the employees.

Arbitration in consumer contracts

Courts have similarly limited the enforce ability of arbitration agreements in consumer contracts. The recent decision in Gutierrez v. AutoWest, lnc., 114 Cal. App. 4th 77 (2004), briefed and argued by LAWorld member Christa & Jackson, is illustrative. The trial court in Gutierrez held that an arbitration agreement preprinted on the reverse side of consumer's automobile lease was unconscionable because it provided no mechanism for the plaintiff to seek a waiver of the required arbitration fee. Because the plaintiff asserted a class claim, he estimated that under the applicable rules his arbitration fees would exceed $10,000, an amount he claimed he could not afford. Based on that cost estimate, the appellate court found the arbitration agreement substantively unconscionable noting, "[w]hile arbitration may be within the reasonable expectations of consumers, a process that builds prohibitively expensive fees into the arbitration process is not." Crucially, however, the Court of Appeal did not declare the entire agreement unenforceable as the court in Armendariz had done. Rather, it left open for the trial court to decide on remand whether the provision requiring the payment of such high fees should be severed and the rest of the arbitration agreement enforced.

On a separate ground, the court ruled that in cases asserting a consumer's unwaivable statutory rights, the law implies in every arbitration agreement that unaffordable fees will not be allocated to the consumer at any point in the arbitration process. Id. at 271-72. But, in a win for those seeking to enforce arbitration agreements, the court declined to follow the arbitration rule applicable in employment cases that any fees above those a claimant would pay in court are unreasonable. Instead, determination of what would be affordable for any particular plaintiff would be decided on a case-by-case basis.

Because many consumer actions are based on nonwaivable statutory rights, in cases subject to arbitration, a company should evaluate whether the arbitration clause itself, or the applicable arbitration rules designated, provide a mechanism for the consumer to seek relief from any arbitration fees he or she claims are prohibitive. As long as the rules have such a mechanism, then the arbitration agreement will be enforceable. If not, then the fee provision will probably have to be severed from the rest of the agreement.

Another significant issue that, as yet, is undecided in California, is whether class action waivers in arbitration agreements are valid. In Szetela v. Discover Bank (2002) 97 Gal. App. 4th 1094, the Fourth District Court of Appeal struck down a provision in an otherwise valid arbitration agreement, in which both parties waived the right to pursue a claim in a representative or class action capacity. In that case, Discover Bank had amended its cardmember agreement by inserting an amendment inside a regular monthly billing statement. That amendment included a waiver of both the bank's and customer's right to bring a representative or class action claim. The court nevertheless found the waiver unconscionable under California law because it contradicted the state legislature's stated policy of creating a mechanism for a representative to seek relief on behalf of the general public.

However, in a case decided less than one year later, and now on appeal to the California Supreme Court, the Second Appellate District declined to follow Szetela. (Discover Bank v. Superior Court (2003) 105 Cal. App. 4th 326, review granted, depublished by Discover Bank v. Superior Court, 2003 Daily Journal DAR 3936.) Interpreting the identical card-holder agreement and class action waiver, the court in Discover Bank applied Delaware law to find the arbitration agreement was valid. The court found that the FAA preempted any state judicial policy precluding class-wide arbitration waivers.

It is expected that the decision by the California Supreme Court will reconcile the conflict between these two cases. But as of yet, the conflict remains. What is certain, however, is that when a form arbitration agreement affects either employees or consumers, courts are more likely to find ways to avoid enforcement of the arbitration agreement, unless those agreements also ensure that the statutory rights of such individuals are not curtailed by pursuing a claim in arbitration. Further, in the employment context, the costs of arbitration to the employee cannot exceed those that the employee would incur in court. In the consumer context, there must be a mechanism for the consumer to seek relief from arbitration fees that she contends she cannot afford. Addressing each of those issues fully, and up front in the arbitration agreement, greatly increases the chances that a court will enforce the agreement, and your company will not find itself facing a sometimes unpredictable jury.

Holly Whatley is an associate with Christa & Jackson, the LAWorld member firm in Los Angeles.