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The Evolution of Arbitration in Employment Agreements

December 31, 2002

Many employers view arbitration as an inexpensive and efficient alternative to court litigation for the resolution of discrimination claims and other workplace disputes. The year 2002 ushered in significant developments in the legal landscape in this area. While arbitration is now widely embraced as an effective alternative dispute mechanism, courts still require arbitration agreements covering statutory employment claims to be substantively and procedurally fair and conscionable to be enforceable. This article will discuss the Supreme Court's 2002 landmark decision regarding the role of the Equal Employment Opportunity Commission ("EEOC") in relation to private arbitration agreements and the evolving views of California courts on the enforceability of such agreements, and will discuss some of the provisions that will make for fair, equitable, and enforceable arbitration agreements.

EEOC v. Waffle House : Supreme Court Affirms EEOC's Rights

Under the Federal Arbitration Act ("FAA"), 9 U.S.C. § 1 et seq., written agreements to arbitrate generally are valid except when contained in "contracts of employment of seaman, railroad employees, or any other class of workers engaged in … interstate commerce." In its landmark 2001 decision in Circuit City Stores, Inc. v. Adams, 532 U.S. 105 (2001), the U.S. Supreme Court interpreted this provision to mean that the FAA bars the enforcement of arbitration agreements only in contracts of employment for workers involved in interstate transportation.

However, a question remained after Circuit City: if an employee is party to an enforceable arbitration agreement, can the EEOC -- which is not a party to that agreement -- bring suit against the employer in federal court on the employee's behalf? In EEOC v. Waffle House, Inc., 534 U.S. 279 (2002), the Supreme Court answered this question in the affirmative, confirming the EEOC's right to bring such a lawsuit.

In Waffle House, the employee agreed that "any dispute or claim concerning his employment would be settled by binding arbitration." The employee subsequently was fired and filed a charge of discrimination with the EEOC. When the EEOC filed suit against Waffle House in federal court, Waffle House argued that its arbitration agreement with the employee precluded the EEOC from proceeding to court for damages on the employee's behalf.

The Supreme Court ruled that an arbitration agreement between an employee and an employer cannot eliminate the right of the EEOC, a non-party to the agreement, to sue for the types of relief it otherwise would be able to pursue. The Court noted that the EEOC is specifically empowered by various statutes, such as Title VII of the Civil Rights Act of 1964 and the Age Discrimination in Employment Act, to bring suit in federal court and to seek injunctive relief, reinstatement, backpay, compensatory damages, and punitive damages. A private agreement between an employer and an employee, the Court reasoned, cannot limit the powers vested in the EEOC by these statutes. Thus, the EEOC was permitted to sue Waffle House on the employee's behalf.

Although the Waffle House decision may seem to undermine the purpose of arbitration agreements between employers and employees, the practical effect of this decision is limited, as the EEOC actually sues employers very infrequently. For example, in the fiscal year 2001, the EEOC received 80,840 charges of discrimination, and filed only 385 lawsuits (including cases filed by private individuals in which the EEOC intervened on the plaintiff's behalf). Given these statistics, the Waffle House decision should not deter employers from entering into arbitration agreements with employees.

The Shifting Arbitration Landscape In California

Until September 2002, the U.S. Court of Appeals for the Ninth Circuit (which includes California and eight other Western states) was the only federal appeals court to refuse to enforce agreements to arbitrate employment discrimination claims. However, in EEOC v. Luce, Forward, Hamilton, & Scripps, 303 F.3d 994 (9th Cir. 2002), the Ninth Circuit finally joined the rest of the federal courts and found such agreements to be enforceable.

In Luce, the employer refused to hire an applicant who would not agree to arbitrate all of his potential employment-related disputes. The EEOC brought suit on the applicant's behalf, arguing that the agreement was unenforceable under state law, and that the employer's rejection of the applicant for refusing to sign it constituted unlawful retaliation. The district court enjoined the employer from requiring an agreement to arbitrate as a condition of employment, but the Ninth Circuit reversed. It concluded that the Supreme Court's decision in Circuit City had "implicitly overruled" prior Ninth Circuit precedent striking down such agreements. The Luce court determined that "an employer may require employees to arbitrate Title VII claims as a condition of employment," and that it was not retaliatory for an employer to deny employment to an individual who would not agree to mandatory arbitration. Thus, the court acknowledged what the Supreme Court and every other federal circuit court already had — that arbitration is a legitimate substitute for litigation of statutory discrimination claims.

Passing The Conscionability Test

All employers (including those in the Ninth Circuit) should now be comfortable that they can require the arbitration of employees' statutory claims. However, various courts have warned that arbitration agreements must comply "with the principles of traditional contract law, including the doctrine of unconscionability" and must meet "procedural" and "substantive" due process requirements to be enforceable.

