Goodbye Saint Agnes?

The California Supreme Court will soon decide a significant legal question for determining when a right to arbitration has been waived through participation in litigation.

In Quach v. Commerce Club, 78 Cal. App. 5th 470 (2022), the California Court of Appeal held that a defendant did not waive its right to arbitrate by litigating for thirteen months before moving to compel arbitration, in part, because the plaintiff did not establish prejudice. The Court of Appeal's finding that prejudice was required to waive a right to arbitrate based on participation in litigation was consistent with numerous federal and California state courts holding that prejudice was required to find waiver under the Federal Arbitration Act (FAA) and the California Arbitration Act (CAA).

Nearly two weeks after the Quach decision, however, the United States Supreme Court unanimously ruled in Morgan v. Sundance, Inc., 142 S. Ct. 1708 (2022), that "prejudice" is not necessary to find waiver under the Federal Arbitration Act , reversing the long line of federal cases to the contrary. The Supreme Court held that the FAA did not create an arbitration-specific waiver standard that required a showing of prejudice. Thus, waiver of a right to arbitrate must be determined under state contract law, just like the waiver of any other contractual right. As a result, a finding of prejudice is required to find waiver of the right to arbitrate only if the applicable state contract law requires it.

In Quach, the California Supreme Court will decide whether, in light of Morgan, a party claiming waiver of a right to arbitrate under the CAA must show that it suffered prejudice. The California Supreme Court's decision could bring the waiver standards under the CAA and the FAA back into harmony. If not, courts addressing arbitration waiver must decide whether the CAA or FAA applies. Previously, courts could punt on that issue because prejudice was required to find waiver no matter what arbitration act applied, as the Court of Appeal in Quach found and courts have done with other arbitration issues. See, e.g. Aixtron, Inc. v. Veeco Instruments Inc., 52 Cal. App. 5th 360, 393 (2020) ("[W]e arrive at the same conclusion under both the FAA and the CAA: the discovery subpoena here was not authorized by either act. We therefore need not resolve the question whether the Arbitration Clause is subject to the FAA or the CAA").

The Trial Court Ruling

The Quach case arose from a dispute between an employee and his employer. Peter Quach worked for Commerce Club, which operated a hotel and casino in the City of Commerce, for nearly thirty years. The parties signed an employment agreement requiring that employment disputes - such as matters relating to termination - be submitted to an informal resolution process within the company and then to arbitration if necessary. A dispute arose when Commerce Club fired Quach on the purported grounds that he failed to stop a customer from using counterfeit bills when gambling at the casino.

Quach sued Commerce Club in court for wrongful termination, claiming, among other things, age discrimination, retaliation, and harassment. Commerce Club responded to the complaint, but while it claimed that arbitration was necessary to the extent Quach agreed to arbitrate any claims asserted in his complaint, Commerce Club did not move to compel arbitration right away. Instead, Commerce Club served discovery requests, including form interrogatories, special interrogatories, requests for admission, and requests for production of documents. Commerce Club also responded to Quach's discovery requests and posted jury fees. Around this time, the COVID-19 pandemic caused delays in court proceedings. The parties nevertheless continued with discovery. Commerce Club served more discovery, engaged in meet-and-confers, and even took Quach's deposition.

Thirteen months after Quach sued, Commerce Club filed a motion to compel arbitration. Commerce Club claimed that its delay in moving to compel arbitration was justified because it was unable to locate a complete copy of the arbitration agreement signed by Quach, and only did so after reviewing Quach's employment file in response to Quach's requests for production of documents. Commerce Club argued that its motion to compel should be granted because Quach suffered no prejudice from the delay. In response, Quach argued that Commerce Club had waived its right to arbitrate.

The trial court denied Commerce Club's motion to compel arbitration, reasoning that Commerce Club had waived its right to arbitrate by displaying "a position inconsistent" with arbitration by participating in "a litany of pretrial exchanges and actions," including participating in case management conferences; propounding a "large amount of written discovery;" spending "significant time meeting and conferring over many months;" and taking Quach's deposition. Commerce Club's actions, the court held, resulted in "prejudice" to Quach, since Quach had spent time and money preparing for litigation and responding to discovery.

The California Court of Appeal Ruling

The Court of Appeal reversed. The court recognized that while the right to arbitrate can be waived under certain circumstances, California law strongly favors arbitration as a speedy and relatively inexpensive means of dispute resolution. Relying on California Supreme Court precedent (that, in turn, had relied on federal caselaw construing the Federal Arbitration Act), the court noted that this pro-arbitration policy dictates that a party arguing waiver shoulders a heavy burden of proof and must meet the multi-factor waiver test established in St. Agnes Medical Center v. PacifiCare of California, 31 Cal. 4th 1187 (2003). The St. Agnes test includes a prejudice factor - whether the delay in seeking arbitration "affected, misled, or prejudiced the opposing party" - which the Court of Appeal confirmed in Quach is a "critical" factor in the waiver analysis.

Relying on St. Agnes, the Court of Appeal held that Quach failed to show waiver as a matter of law. The court noted that "waiver does not occur by mere participation in litigation if there has been no judicial litigation on the merits of arbitrable issues." Because the parties had only been conducting discovery - without any judicial resolution of any discovery dispute, let alone any dispute on the merits - the court held that Commerce Club did not waive its right to arbitrate unless it could show prejudice. The court found that Quach could not show prejudice because St. Agnes made clear that litigation expenses alone cannot establish prejudice. Quach, the court stated, did not claim any prejudice apart from the expenditure of time and money in the litigation, such as lost evidence as a result of the delay or any other kind of information or advantage that Commerce Club obtained in court that it would not have obtained in arbitration.

