California’s halting retreat from the arbitration tug of war

OCTOBER 2017 TERM

For over 25 years, the California Supreme Court has been locked in a battle with the U.S. Supreme Court over arbitration. Our high court would endorse restrictions on the enforcement of arbitration agreements, only to have the U.S. high court strike those restrictions down, in accord with Congress' mandate -- enshrined in the Federal Arbitration Act --that arbitration agreements be enforced according to their terms. One law review article described this as the "endless battleground."

On Monday, in Epic Systems Corp. v. Lewis, 2018 DJDAR 4705, we were treated to the rare spectacle of the California Supreme Court accurately anticipating the U.S. Supreme Court and conforming to its ruling in advance -- and yet, somehow, the foundation for the California court's next arbitration rebuke was still laid.

The issue in Epic Systems was whether the National Labor Relations Act barred class relief waivers in employment arbitration agreements. Section 7 of the act guarantees workers "the right ... to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection." Except for a short period in the late 1970s and early 1980s when the National Labor Relations Board experimented (and later abandoned) a broader interpretation, "concerted activities" has always meant joint action between two or more workers, not an attempt by a single worker to act in the interest of others (as in a class action).

The NLRB -- in D.R. Horton, Inc., 357 N.L.R.B. 2277 (2012), rev'd in relevant part, D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir. 2013) -- rejected a contrary opinion from its own general counsel issued just two years earlier to hold that seeking class certification of a wage and hour suit was "concerted activity," and that including a class relief waiver provision in an employee arbitration program was an unfair labor practice. The 2nd, 5th and 8th U.S. Circuit Courts of Appeals disagreed with the reasoning of D.R. Horton, while the 6th, 7th and 9th U.S Circuit Courts of Appeals endorsed it.

The U.S. Supreme Court agreed with the 5nd, 5th and 8th. As with its other arbitration rulings over the past three decades, it started with the "liberal federal policy favoring arbitration agreements." Moses H. Cone Memorial Hosp. v. Mercury Constr. Co., 460 U.S. 1 (1983). "Not only did Congress require courts to respect and enforce agreements to arbitrate," Epic Systems held, "it also specifically directed them to respect and enforce the parties chosen arbitration procedures. ... On first blush, these emphatic directions would seem to resolve any argument under the" FAA.

The employees in Epic Systems argued that the FAA's savings clause -- which allows courts to refuse to enforce arbitration agreements "upon such grounds as exist at law or in equity for the revocation of any contract" -- permits the rule of D.R. Horton to trump the FAA. The U.S. Supreme Court roundly rejected this contention. The savings clause "establishes a sort of 'equal treatment' rule for arbitration contracts." It "recognizes only defenses that apply to 'any' contract." It "offers no refuge for 'defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.'" It "does not save defenses that target arbitration either by name or by more subtle methods." The rule of D.R. Horton is clearly such a defense. It would violate the principles establish by the U.S. Supreme Court in AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011), that "courts may not allow a contract defense to reshape traditional individualized arbitration by mandating classwide arbitration procedures without the parties' consent."

Having ruled that the FAA would not recognize the rule of D.R. Horton as a valid defense to enforcement of an arbitration agreement, the Supreme Court turned to the question of whether the FAA and the NLRA conflict, and whether the NLRA prevailed over the FAA to the extent that they do conflict. The court held that they don't. First, "the term 'other concerted activities'" in Section 7 "should, like the terms that precede it, serve to protect things employees 'just do' for themselves in the course of exercising their right to free association in the workplace, rather than 'the highly regulated, courtroom-bound "activities" of class and joint litigation.'" Second, because there was no "clearly expressed congressional intention" that the NLRA should prevail over the FAA (or vice-versa), the courts were obliged to interpret both statutes "to give effect to both." Third, the interpretation that best gives effect to both statutes is one that construes the FAA to apply to the enforcement of arbitration agreements, and the NLRA to apply to labor-management relations.

