U.S. Supreme Court Decision May Dramatically Affect California Employee Arbitration Agreements

On April 27, 2011, the Supreme Court of the United States handed down its opinion inAT&T Mobility LLC v. Concepcion. The High Court held that California's Discover Bank rule, which required most consumer (and employee) contract arbitration agreements to allow for class arbitration, was preempted by the Federal Arbitration Act (FAA) and thus invalidated.

Standing alone, this ruling is good news for California employers, since it may allow them to avoid costly and burdensome class action lawsuits with their employees. InConcepcion, the plaintiffs filed a class action lawsuit in federal court against AT&T, alleging false advertising and fraud for charging sales tax on phones that AT&T advertised as free. The High Court held that arbitration agreements in standard form contracts that waive the right to pursue a class action are enforceable, and that the FAA preempts the Discover Bank rule. Specifically, the High Court held that theDiscover Bank rule interferes with arbitration in a manner inconsistent with the FAA's purpose by allowing consumers/employees to insist upon class-wide arbitration. The High Court held that class-wide arbitration, unless consensual, sacrifices arbitration's informality, slows down the process and makes it more costly. Moreover, the High Court found that there is also little incentive for defendants to arbitrate class-wide claims because (1) class actions impose significant risks and (2) arbitrations are poorly suited to resolve such high-stakes matters.

Navigating California Case Law

For employers considering adding a class action waiver to their arbitration agreements or those wanting to begin implementing arbitration agreements with their California employees, California case law has placed other restrictions on those agreements that were not explicitly addressed by the High Court in Concepcion. (Although, as we shall see, the holding does place some of those existing restrictions in doubt).

In 2000, the California Supreme Court ruled in Armendariz v. Foundation Health Psychcare Services, Inc., a decision that, like Discover Bank, relied on a mix of public policy and common law unconscionability in limiting how employers could structure mandatory arbitration agreements. In Armendariz, the California Supreme Court found that mandatory arbitration agreements for employees must meet the following requirements in order to be enforceable:

1. The agreement must provide the employee all remedies available in a court action.
2. The agreement must provide for enough discovery to allow employees to gather necessary evidence to prove their claims.
3. The agreement must provide for a written decision that will allow meaningful review.
4. The employee cannot be required to pay any additional costs beyond those routinely faced in court litigation.
5. The employer cannot limit the types of claims subject to arbitration such that only claims typically brought by employees are subject to arbitration.

Since then, hundreds of decisions have come down that have further refined theArmendariz rules, usually by placing additional restrictions.

Even though the Concepcion court did not purport to ban states from imposing any limitations on arbitration agreements, the decision may have an impact on theArmendariz restrictions. While the Concepcion court opined that a state could legitimately enact a law "requiring class-action-waiver provisions in adhesive arbitration agreements to be highlighted" or other laws requiring adequate notice of arbitration agreements that do not "conflict with the FAA or frustrate its purpose to ensure that private arbitration agreements are enforced according to their terms," some of the Armendariz limitations may violate this rule as laid out by the High Court inConcepcion.

The first three Armendariz limitations listed above do not appear to be invalidated by the Concepcion reasoning. In other words, requiring at least minimal discovery, precluding restrictions on remedies and requiring the arbitrator to furnish a written decision are all wholly consistent with the FAA and do not serve to chill employers from instituting mandatory arbitration.

The last two Armendariz provisions, however, may be successfully challenged in light of the Concepcion ruling. For example, under Armendariz, the employer is responsible for all forum costs (except for a trivial filing fee that cannot exceed the cost of filing an action in court), making arbitration significantly less appealing from an employer's point of view. This follows because arbitration is rarely resolved by a pretrial motion since arbitrators have strong incentives (e.g., the desire to seem fair to employees and the fact that the majority of their pay is generated by conducting evidentiary hearings) to allow a full hearing before issuing a decision. As a result, employers can virtually always expect arbitration claims to either settle or involve a full evidentiary hearing, with an arbitrator charging them tens of thousands of dollars per case.

On the flip side, employees who know they could be held responsible for sizable arbitration costs if they do not prevail would likely be dissuaded from bringing even meritorious claims. Before Concepcion, a state was presumably free to weigh pro-arbitration public policy against public policy that protects employees. But Concepcionfound that the FAA preempts states' rights to engage in such a balancing exercise. As a result, the Armendariz requirement that employers pay all the costs of arbitration cannot be defended on public policy grounds, but must instead be defended by trying to show that such a requirement does not burden arbitration—despite the arguments above that it does burden arbitration.

Likewise, the Armendariz requirement that all claims must be arbitrated, rather than just those typically filed by employees, appears to burden arbitration. The court inConcepcion noted that "parties may agree to limit the issues subject to arbitration." If that is true, there is no reason to assume that parties could not rationally agree that only a particular type of claim (e.g., wrongful termination claims) would be subject to arbitration. Indeed, the rationale underlying Armendariz that no rational employee would agree to that restriction rests on a premise that arbitration is an inferior forum for the employee. Whether or not this is the case, that rationale is hostile to arbitration and is a clear burden.

The Road Ahead for Employers

Despite the High Court's ruling in Concepcion, Armendariz is still technically the law in California and no employer wants to be the test case for an arbitration provision that conflicts with it. Thus, employers with mandatory arbitration programs in California fashioned under the Armendariz strictures should not immediately change their agreements (unless, of course, they are willing to become a test case). That being said, the continuing viability of Armendariz's restrictions on employee arbitration agreements is bound to be raised eventually by employers. In light of Concepcion, some employers may decide to take the risk of running afoul of Armendariz in return for more favorable arbitration agreements that will potentially reduce costs. Alternatively, Armendariz may be tested by an employer after the denial of a motion to compel arbitration where the employer failed to follow all the Armendariz factors. The true power of Concepcion is that trial and appellate courts evaluating agreements cannot overturn those agreements solely because they run afoul of state public policy.