An arbitration agreement will generally meet the "substantive" requirement unless an element of the agreement is unfair, oppressive, or unreasonably favorable to the party against whom unconscionability is claimed. See Ferguson v. Countrywide Credit Industries, Inc., 298 F.3d 778 (9th Cir. 2002); Brennan v. Bally Total Fitness, 198 F. Supp.2d 377 (S.D.N.Y. 2002). The "procedural" requirement is typically met unless there is an element of unfair surprise or trickery in one or more of the agreement's provisions, or one of the parties lacked a "meaningful choice" in deciding whether to sign the contract. See Ferguson, 298 F.3d at 778; Brennan, 198 F. Supp.2d at 377. States have different standards for determining unconscionability, and there are no bright-line rules; rather, employers must consider the locale of their workforce and the applicable standards of each jurisdiction when drafting such agreements and tailor them accordingly. Set forth below are some examples of issues that arise in determining whether arbitration agreements pass muster.

Arbitration Agreements That Fail The Conscionability Test

The Ninth Circuit and California courts require arbitration agreements to meet strict conscionability standards. In Ferguson, 298 F.3d at 778, the Ninth Circuit examined the validity of an arbitration agreement in light of California's conscionability standards set forth in Armendariz v. Foundation Health Psychcare Services, Inc., 6 P.3d 669 (Cal. 2000). The court found that the agreement at issue in Ferguson contained several offensive provisions. Initially, the court determined that the agreement was procedurally unconscionable because of the parties' unequal bargaining power and because the terms of the arbitration agreement were presented to the employee as a non-negotiable "take it or leave it" proposition. The court also examined the scope of the agreement, its fee provisions, and its discovery provisions, and found the agreement substantively unconscionable. The scope of the agreement was unfairly one-sided because it exempted from arbitration those claims likely to be pursued by the employer (such as claims based on the employee's alleged misappropriation of trade secrets or confidential information), but required all claims brought by the employee to be arbitrated. Moreover, the court found that the fee provisions, requiring the employee to pay $125 to initiate the proceedings and then to share equally in all arbitration costs beginning on the second day of the arbitration (with the employer paying for the first day of arbitration), placed an unreasonable financial burden on the employee; the court reasoned that employees cannot lawfully be required to pay fees beyond those they would incur in an analogous court proceeding. Lastly, the Ninth Circuit found that various restrictive provisions of the agreement, such as one limiting the scope of the employee's discovery, reflected an overall "insidious pattern" favoring the employer.

Because the agreement was "so permeated with unconscionable clauses," the court concluded that the offending provisions could not be severed from the agreement, and that the agreement as a whole was therefore unenforceable. See also, Mercuro v. Superior Court, 116 Cal. Rptr.2d 671 (2002) (employment arbitration agreement was unenforceable because it was "unfairly one-sided" because it required "arbitration of most claims of interest to employees but exempt[s] from arbitration most claims of interest to [the employer]" and because of the employer's threats to employee); Brennan, 198 F. Supp.2d at 377 (agreement found unconscionable due to variety of factors, including (i) inequality in bargaining positions; (ii) inadequate time for employee to review arbitration agreement; (iii) employer's threats regarding job security to employee refusing to sign the agreement; (iv) employer's failure to advise employee of her right to have an attorney review the agreement; (v) employer's failure to inform employee of the agreement's impact on complaints against employer; and (vi) employer's high pressure tactics to coerce employee's acceptance of onerous arbitration agreement).

In New Jersey, the unconscionability standards are not as strict as those applied in California, but the courts nevertheless require that an employee provide a "knowing and voluntary" waiver of the right to bring lawsuits. In Garfinkel v. Morristown Obstetrics and Gynecological Associates, 168 N.J. 129 (2001), the New Jersey Supreme Court ruled that employees must make a "knowing and voluntary" waiver of their right to sue in court in order for an arbitration policy contained in an employee handbook to be enforced. In particular, the court found that a generally phrased arbitration clause in an employment agreement, stating that "any controversy arising out of, or relating to, this Agreement or the breach thereof shall be settled by arbitration," was insufficient to constitute a knowing and voluntary waiver of statutory rights, as it suggested only that the parties intended to arbitrate contract disputes. The court concluded that, to be enforceable as to statutory claims, an arbitration provision should specify that the employee agrees to arbitrate all statutory claims arising out of the employment relationship or its termination.

The New Jersey Supreme Court will shortly revisit the question of the enforceability of an employee handbook's arbitration policy. The court recently heard oral argument in Leodori v. Cigna Corp. In that case, a New Jersey appellate court found such a policy to be unenforceable under Garfinkel; it reasoned that a knowing and voluntary waiver of the right to a bring a lawsuit and obtain a jury trial must be set forth explicitly and in a separate document and could not merely be part of a handbook. The New Jersey Supreme Court's decision is expected to provide significant guidance for employers in determining whether arbitration agreements in New Jersey which do not include an explicit and/or separate waiver of a jury trial will be enforceable.

