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California Court Voids Employee’s Arbitration Agreement

July 7, 2008

Although generally supportive of alternative dispute resolution, and arbitration in particular (see, e.g., Moncharsh v. Heily & Blase, 3 Cal.4th 1 (1992)), California courts have also closely scrutinized agreements drafted by employers that require employees to submit claims to arbitration.  For example, in Armendariz v. Foundation Health Psychare Services, Inc., 24 Cal.4th 83 (2000), the California Supreme Court ruled that an employee’s arbitration agreement can be voided if it is unfair.  The Court noted that  while arbitration “may have its advantages in terms of greater expedition, informality and lower cost, it also has, from the employee’s point of view, potential disadvantages . . . because it reduces the size of the award that an employee is likely to get, particularly if the employer is a ‘repeat player’ in the arbitration system.”  24 Cal. 4th at 115.  The Court further observed that “[g]iven the lack of choice and the potential disadvantages that even a fair arbitration system can harbor for employees, we must be particularly attuned to claims that employers with superior bargaining power have imposed one-sided, substantively unconscionable terms as part of an arbitration agreement.” Id.

The California Court of Appeal has just expanded on this theme, ruling that an employee’s arbitration agreement was void because, among other things, it purported to deprive the court of jurisdiction to determine whether the agreement was fairly entered into in the first instance. Ontiveros v. DHL Express ( USA), Inc. 08 CDOS 8379 (Cal App.1st, June 30, 2008). 

The case arose when a former employee of DHL sued the company for sexual harassment and retaliation.  In response, the company filed a petition to compel arbitration, relying upon an arbitration agreement that the plaintiff has signed when she was hired as a permanent employee.  The trial court denied the petition on the ground that the arbitration agreement was unconscionable and, therefore, void as a matter of law.  On appeal, that ruling was affirmed in a powerfully worded opinion. Echoing the Supreme Court’s opinion in Armendariz, the Ontiveros court noted:  “We have a genuine concern about the potential for the inequitable use of such arbitration provisions in areas, such as employment, where the parties are not at arm’s length and do not have equal bargaining power.”

One of the key issues in Ontiveros was the “arbitrability of arbitrability.”  Specifically, the arbitration agreement at issue provided that the arbitrator (not a judge) would have the authority to rule on all questions pertaining to the validity of the agreement, including questions about whether there was an enforceable agreement at all. Citing First Options of Chicago v. Kaplan, 514 U.S. 938 (1995) and Freeman v. State Farm Mut. Auto. Ins. Co., 14 Cal.3d 473 (1975), the court observed that the parties can agree that the arbitrator may determine the scope of his authority, but only if the parties have “so provided in the contract.”  The question, however, is who determines if the contract “so provides”?  Who determines if there is, indeed, a contract in the first place?

According to the Ontiveros court, a judicial tribunal, not the arbitrator, must make that determination.  And in a case where an employee argues the arbitration agreement is unconscionable, “the judge is the proper gatekeeper to determine unconscionability.”  (Citing Murphy v. Check ‘n Go of California, Inc., 156 Cal.App.4th 138, 145 (2007)).

So, what is an employer to do to ensure that an arbitration agreement will be enforceable?

The Ontiveros court gives us several clues.  First, make sure that both parties sign the arbitration agreement.  In Ontiveros, only the employee had signed.  If there is an arbitration clause within a larger document, make sure it is set out in bold type and have both parties initial it.

Next, make sure the employer and the employer actually discuss the arbitration provision.  The employer should explain to the employee (or prospective employee) that an arbitration agreement is a condition of employment.  Employers should give the employee ample time to review the agreement.  In Ontiveros, there was no such discussion at all.

The arbitration procedure provided for in the agreement must allow for reasonable discovery. In Ontiveros, the agreement limited each party to a single “fact” deposition, and only allowed the arbitrator to permit more discovery on a showing of “substantial need” – clearly a greater burden than that imposed by normal civil discovery statutes.

One key issue raised in Ontiveros was whether the court should sever the “bad” clauses (such as the overly restrictive provision on discovery) from the rest of the agreement, leaving the arbitration agreement as a whole enforceable.  The court refused to do so, noting that severance is not appropriate when the unconscionable terms run through the entire agreement. The court concluded that to save the contact, it would have to fundamentally rewrite it.

Employers should note that the Ontiveros decision demonstrates that California courts will continue to view employee arbitration agreements with some skepticism. In this regard, employers seeking to obtain enforceable arbitration agreements should also keep in mind the five minimum requirements for lawful mandatory arbitration of civil rights claims enunciated in the Supreme Court’s Armendariz decision. To be enforceable, such agreements must provide for: 

(1)   A neutral arbitrator;
(2)   More than minimal discovery;
(3)   A written award;
(4)   All type of relief that would otherwise be available in court; and
(5)   No unreasonable costs imposed on employees (employers cannot force employees to bear greater costs in arbitration than they would face in court).

Mandatory arbitration of employment claims remains a valuable tool for employers. Needless to say, however, employers who wish to use arbitration agreements must not only draft them carefully, but they must also present them in a manner that is procedurally fair.

If you would like further guidance on this topic, please feel free to call the attorneys in any of our offices.