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Some Questions Resolved, Others Remain: Mandatory Employment Arbitration in California

December 31, 2003

In its seminal decision two years ago in Circuit City Stores, Inc. v. Adams, 532 U.S. 105 (2001), the U.S. Supreme Court ruled that the Federal Arbitration Act, 9 U.S.C. § 1, generally permits employers to require prospective employees to enter into pre-dispute arbitration agreements as a condition of employment. Nevertheless, the two years since Adams was decided have been marked by continuing uncertainty among federal courts in the nine western states, including California, making up the Ninth Circuit as to the circumstances under which employers may condition employment upon an agreement to arbitrate discrimination claims under Title VII of the Civil Rights Act of 1964. The U.S. Court of Appeals for the Ninth Circuit finally resolved the issue in 2003 in EEOC v. Luce, Forward Hamilton & Scripps, 345 F.3d 742 (9th Cir. 2003). With this decision, the Ninth Circuit joined the rest of the federal circuits and the California Supreme Court in holding that such arbitration agreements are permissible. In addition, just a few weeks after this decision was issued, then-California Governor Gray Davis vetoed a bill that would have prohibited mandatory arbitration of claims brought under the state's anti-discrimination law, the Fair Employment and Housing Act. Although these events are undoubtedly positive ones for California employers, employers must remain mindful that courts will continue to analyze the enforceability of these arbitration agreements and employers therefore must continue to exercise great care in drafting agreements that are both substantively and procedurally fair to all parties.

EEOC v. Luce, Forward, Hamilton & Scripps:
The Ninth Circuit Upholds Mandatory Arbitration of Title VII Claims

The Court's decision in Equal Employment Opportunity Commission v. Luce, Forward, Hamilton & Scripps ("Luce Forward III") formally overruled the Ninth Circuit's earlier decision in Duffield v. Robertson Stephens & Co., 144 F.3d 1182 (9th Cir. 1998), holding that Duffield was "wrongly decided."

The decision of the full Court in Luce Forward III was widely anticipated as a resolution to the unsettled state of affairs within the Ninth Circuit with respect to compulsory arbitration of employment disputes. Duffield held in 1998 that compulsory agreements to arbitrate employment claims arising under Title VII were not enforceable. On the other hand, California courts, applying state law, have long held that compulsory agreements to arbitrate are enforceable, provided they meet the "conscionability" standards set forth by the California Supreme Court in Armendariz v. Foundation Health Psychcare Services, Inc., 6 P.3d 669 (Cal. 2000). Thus, employers in the Ninth Circuit, and particularly in California, were faced with the prospect that agreements to arbitrate could be enforceable in state courts but wholly ineffective in federal courts.

The Luce Forward case arose when Donald Lagatree was offered a position as a legal secretary at the law firm Luce Forward Hamilton and Scripps, LLP, conditioned on his agreement to arbitrate all employment-related disputes. His offer letter contained, as an express condition of the job offer, a compulsory, pre-dispute arbitration clause. The arbitration clause provided that he agreed to submit all claims arising from, or related to, his employment, or termination of his employment, to binding arbitration. After working at the law firm for two days, Lagatree refused to sign the arbitration agreement and Luce Forward revoked the job offer.

Lagatree sued the law firm in California state court, alleging that the requirement to arbitrate as a condition of employment was unlawful. He also filed a charge of discrimination with the U.S. Equal Employment Opportunity Commission ("EEOC"), alleging that the employer's decision to revoke the job offer for his refusal to agree to compulsory arbitration constituted unlawful retaliation. Although Lagatree's state court litigation was not successful, the EEOC found the law firm had violated Title VII by requiring the arbitration agreement as a condition of employment, and the agency proceeded to prosecute the case on Lagatree's behalf in federal court.

