Preemption and predispute arbitration agreements

On Jan. 3, Attorney General Rob Bonta settled the lawsuit brought by the Chamber of Commerce of the United States and other entities that sought to enjoin the enforcement of Section 432.6 of the Labor Code and Section 12953 of the Government Code, statutes that were created by the passage of AB 51 in 2019. The State agreed to an injunction barring enforcement of the two statutes where the underlying arbitration agreement was covered by the Federal Arbitration Act (FAA). The State also agreed to pay the plaintiffs $822,496 in attorney fees.

Section 432.6(a) states that “A person shall not, as a condition of employment, continued employment, or the receipt of any employment-related benefit, require any applicant for employment or any employee to waive any right, forum, or procedure for a violation of any provision of the California Fair Employment and Housing Act [FEHA]…, including the right to file and pursue a civil action…” It has long been established that the “waiver of any right, forum, or procedure…to file and pursue a civil action” includes an agreement to arbitrate. Thus, Section 432.6 bars employers from imposing a condition of employment that requires employees to arbitrate FEHA disputes.

AB 51 also created Government Code Section 12953 which states: “It is an unlawful employment practice for an employer to violate Section 432.6 of the Labor Code.” Because Section 432.6 is contained in Article 3 of the Labor Code, Section 433 of the Labor Code applies. It states: “Any person violating this Article (Article 3) is guilty of a misdemeanor.”

Agreements by employees to arbitrate disputes that are executed when they are hired are often a condition of employment and are known as predispute arbitration agreements or PDAAs. AB 51 was the Legislature’s fourth attempt in five years to bar this practice, at least in part. In 2014, the Legislature passed AB 2617, which barred arbitration of disputes alleging violation of Civil Code 51.7 (the Ralph Civil Rights Act) and Civil Code 52.1 (the Tom Bane Civil Rights Act). The Court of Appeal ruled that AB 2617 was preempted by the FAA. See Saheli v. White Memorial Medical Center (2018) 21 Cal. App. 5th 308. In 2015, the Legislature passed AB 465, which banned employers from requiring arbitration agreements as a condition of employment and rendered unenforceable any contract including such a requirement. The bill was vetoed by Governor Jerry Brown on the ground that it was preempted by the FAA. Three years later, the Legislature passed AB 3080, which prohibited an employer from requiring an employee to waive a judicial forum as a condition of employment. Once again, Brown vetoed the bill on the ground of preemption.

AB 51 is very similar to AB 3080. However, one major exception is Section 432.6(f), which states: “Nothing in this section is intended to invalidate a written agreement that is otherwise enforceable under the Federal Arbitration Act.” In other words, if the employee signs the agreement, even as a condition of employment, the agreement is enforceable. Thus, Section 432.6 only applies to contract formation, not contract enforcement. Proponents of the bill contended that this difference saved the statute from FAA preemption.

Several trade associations and business groups immediately filed suit in the Eastern District of California to enjoin enforcement of Section 432.6 and Section 12953, asserting that AB 51 was preempted. Judge Kimberly Mueller agreed with the plaintiffs and granted the injunction. See Chamber of Commerce of the United States v. Becerra, 438 F. Supp. 3d 1078 (E.D. Cal. 2020). She relied heavily on Doctor’s Associates, Inc. v. Casarotto, 517 U.S. 681 (1996) and Kindred Nursing Centers Limited Partnership v. Clark, 137 S. Ct. 1421 (2017). She noted that both cases held that 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 and that this principle applied not only to the enforcement of arbitration agreements, but also to their creation. 438 F. Supp. 3d at p. 1096.

The State appealed to the Ninth Circuit, and in a 2-1 decision written by Judge Lucero, the lower court decision was reversed in part. See Chamber of Commerce of the United States v. Bonta, 13 F. 4th 766 (9th Cir. 2021). Judge Carlos F. Lucero stated that Judge Mueller’s reasoning would be persuasive if either (1) Section 432.6 regulated the enforcement or validity of arbitration agreements or (2) Kindred Nursing or Casarotto held that regulation of pre-agreement conduct was preempted by the FAA, but that neither condition was met. See 13 F. 4th at p. 776. Thus, he bought into the State’s argument that FAA preemption only applied to contract enforcement and not contract formation. But the court affirmed the lower court’s ruling that Section 12953 was preempted because an arbitration agreement cannot simultaneously be valid under federal law and grounds for a criminal conviction under state law.

The dissent was authored by Judge Sandra Segal Ikuta who, among other things, noted that the decision created an odd anomaly. An employer who unsuccessfully attempted to violate Section 432.6 because its employee declined to sign the arbitration agreement would be guilty of a misdemeanor, while an employer who successfully violated the statute by inducing the employee to sign the agreement would not be subject to criminal liability.

