The battle for the future of arbitration

When it comes to arbitration agreements in the employment context, lawyers, judges and politicians appear to fall into two camps. There is the Freedom to Contract Camp, made up of those that believe in an individual's freedom to contract for anything that is legal, including to use arbitration to resolve employment disputes instead of court litigation. And there is the Concerned Camp (which this author imagines is called the Paternalistic Camp behind its back by the Freedom to Contract Camp). The Concerned Camp acknowledges the theoretical concept of freedom to contract, but deep down they believe that almost all employees lack the ability to freely choose whether to enter into an arbitration agreement with their employer. Members of both camps could likely debate whether arbitration is a "good" or "bad" thing for employment disputes, but legally speaking the debate comes down to whether employers and employees can freely bargain with each other.

For almost a hundred years, our federal laws have reflected the beliefs of the Freedom to Contract Camp. (The Concerned Camp is trying to change that, but change appears unlikely given the make-up of the United States Senate) Back in 1925, the United States Arbitration Act, now commonly called the Federal Arbitration Act, was passed "in response to widespread judicial hostility to arbitration agreements." AT&T Mobility LLC v. Concepcio, 563 U.S. 333, 339 (2011). It makes all arbitration agreements (with limited exceptions) "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C. Section 2. Its primary purpose is the motto of the Freedom to Contract Camp: "ensure that private arbitration agreements are enforced according to their terms." Concepcion, 563 U.S. 344.

Given that clear purpose, the FAA "establishes an equal-treatment principle: A court may invalidate an arbitration agreement based on 'generally applicable contract defenses' like fraud or unconscionability, but not on legal rules that 'apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.'" Kindred Nursing Centers Ltd. P'ship v. Clark, 137 S. Ct. 1421, 1426 (2017) (quoting Concepcion, 563 U.S. at 339). Thus, rules that "disfavor[] arbitration" are preempted. Concepcion, 563 U.S. at 342. Indeed, when it decides to hear a case, the Supreme Court regularly applies the FAA to "preempt" state laws and court decisions reflecting the views of Concerned Camp.

For example, when the California Supreme Court held that class action waivers in arbitration agreements were "unconscionable," the U.S. Supreme Court stepped in to preempt that rule because it negated the parties' intent and interfered with arbitration. See id. More recently, the U.S. Supreme Court struck down a Kentucky ruling prohibiting individuals holding "powers of attorneys" from agreeing to arbitration on behalf of their charges because that rule singled out arbitration agreements for negative treatment. Kindred Nursing. There are many other examples, including quite a few involving California court decisions.

But that's federal law. Here in California, it is pretty clear that the politicians in power are card carrying members of the Concerned Camp. Governor Gavin Newsom just signed into law Assembly Bill 51, which purports to limit employers' ability to require employees to agree to arbitration as a condition of employment. According to one article, Assemblywoman Lorena Gonzalez, D-San Diego, was quoted as saying "When both parties choose arbitration freely, it can be a highly effective tool ... But it doesn't work when corporations say you won't be hired unless you sign away your rights." Of course, the Freedom to Contract Camp would counter that concern by explaining that such quid pro quo is a non-controversial contractual arrangement (the employer provides employment and wages in exchange for work and the agreement to arbitrate disputes). But that camp is not in charge in Sacramento.

The good news for Freedom to Contract Campers is that that new law may be struck down as preempted, and quickly. Indeed, New York State recently passed a similar law. See N.Y.C.P.L.R. Section 7515. It lasted 11 months before it was invalidated as preempted. See Latif v. Morgan Stanley & Co., 2019 WL 2610985 (S.D.N.Y. June 26, 2019).

Cognizant of that possibility, however, the Concerned Camp included a provision that they hope will save the new law. It states that California's new prohibition on employment arbitration agreements is not "intended to invalidate a written arbitration agreement that is otherwise enforceable under the Federal Arbitration Act (9 U.S.C. Sec. 1 et seq.)." Thus, only agreements not subject to the FAA are affected. As any Freedom to Contract Camper will gladly tell you, most agreements are governed by the FAA so the new law may not have wide reaching effect.