The majority opinion in Luce Forward III went beyond the grudging admission of the panel in Luce Forward II that Duffield had been implicitly overruled, squarely holding that: "[O]ur decision in Duffield stands alone. All of the other Circuits have concluded that Title VII does not bar compulsory arbitration agreements." This holding sparked angry dissents from some members of the panel, accusing the majority of allowing employers to force employees to choose between their jobs and their right to bring future Title VII claims in court. Despite these dissents, in the event the EEOC seeks Supreme Court review, the Supreme Court is unlikely to hear the case, because the Ninth Circuit has resolved the split of authority among the Circuits as to the enforceability of compulsory agreements to arbitrate Title VII claims. Accordingly, the Ninth Circuit's decision in Luce Forward III restores the availability of arbitration agreements to employers doing business within the Ninth Circuit's jurisdiction.

Departing California Governor Vetoes Bill That Would Have Banned Pre-Dispute Arbitration Agreements For Claims Under FEHA

In one of his last acts as California Governor, Gray Davis vetoed a bill in October 2003 that would have prohibited employers from requiring employees to agree to arbitrate discrimination claims as a condition of employment. AB 1715, which was enacted by the Legislature on party-line votes, would have invalidated all existing agreements in which employees and employers had agreed to arbitrate claims under the state's Fair Employment and Housing Act ("FEHA"). The vetoed legislation would have allowed employers and employees to enter into new arbitration agreements, but only if the employee's consent to arbitration was "knowing, voluntary, and not made a condition of employment or continued employment."

Although Governor Schwarzenegger has only been in office since November 2003, there is little reason to believe that this pro-business Governor will be willing to sign a similar bill should the Legislature decide to pursue such legislation again. That stated, there remains the possibility that future federal legislation could change the present landscape. For example, a number of members of the U.S. House of Representatives filed a brief with the Ninth Circuit supporting Duffield's prohibition on such agreements. More recently, Congressman Dennis Kucinich of Ohio and other Democratic members of the House and Senate announced plans to introduce the "Preservation of Civil Rights Protections Act of 2003" which would bar pre-dispute agreements to arbitrate claims arising under federal statutes and would require that any agreement to arbitrate such claims be entered into only after a dispute has arisen, to ensure that the waiver of an employee's right to a jury trial is truly knowing and voluntary.

For now, it is clear that employers in California and elsewhere across the U.S. may require employees to sign agreements to arbitrate as a condition of employment. It is equally clear that further developments in this contentious area of the law are just over the horizon.

While Mandatory Arbitration Agreements Are Now Permissible in California, the Doctrine of Unconscionability is Still Alive and Well in the Ninth Circuit

For the third time in 18 months, the U.S. Court of Appeals for the Ninth Circuit ruled on July 22, 2003 that Circuit City's employment arbitration agreement was unenforceable under California law. In Circuit City Stores, Inc. v. Mantor, 335 F.3d 1101 (9th Cir. 2003), the Ninth Circuit held that Circuit City's arbitration agreement was both procedurally and substantively unconscionable under California contract law. As a result, the Court reversed the lower court's order compelling arbitration and remanded the case to the lower court with instructions to allow the civil action to continue in state court.

The plaintiff in Mantor worked for Circuit City from August 1992 until October 2000, when his employment was involuntarily terminated. Although it did not have an arbitration program in place when Mantor was hired, Circuit City implemented such a program in 1995. Mantor was somehow able to avoid agreeing to participate in the arbitration program for three years. However, in 1998, two Circuit City managers arranged a meeting with him to discuss the consequences of his continuing refusal to participate in the arbitration program. During that meeting, the managers told Mantor in effect that he would have no future with Circuit City. Mantor therefore agreed to participate in the program.

In 2001, a year after he was terminated from his employment, Mantor brought a civil action in state court, asserting twelve causes of action, including wrongful termination, fraud, defamation, unpaid wages and age discrimination. Circuit City moved to compel arbitration of these claims, which was granted by the lower court, and Mantor appealed.

On appeal, the Ninth Circuit noted that under California law, courts may refuse to enforce an arbitration agreement if it is procedurally and substantively unconscionable. Procedural unconscionability exists when one party lacks a meaningful choice in entering into a contract or negotiating its terms. Substantive unconscionability exists when the terms of the contract are unreasonably favorable to one party. Accordingly, in order for a contract to be invalidated as unconscionable, there must be both a procedural and a substantive element of unconscionability.

