California, 9th Circuit again on collision course with the Supreme Court

A split decision by a panel of the 9th U.S. Circuit Court of Appeal upholding the validity of Assembly Bill 51 -- the state law which effectively precludes California employers from including arbitration clauses in their employment contracts -- again sets up California and the 9th Circuit on a collision course with the U.S. Supreme Court regarding whether the statue is preempted by the Federal Arbitration Act. Chamber of Commerce of the U.S. et al. v. Bonta et al., 2021 DJDAR 9599.

AB 51, signed by Gov. Gavin Newsom into law in 2019, was scheduled to take effect on Jan. 1, 2020. In response to a lawsuit brought by the California Chamber of Commerce on behalf of affected businesses, a federal court in Sacramento found that the statute was preempted by the FAA as interpreted by the Supreme Court because it treated contracts with an arbitration clause differently than contracts that did not include such a clause.

On appeal, the 9th Circuit panel reversed the district court decision, holding that AB 51 was not preempted by the FAA. The panel explained that AB 51 did not place arbitration agreements on unequal footing with other contracts because the law did not affect the validity of such contracts, but rather regulated employer conduct prior to formation of employment contracts by prohibiting employers from including such clauses in employment contracts.

For at least two reasons, the 9th Circuit decision is likely headed for review to the Supreme Court. First, the statute is a little disguised effort by California to get around prior Supreme Court precedents striking down similar burdens on contracts with arbitration clauses; and second, the decision creates a conflict between the 9th Circuit and two other circuit courts on interpretation of similar burdens placed on contracts with arbitration clauses.

The fundamental challenge facing AB 51 is Supreme Court precedent, dating back decades, which consistently holds that the FAA requires courts to place arbitration agreements on equal footing with contracts that do not have an arbitration clause and that the FAA preempts state laws which fail to observe this principle. Kindred Nursing Centers Ltd. P'ship v. Clark, 137 S. Ct. 1421, 1424 (2017). In Kindred, the Supreme Court addressed a Kentucky law, which prohibited a person holding a power of attorney for a family member to agree to an arbitration agreement on behalf of that family member, without a "clear statement" in the power of attorney providing the authority to do so. The Supreme Court held that the rule constituted an impermissible burden on contracts that included an arbitration clause.

Likewise, in Doctor's Assocs., Inc. v. Casarotto, 517 U.S. 681, 683 (1996), the Supreme Court struck down a Montana law, which required that contracts with an arbitration clause to provide a prominently displayed notice on their first page. The Supreme Court found such requirement to be at odds with FAA because it did not treat contracts with an arbitration clause on an equal footing with contracts that did not include such a clause.

With respect to AB 51, the 9th Circuit panel majority sought to distinguish the statute from prior Supreme Court holdings striking down similar burdens, by pointing out that AB 51 does not affect enforceability of contracts including an arbitration clause, but rather targets the conduct of employers prior to the formation of such a contract. Another argument put forth by the state is that AB 51 is of "general applicability" and does not target arbitration clauses specifically, but also applies to other contractual clauses that are inconsistent with the statute, including nondisclosure agreements, forum selection clauses, choice-of-law provisions and administrative exhaustion requirements. As noted above, these arguments are unlikely to persuade the Supreme Court to uphold AB 51 because they impermissibly place arbitration contracts on an unequal footing with other contracts.

Still another rationale articulated by the Court of Appeal for upholding AB 51 is that it seeks to prevent "forced arbitration," which was not the "result of mutual consent" but was imposed on employees "against their will." This argument is inconsistent with the long-standing law of contract interpretation, under which presence of unfavorable terms in contracts due to unequal bargaining power of the parties does not, by itself, render a contract unenforceable. California courts define a contract of adhesion as one, which is drafted by the party of superior bargaining strength and relegates to the subscribing party only the opportunity to adhere to the contract or reject it. Such contracts are nevertheless valid and enforceable under they are found to be unconscionable for reasons other than existence of an arbitration clause.

AB 51 is not California's first challenge to arbitration in contract clauses. The state has long been at odds with the Supreme Court's interpretation of the FAA. Some of these efforts have been turned back at the executive level, while others have been rejected by courts. For example, back in 2015, the California Legislature passed AB 465, which prohibited employers from requiring arbitration agreements as a condition of employment and rendered unenforceable any contracts with such clauses. The bill was vetoed by then-Gov. Jerry Brown who found the measure's "blanket ban" to be in conflict with clear and unambiguous past interpretations of the FAA by the U.S. Supreme Court. Governor's Veto Message for AB 465, 2015-16 Cal. Leg., Reg. Sess. (2015).

In another unsuccessful challenge to the FAA, a California court of appeal held in 2018 that the FAA preempted a California statute, which had made agreements to arbitrate certain state civil rights claims unenforceable. Saheli v. White Mem'l Med. Ctr., 21 Cal. App. 5th 308, 323 (2018). Later in that year, Brown vetoed another state law, AB 3080, which prohibited an employer from requiring an employee to waive a judicial forum as a condition of employment.

The legislative history of AB 51 itself makes clear that the Legislature intended the get around the previous interpretations of the FAA by crafting a version that allows enforcement of employment contracts with the arbitration clause while penalizing the formation of such contracts. The legislative history confirms that the drafters of AB 51 fully expected the measure to reach the Supreme Court. According to the Senate Judiciary Committee report on AB 51 "there is little doubt that, if enacted, the bill would be challenged in court and there is some chance, under the current composition of the U.S. Supreme Court, that it would be found preempted." Senate Judiciary Committee Report at 7, 2019-20 Cal. Leg., Reg. Sess. (2019).

Based on the current makeup of the U.S. Supreme Court and its decades long precedent, it is unlikely that AB 51 will survive.