San Luis Obispo Superior Court Judge Charles S. Crandall, sitting by designation, concurred in part and dissented in part. Judge Crandall disagreed with the majority and would have found that Commerce Club waived its right to arbitration because it "'substantially invoked' the litigation machinery before its motion to compel arbitration was filed." Quach, 78 Cal. App. 5th at 486 (quoting Iskanian v. CLS Transportation Los Angeles, LLC, 59 Cal. 4th 348, 375 (2014)). The concurring and dissenting opinion also viewed prejudice as a "critical" element in finding waiver, but found that prejudice was "obvious" because "Commerce Club's tactics ... deliberately and forever undermined the very nature of a quick resolution that is the central tenet of arbitration." Id. at 488-89.

The United States Supreme Court's Decision in Morgan v. Sundance, Inc.

On May 23, 2022, less than two weeks after the Quach decision, the United States Supreme Court issued its opinion in Morgan v. Sundance, Inc. 142 S. Ct. 1708 (2022). In Morgan, the Supreme Court held that the FAA does not require a showing of "prejudice" to establish waiver of a right to arbitrate based on participating in litigation. Morgan expressly overruled nine federal courts of appeals, including the Ninth Circuit, which had "invoked the strong federal policy favoring arbitration in support of an arbitration-specific waiver rule demanding a showing of prejudice." Morgan, 142 S. Ct. at 1712 & n.1. Contrary to these cases, the Supreme Court held that "the text of the FAA makes clear that courts are not to create arbitration-specific procedural rules." Id. at 1714.

Thus, Morgan clarifies that the FAA's "federal policy is about treating arbitration contracts like all others, not about fostering arbitration," and as a result, the usual principles of state-contract law apply to determining whether a right to arbitrate has been waived, just like other contractual rights. Id. at 1713. Morgan expressly leaves open "the role state law might play in resolving when a party's litigation conduct results in the loss of a contractual right to arbitrate," and "whether to understand that inquiry as involving rules of waiver, forfeiture, estoppel, laches, or procedural timeliness." Id. at 1712. Hence, if the applicable state law requires prejudice as a condition of waiver, a party claiming waiver of a right to arbitrate will have to establish prejudice.

Issues for the California Supreme Court

The California Supreme Court can clarify the waiver standard in light of Morgan. As noted above, the California Court of Appeal in Quach did not decide whether the FAA or the CAA applied because the arbitration agreement did not answer the question and, before Morgan, prejudice was required regardless of which act applied. If the California Supreme Court concludes that the FAA applies, then Morgan precludes a finding that prejudice is required for waiver under the FAA. In that case, the Court must determine the state-law contractual doctrine that applies to the waiver inquiry, an issue Morgan left open. Prejudice would still be required for waiver if the applicable state law requires it.

The California Supreme Court could determine that California contract principles like waiver, estoppel, forfeiture, bad faith, fraud, and failure to timely perform apply to the waiver inquiry. See, e.g., DRG/Beverly Hills, Ltd. v. Chopstix Dim Sum Cafe & Takeout III, Ltd., 30 Cal. App. 4th 54, 59 (1994) ("Waiver is the intentional relinquishment of a known right after full knowledge of the facts and depends upon the intention of one party only. Waiver does not require any act or conduct by the other party. Estoppel is applicable where the conduct of one side has induced the other to take such a position that it would be injured if the first should be permitted to repudiate its acts."); Platt Pacific, Inc. v. Andelson, 6 Cal. 4th 307, 314-15 (1993) ("waiver" or forfeiture by "failing to timely demand arbitration"); Wagner Constr. Co. v. Pac. Mech. Corp., 41 Cal. 4th 19, 30 (2007) ("When no time limit for demanding arbitration is specified, a party must still demand arbitration within a reasonable time."). Under this approach, prejudice will remain relevant only if it is an element of the applicable contract law doctrine. Adopting a specific arbitration waiver rule under state law would likely raise preemption issues under the FAA, an issue that the United State Supreme Court did not decide in Morgan.

If it finds that the CAA applies, the California Supreme Court may revisit St. Agnes and other California precedent holding that prejudice is required under both the FAA and the CAA to find that a party waives its right to arbitrate by participating in litigation. Among other things, Quach will argue that Morgan abrogated St. Agnes by undoing the uniformity that St. Agnes sought to keep between the FAA and CAA waiver standards. In its place, Quach will argue that ordinary contract principles should apply as courts have held in other cases in the arbitration context. See, e.g., OTO, L.L.C. v. Kho, 8 Cal. 5th 111, 117 (2019) ("[g]enerally applicable contract defenses, such as ... unconscionability, may be applied to invalidate arbitration agreements without contravening the FAA or California law"). Quach will also point to the similarity in the language in the FAA and CAA concerning the enforceability of arbitration clauses. See Cal. Civ. Pro. § 1281 ("A written agreement to submit to arbitration an existing controversy or a controversy thereafter arising is valid, enforceable and irrevocable, save upon such grounds as exist for the revocation of any contract."); 9 U.S.C. § 2 (providing that an arbitration agreement "shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract or as otherwise provided in chapter 4").

Conclusion

For now, in light of the Morgan decision, the standard for determining whether a party waived its right to arbitrate by participating in litigation differs under the FAA and CAA. For those cases to which the FAA applies, a showing of prejudice is no longer required unless the applicable state law contract principles supporting waiver requires a showing of prejudice. For those cases to which the CAA applies, a showing of prejudice is required under St. Agnes. In Quach, we will see whether the California Supreme Court decides to retain the St. Agnes prejudice requirement under the CAA or bids it farewell by bringing the waiver standards under the CAA and the FAA back into harmony.