However, that carve-out shines a light on the need to understand what agreements are "otherwise enforceable under the FAA." The Freedom to Contract Camp would say that is simple: All arbitration agreements are enforceable, unless they are invalidated by a generally applicable contract defense such as fraud or unconscionability. E.g., Kindred Nursing, 137 S. Ct. at 14263. The Concerned Camp would begrudgingly agree, but would the two would likely part ways when it comes time to decide whether a "generally applicable" contract defense is applied in a way that disfavors arbitration or not.

As explained in Concepcion, preemption analysis is "straightforward" when state law outright prohibits arbitration, but "the inquiry becomes more complex when a doctrine thought to be generally applicable, such as ... unconscionability ... is alleged to have been applied in a fashion that disfavors arbitration." 563 U.S. at 341. That "complex" inquiry has played out in California courts in connection with arbitration agreements that waive state administrative proceedings called "Berman hearings" and continues to befuddle California jurists.

As noted, in Concepcion, the Supreme Court overturned California's rule that class action waivers were unconscionable. Following that decision, the California Supreme Court reversed its prior precedent to hold that the FAA preempts any per se prohibition on arbitration agreements that prohibit employees from seeking wages in Berman hearings, because such a rule disfavors arbitration. See Sonic-Calabasas A, Inc. v. Moreno, 57 Cal. 4th 1109, 1146 (2013). That decision held that arbitration agreements waiving Berman hearings were not unconscionable so long as they provided an affordable and accessible dispute resolution forum. Id.

Recently, the California Supreme Court applied that rule to an arbitration agreement in OTO, L.L.C. v. Kho, 8 Cal. 5th 111 (2019). In that case, a non-native English speaker was pulled away from his work and made to sign a dense, nearly unreadable, arbitration agreement while his employer's "porter" watched on, expecting him to immediately sign without question. The court found that process was highly procedurally unconscionable. It then invalidated the agreement because it was substantively unconscionable. Among other issues, the arbitration agreement did not include an accessible and affordable substitute for the Berman hearing because it did not explain how to initiate an arbitration and required more "formal" procedures than in the less formal Berman hearing.

Given the ultimate result in that case, the Freedom to Contract Camp may consider the decision as a set-back for its cause. Arguably, however, the decision gives that camp additional hope in its quest to enforce arbitration agreements as written pursuant to the FAA.

Understanding that positive aspect starts with Justice Ming Chin's spirited dissent. In his dissent, which follows his dissents in many similar cases dealing with such issues, Justice Chin painstakingly details why the arbitration agreement at issue was not unconscionable, including by explaining that the arbitration procedures included in the agreement were not less advantageous compared to a Berman hearing. 251 Cal.Rptr. at 748-62. Since the two procedures were comparable, Justice Chin concluded that the majority's conclusion that the arbitration agreement was unconscionable reflected a judicial preference for Berman hearings over arbitration. As such, its reasoning improperly disfavored arbitration, in violation of the FAA.

The majority's response to the Justice Chin's analysis was to emphasize that its holding did not create a per se rule and was limited to the "particular arbitral process" at issue, which was "forced upon Koh under especially oppressive circumstances." Id. at 736 (emphasis added). By so limiting its holding, the California Supreme Court arguably showed restraint that it has previously been unwilling to show when setting out per se rules regarding arbitration. Given its previous holding in Sonic, it likely would not have done so if not for the power of FAA preemption.

That is not to say the Freedom to Contract Camp is happy. Members of that camp will likely side with Justice Chin in concluding that the majority judged the arbitration agreement more harshly than it would have any other contract and that its judgment was clouded by a judicial preference for Berman hearings over court proceedings (the same type of judicial hostility that favored court proceedings over arbitration prior to the FAA's adoption in 1925). Indeed, the simple act of comparing Berman procedures to those in arbitration arguably violates the rule requiring the enforcement of arbitration agreements according to their terms.

It is still possible that the Freedom to Contract camp will find additional relief if the U.S. Supreme Court decides to weigh in. If not, expect more debates like this one in the future, which will hinge on how a court conducts its unconscionability analysis. 