After the decision was issued, the plaintiffs requested an en banc ruling from the court. Before the court could act, Judge William A. Fletcher, who had joined Judge Lucero in the majority, apparently changed his mind. The panel issued a new 2-1 decision, with Judge Lucero in the minority this time, affirming the district court’s injunction grant. See Chamber of Commerce of the United States v. Bonta, 62 F. 4th 473 (9th Cir. 2023). The Court held that Kindred and Casarotto made clear that state rules that burdened the formation of contracts, as well as the enforcement of contracts, were an obstacle to the FAA. See 62 F. 4th at p. 484.

Some proponents of AB 51 were upset with Attorney General Bonta’s decision to settle the case. They would have preferred that the State request an en banc hearing and, if necessary, an appeal to the United States Supreme Court. But the attorney general had no real choice. There is no basis for the argument that only statutes that bar enforcement of arbitration agreements are preempted and that statutes that only deal with the formation of arbitration agreements are not an obstacle to the FAA. The Supreme Court made that point very clear in Kindred, when it stated the “FAA cares not only about the enforcement of arbitration agreements, but also about their initial validity – that is, about what it takes to enter into them.” See Kindred, 137 S. Ct. at p. 1478. If anything, the attorney general’s decision probably saved the State from paying additional attorney fees to the plaintiffs.

Why are PDAAs so reviled that the Legislature has made repeated attempts to get rid of them? Those who are unfamiliar with how arbitration works argue that employers demand arbitration because they believe that their status as “repeat players” will cause arbitrators to favor them and enable them to be less liable for violations of the Labor Code and the federal and state anti-discrimination statutes, as well as other statutes designed to protect employees.

That argument may have had some validity when PDAAs were created over fifty years ago. But the argument is not valid any longer. The true “repeat players” in arbitration are the attorneys, both plaintiff and defense. This is so because of the strict disclosure requirements that are imposed on arbitrators by the California Arbitration Act. An arbitrator who is initially selected by the parties must disclose substantive prior contacts with all parties and all attorneys in the case. This includes the outcome of any prior arbitration that involved the parties and attorneys. If any party objects to the arbitrator within fifteen days of receiving the disclosure, the arbitrator cannot serve. Thus, an arbitrator who repeatedly rules in favor of employers will have a short career.

There is also an argument that employers want to force their employees to arbitrate disputes because they will not be subject to punitive damages and can avoid class actions. But arbitrators award punitive damages in appropriate cases. Class action waivers were approved by the United States Supreme Court in AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011). Concepcion is an unfortunate decision and while it arose from a dispute over the enforcement of an arbitration agreement, the bottom line is that class action waivers can be inserted into employee contracts that do not have arbitration clauses. Thus, elimination of PDAAs will not put an end to class action waivers.

The real problem with PDAAs is that they deprive the employee of a choice. Although an employee is often better off if a dispute is arbitrated, rather than litigated, there are situations where this is not the case. If the employee is more comfortable in court, even if that feeling is irrational, why should the employee be deprived of that opportunity? On the other hand, the employer retains the ability to choose because it can refrain from filing a motion to compel arbitration.

Notwithstanding that PDAAs deprive employees of a choice, a wholesale elimination of PDAAs will not necessarily be a boon to employees who have disputes with their employers. Arbitration is quicker and less expensive than court litigation. An employee with a claim under $150,000 may have a difficult time finding an attorney who will file the case in court and an employer, knowing this, may decline to arbitrate voluntarily, leaving the employee without a remedy. Even if the claim is far in excess of $150,000, it may take years to resolve it, and this might cause an employee who needs the money to accept an amount in settlement that is less than what an arbitrator would have awarded.

The answer to this dilemma is to allow enforcement of PDAAs if they have an opt-out provision, i.e, the employee has the right to opt out of the agreement within a specific period after executing it. The time period needs to be reasonable, the opt-out provision must be prominently displayed, the advantages and disadvantages of arbitration and litigation need to be stated in the agreement, and the agreement must state there is no penalty for opting out.

Unfortunately, a statute which would allow PDAAs only if they contained an opt-out provision would also be preempted because it singles out arbitration. But it can be argued that it would be in the best interest of employers to voluntarily include these clauses in their agreements. The advent of PDAAs has given arbitration an undeserved bad reputation. Employers need only look to the fact that state legislators from both parties throughout the country usually vote in favor of anti-arbitration bills. So long as the FAA is in place, anti-arbitration bills are likely to be preempted and not become law. But the day may come when Congress puts an end to PDAAs. Congress has already narrowed the ability to impose arbitration in contracts between automobile manufacturers and automobile dealers and in nursing home contracts. Finally, employers need to remember that the injunction agreed to by the State only applies to agreements covered by the FAA. The two statutes created by AB 51 still apply to agreements that are in intrastate commerce, agreements that specifically state that the California Arbitration Act or that the law of California applies without exception, and to agreements that involve transportation workers because Section 1 of the FAA exempts transportation workers from its coverage.

It would be much better if the problem were resolved on a voluntary basis.