The California Supreme Court anticipated the first part of Epic Systems in Iskanian v. CLS Transp. Los Angeles, LLC, 59 Cal. 4th 348 (2014). Iskanian rejected an argument that D.R. Horton permitted Gentry v. Superior Court, 42 Cal. 4th 443 (2007), cert. denied sub nom Circuit City Stores, Inc. v. Gentry, 552 U.S. 1296 (2008), to survive Concepcion. "We thus conclude, in light of the FAA's 'liberal federal policy favoring arbitration' [citation omitted] that sections 7 and 8 of the NLRA do not represent 'a contrary congressional command' overruling the FAA's mandate." Iskanian also held that D.R. Horton was not validated under the FAA's savings clause, noting that "Concepcion makes clear that even if a rule against class waivers applies equally to arbitration and nonarbitration agreements, it nonetheless interferes with fundamental attributes of arbitration and, for that reason, disfavors arbitration in practice." Ultimately, the California Supreme Court ultimately joined the 5th Circuit in rejecting D.R. Horton.

Thus far, Iskanian represents two strong steps back from the "endless battleground": one step when bowed to Concepcion and reversed the 7-year-old Gentry rule, and a second when it anticipated Epic Systems and rejected D.R. Horton.

But it eventually took a step forward into the fray when it held a waiver of representative relief in arbitration "frustrates PAGA's objectives" of permitting employees to act in a representative capacity, constitutes a waiver of the rights conferred by California's Private Attorneys General Act, and thus runs afoul of Civil Code Section 3513. Specifically, the Iskanian court held that "where, as here, an employment agreement compels the waiver of representative claims under the PAGA, it is contrary to public policy and unenforceable as a matter of state law."

This public policy defense clearly violates the "equal treatment" principle of the FAA's savings clause described in of Epic Systems and last term's decision in Kindred Nursing Centers Ltd. Partnership v. Clark, 137 S. Ct. 1421 (2017), in that it "appl[ies] only to arbitration or ... derive[s its] ... meaning from the fact that an agreement to arbitrate is at issue."

Iskanian side-stepped FAA preemption considerations by holding that "a PAGA claim lies outside the FAA's coverage because it is not a dispute between an employer and an employee arising out of their contractual relationship. It is a dispute between the employer and the state, which alleges directly or through it agents -- either the Labor and Workforce Agency or aggrieved employees -- that an employer has violated the Labor Code." The problem with this holding is that when an employer seeks to enforce a representative relief waiver against an employee, the state's claim is not being waived or abrogated in any fashion. Rather, the employee's personal statutory right to act as an "agent" of the state for PAGA purposes is being subject to arbitration. As Iskanian conceded, the U.S. Supreme Court "has found the FAA applicable to statutory claims between parties to an arbitration agreement." It remains so when private parties act is relators in PAGA cases, which are variety of qui tam suit.

Epic Systems warns that "an argument that a contract is unenforceable just because it requires bilateral arbitration is a different creature" from "traditional, generally applicable contract defense[s]" (emphasis in original) -- "A defense of that kind, Concepcion tell us, is one that impermissibly disfavors arbitration whether it sound sin illegality or unconscionability." The illegality defense to representative relief waivers in PAGA arbitrations is precisely this kind of impermissible defense to enforcement under the FAA.

A more perfect parallel to Gentry could not be imagined. In Gentry the California Supreme Court rejected arguments that its rule was preempted by the FAA. Seven years later, after the U.S. Supreme Court hands down Concepcion, the California Supreme Court is forced in Iskanian to reverse Gentry. Now -- four years after Iskanian -- the U.S. Supreme Court hands down Kindred Nursing and Epic Systems, forcing the California Supreme Court to reverse the rule in Gentry barring representative relief in arbitration.

The California Supreme Court's retreat from the "endless battleground" is a halting and fitful one: For every two steps forward, the court takes one step back.

Steven filed a friend-of-the-court brief in the Epic Systems case.