Turning to the arbitration agreement before it, the Court determined that Mantor had no meaningful opportunity to opt-out of the arbitration program, given the fact that management "impliedly and expressly pressured" him not to opt-out and even resorted to threatening his job outright should he refuse to sign the agreement. The Court concluded that, at a minimum, a party must have "reasonable notice of his opportunity to negotiate or reject the terms of a contract, and he must have an actual, meaningful, and reasonable choice to exercise that discretion." Otherwise, the Court held, the agreement is procedurally unconscionable.

As noted above, however, procedural unconscionability, standing alone, is insufficient to render an arbitration agreement unenforceable—the agreement is only invalid if it is substantively unconscionable as well. In this regard, the Ninth Circuit acknowledged that Circuit City had modified and improved its arbitration agreement to comport with the Court's prior decision in which it had concluded that the agreement was substantively unconscionable because it limited the remedies available to an aggrieved employee. Specifically, the modified agreement in Mantor directed the arbitrator to "award appropriate relief in accordance with applicable law," which the Court stated brought the provision in line with its previous holdings. However, the Ninth Circuit determined that the Circuit City agreement, even as revised, still contained substantively unconscionable provisions concerning the statute of limitations (requiring an employee to submit a request for arbitration not later than one year after the date on which the employee knew or had reason to know through reasonable diligence of the facts giving rise to the claim), class actions (directing arbitrators not to consolidate claims of different employees into one proceeding and generally prohibiting the arbitrator from hearing an arbitration as a class action), cost-splitting (requiring each party to pay one-half of the costs of arbitration following issuance of the arbitration award and also allowing the arbitrator to require the employee to pay Circuit City's cost of arbitration and incidental costs should Circuit City prevail at the arbitration), and Circuit City's unilateral power to modify or terminate the agreement. In addition, the Court concluded that the $75 filing fee to initiate the arbitration proceeding was one-sided and substantively unconscionable because, at that time, Circuit City made no provision for waiver of that filing fee. Although the Court acknowledged that by 2001, Circuit City had further modified the agreement to allow for waiver of the filing fee in certain circumstances, the modification was still insufficient because it vested in Circuit City the sole discretion to consider applications for fee waivers. The Court observed that the fee waiver provision might be adequate if the discretion to waive the fee were assigned to a neutral party, instead of being reserved to the employer.

Lastly, just as in its earlier decision in Ingle v. Circuit City Stores, 328 F.3d 1165 (9th Cir. 2003), the Court in Mantor reiterated that there is a rebuttable presumption that a mandatory employment agreement is unconscionable unless the employer can demonstrate that the effect of the contract is bilateral, meaning that it binds both parties equally to arbitrate their claims. Having reiterated that position, the Court still offered no guidance as to how employers could overcome this presumption. Because the Court concluded that the Circuit City arbitration agreement was both procedurally and substantively unconscionable, it was not willing to salvage the agreement by severing particular terms found to be unconscionable and it instead invalidated the contract in its entirety.

Given the Ninth Circuit's prior decisions strictly scrutinizing employment arbitration agreements, this decision is not altogether surprising. However, it is important to note that the Ninth Circuit did not strike down the arbitration agreement simply because it lacked an opt-out provision; rather, the Court struck down the mandatory agreement because it also contained what the Court deemed to be substantively unconscionable terms. Accordingly, assuming an arbitration agreement does not contain any substantively unconscionable terms, an employer will still be able to utilize mandatory employment arbitration agreements, notwithstanding the Mantor decision.

Concluding Thoughts

In sum, 2003 was a good year for California employers in terms of establishing arbitration as a viable and lawful means of addressing employment-related disputes with employees. In order to preserve these hard-won gains, however, employers must still ensure that their arbitration agreements are both procedurally and substantively fair. This includes making sure the employee's waiver of the right to proceed in court was knowing and voluntary, ensuring that both the employee's and the employer's claims are arbitrable, providing for adequate discovery of information prior to arbitration, providing for all types of relief that would otherwise be available in court, and establishing fee-splitting provisions that do not place an unreasonable financial burden on the employee. If these conditions are met, the likelihood of an employee being able to successfully challenge a mandatory employment arbitration agreement will be significantly reduced.