Arbitration Agreements That Pass The Conscionability Test

In courts outside the Ninth Circuit, employers are granted more latitude in the language of arbitration agreements and can take a more aggressive approach in their drafting. Courts have upheld these agreements notwithstanding an inequality of bargaining power between the parties. See Desiderio v. National Assoc. of Securities Dealers, Inc., 191 F.3d 198 (2d Cir. 1999); Abbott v. Lexford Apartment Services, Inc., 2002 WL 1800320 (S.D. Ind. Aug. 2, 2002). Courts even have upheld arbitration agreements where the parties are required to share the costs of arbitration, at least where the employee has not put forth any evidence of his/her inability to pay. See Stewart v. Paul, Hastings, Janofsky, & Walker, LLP, 201 F. Supp.2d 291 (S.D.N.Y. 2002). Additionally, arbitration agreements have been enforced when each party was permitted adequate discovery and there was no basis for the plaintiff's assumption that damage recovery would be more limited in arbitration than in court. Id.

In Adkins v. Labor Ready, Inc., 303 F.3d 496 (4th Cir. 2002), the employer moved to compel the arbitration of claims for failure to pay waiting time, travel time, training time and overtime pay under the Fair Labor Standards Act ("FLSA") based on an arbitration provision contained in the employees' job applications. The provision stated that all claims by the employee or employer were to be resolved through binding arbitration. Attempting to avoid the arbitration provision, the plaintiff argued that there was no exchange of consideration. The court disagreed, finding that the mutual agreement to binding arbitration was sufficient. The plaintiff next argued that the agreement was an unconscionable contract of adhesion because the employer was a large, international corporation while he was uneducated and unsophisticated, and did not understand the arbitration provision when he signed the application. The Fourth Circuit found that under the applicable law (West Virginia), a contract may be struck down as unconscionable only if there both exists "gross inadequacy in bargaining power" and "terms unreasonably favorable to the stronger party." The plaintiff also argued that the arbitration costs were so high that no individual would be able to use the arbitration procedure. The court rejected the argument because the plaintiff had the burden of showing the likelihood of incurring prohibitive costs, and he made no showing of the specific financial status of any potential plaintiff, nor did he proffer any evidence of the allegedly prohibitive arbitration fees. Finally, the plaintiff argued that this arbitration procedure was unconscionable because it prohibited class actions, while the FLSA confers a nonwaiveable right to a class action. The court found that "simply because judicial remedies are part of a law does not mean that Congress meant to preclude parties from bargaining around their availability," and held that the plaintiff's inability to bring a class action cannot defeat the strong Congressional preference for arbitration.

The plaintiff in Mildworm v. Ashcroft, 200 F. Supp.2d 171 (E.D.N.Y. 2002), signed an employment agreement requiring him to submit to binding arbitration all legal and/or equitable claims arising out of his employment or termination. Among other provisions, the agreement provided that the costs of arbitration would be shared equally by the parties, although the employee's total cost was capped at $2,500. The agreement also stated that "[b]y agreeing to arbitrate, the employee understands that he/she is not giving up any substantive rights under either federal or state law." The employee was discharged and sued the employer for employment discrimination and retaliation under various anti-discrimination statutes. The employer moved to compel arbitration, arguing that the plaintiff's claims fell within the arbitration provision's coverage.

The plaintiff argued that the arbitration provision was unenforceable because it was vague and did not sufficiently notify him that he waived his right to bring federal and state employment discrimination claims in court. The court disagreed and found that the agreement plainly provided for binding arbitration and advised employees of the effect of arbitration on their statutory rights. Second, the agreement cross-referenced another "arbitration procedure" described elsewhere as an optional program applying to unresolved "grievances," and the plaintiff argued that this reference rendered this arbitration clause vague, as it implied that arbitration was not mandatory and did not cover statutory discrimination claims. However, the court found that, irrespective of the reference to another "arbitration procedure," this agreement was clear that "any legal and/or equitable claims" arising out of an employee's employment were subject to arbitration.

Additionally, the plaintiff argued that the agreement was unenforceable because it required him to pay significant, mandatory arbitrator's fees and costs; the arbitration provision in the employment agreement did not indicate that he should seek legal assistance; the employer never explained to him the significance of the arbitration provisions; and the employer pressured him to sign the agreement. The court found that the cost-sharing provision required a case-by-case inquiry into whether such costs prohibited a plaintiff from effectively vindicating his statutory rights in an arbitral forum. Here, the plaintiff did not adequately set forth the costs of arbitration, how much he would be required to pay, and whether he could effectively vindicate his statutory rights. Thus, the agreement could not be invalidated on this basis. The court did not address the plaintiff's other arguments, possibly indicating that, in the court's view, those factors alone are insufficient to invalidate an otherwise valid arbitration agreement.

Conclusion

The law surrounding arbitration agreements is still developing, and differing jurisdictions adopt various standards in determining whether an agreement is enforceable. As a general matter, however, so long as arbitration agreements contain sufficient due process protections to enable employees to vindicate their statutory rights (such as making sure the waiver of one's right to proceed in court was knowing and voluntary, ensuring that both employee's and employer's claims are arbitrable, providing adequate discovery and the ability to recover damages, and setting up fee-splitting provisions that do not place an unreasonable financial burden on the employee), employers may require such agreements as a condition of employment.