Mar 22, 2001 General Employment Issues

Supreme Court Determines That The Federal Arbitration Act Applies To Employment Disputes

On March 21, 2001, a divided United States Supreme Court ruled that the Federal Arbitration Act (“FAA”), 9 U.S.C. § 1, permits employers to require employees to arbitrate work-related disputes. Circuit City Stores, Inc v. Adams, No. 99-1379 (“Circuit City“). Most significantly, the Circuit City decision paves the way for employers to require employees to submit employment discrimination claims to arbitration, rather than pursuing them in court.

Circuit City’s employment application included a provision requiring that all employment-related disputes be resolved exclusively in arbitration. Two years after a candidate for employment completed this application and was hired by Circuit City, he filed a lawsuit in a California state court, alleging that he was harassed because of his sexual orientation and asserting various statutory and tort claims. Circuit City then filed suit in federal court seeking to enjoin the state court action and to compel arbitration on the basis of the arbitration provision incorporated in its employment application. The district court granted the employer’s application and the plaintiff appealed. The United States Court of Appeals for the Ninth Circuit reversed that ruling on the basis of its earlier decision in Craft v. Campbell Soup Co., 177 F.3d 1083 (9th 1999), in which the court had found that, under the FAA, arbitration provisions in the employment context are unenforceable. Circuit City appealed to the Supreme Court.

At the time, the Ninth Circuit (which includes California and much of the western U.S.) was the only federal court that would not apply the FAA to employment contracts. To further complicate matters, state courts in California were consistently siding with the majority of federal circuits in enforcing mandatory arbitration agreements in the employment context. For California employers with arbitration agreements, this created an untenable situation. If an employee covered by an arbitration agreement sued the employer, the employer’s ability to enforce the agreement would depend on whether the case was filed in state or federal court.

The FAA, enacted in 1925, generally requires that federal courts enforce arbitration provisions, applying to all transactions “involving commerce.” 9 U.S.C. § 2. The Supreme Court’s decision turned on an interpretation of a specific exception contained in the statute; that provision, 9 U.S.C. § 1, states that “contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce” are outside the purview of the FAA, rendering arbitration agreements applicable to those workers unenforceable.

The Court directed its attention to the final phrase of the Section 1, excluding from coverage under the FAA workers “engaged in . . . interstate commerce.” While the Ninth Circuit interpreted this exclusion broadly to exclude all employment contracts, the Supreme Court agreed with a more restrictive interpretation, as enunciated by numerous other federal courts. Specifically, the Court concluded that the references in Section 1 to “seamen” and “railroad employees” would be rendered entirely superfluous if the exception for “employees engaged in interstate commerce” were read to exclude from FAA coverage arbitration agreements for all employees engaged in commerce. The Court further noted that exclusion of all employment agreements was contrary to the fundamental pro-arbitration objective of the FAA.

The Court also addressed the contention that requiring employees to arbitrate all employment-related claims would force them to forego their rights under the federal discrimination statutes. The Court noted that an agreement to arbitrate does not preclude employees from exercising their statutory rights, but rather provides an alternative to costly and time-consuming litigation. For all of these reasons, the Court ruled that the Section 1 exclusion is limited in scope to contracts of employment involving transportation workers; arbitration agreements applicable to all other employees are enforceable under the FAA.

While the Circuit City decision eliminates a significant barrier to the enforceability of arbitration agreements, a number of important issues remain unresolved. For example, most federal employment discrimination statutes authorize courts to award punitive damages; it is unclear whether an arbitration program that precludes the arbitrator from awarding such damages would be enforceable under federal law. [For a discussion of how California state courts deal with such a limitation, see California Supreme Court Provides Guidance on Mandatory Employment Arbitration Agreements, August 29, 2000.] Also unresolved is whether the Equal Employment Opportunity Commission retains the right to pursue a discrimination claim on behalf of an employee who has agreed to submit all employment disputes to arbitration.

The Supreme Court’s decision in Circuit City will play a significant role in the development and implementation of management strategies designed to minimize the expense commonly associated with litigation of employment disputes. Employers who have required employees to agree to arbitration as the sole forum for resolving workplace disputes now can assume that those agreements will be fully enforceable. On the other hand, now that the Circuit City decision has removed much of the doubt about the enforceability of these agreements, employers who have not adopted arbitration programs should revisit the issue, and determine whether it now makes sense to do so.