April 4, 2013

Will The U.S. Supreme Court Force A Sea Change On California Arbitration Agreements

Although arbitration agreements are supposed to ease disputes, for the last decade they have had a tendency to exacerbate them.  Proponents of arbitration see it as an efficient, cost-effective way to resolve disputes, particularly given the budget crisis among California courts, but opponents decry arbitration as a means for employers to set barriers that effectively exculpate themselves from liability.

California courts have strongly sided with the opponents of arbitration particularly as it concerns employment agreements.  In 2000, the California Supreme Court decided Armendariz v. Foundation Health Psychcare Services, the seminal case in California on arbitration agreements in the employment context which held that the common law defense of unconscionability applied in full force to arbitration agreements.

Unconscionability: A “Peculiar” Common Law Defense

On its face, that principle seems rather uncontroversial.  After all, while the Federal Arbitration Act strongly favors the use of arbitration and requires that arbitration agreements be placed on equal footing with other contracts, the FAA explicitly acknowledges that common law “grounds as exist at law or in equity for the revocation of any contract” remain in full force.   So, the application of a common law defense that is seemingly applicable to all contracts should not be of any special concern.

But, it was never that clear.  While Armendariz recognized that unconscionability was a traditional common law defense to the enforcement of contracts, it also noted that “the ordinary rules of unconscionability may manifest themselves in forms peculiar to the arbitration context.”

The Armendariz court identified a few “peculiar” ways unconscionability presents itself in arbitration agreements involving the employment relationship.  Arbitration agreements in the employment context require that arbitration be mutually binding on all parties in all respects unless the employer can establish “business realities” require a lack of mutuality.  Ostensibly the same is true for an arbitration agreement that limits discovery below that which is allowed in court.

Since Armendariz, California courts have expanded the scope of the unconscionability defense as it applies to arbitration agreements.  At first, California courts struck down arbitration agreements as unconscionable because they allowed employers to seek preliminary injunctive relief but did not afford employees that same opportunities.  Then, the same courts struck down arbitration agreements even when they contained mutual carve-outs for preliminary injunctions on the grounds that an employer was more likely to seek an injunction than an employee.

Likewise, the California Supreme Court has refused to allow waivers of class actions in arbitration agreements in the employment context.  In Gentry v. Superior Court, the Court held that a class waiver provision in an arbitration agreement should not be enforced if “class arbitration would be a significantly more effective way of vindicating the rights of affected employees than individual arbitration.”  The California Supreme Court extended that rule to “consumer contracts of adhesion” in Discover Bank v. Superior Court.

Other California courts have struck down arbitration agreements for issues on issues of much less significance.  Some courts, for example, struck down agreement which did not attach a copy of the applicable arbitration rules.  Others did so if the agreements limited discovery to a point that the court deemed insufficient for the plaintiff to pursue his case, or in some cases if the employer did not translate the agreement to another language.

The U.S. Supreme Court Scolds California Again

California’s hostility toward arbitration agreements seemed like it was headed for a change after the U.S. Supreme Court issued its groundbreaking decision in AT&T Mobility LLC v. Concepcion, a 5-4 decision authored by Justice Antonin Scalia.  In that case, the U.S. Supreme Court overruled Discover Bank insofar as it held that class action waivers in arbitration agreements in consumer contracts were unconscionable.  The U.S. Supreme Court identified two situations where state law would be pre-empted by the FAA: (1) when state law prohibits outright the arbitration of a particular type of claim; and (2) when a common law defense is “applied in a fashion that disfavors arbitration.”

The Discover Bank rule falls into that second category because class actions “interfered with” the purpose underlying arbitration, namely the “efficient, streamlined” resolution of disputes.  The U.S. Supreme Court reasoned that requiring defendants to arbitrate class actions would make arbitration unnecessarily costly, inefficient and time-consuming.

Justice Scalia did not pull any punches in his criticism of the unconscionability in general in California courts.  In particular, he notedthat statistically “California’s courts have been more likely to hold contracts to arbitrate unconscionable than other contracts.”  And, in dicta, he signaled that he could foresee a number of situations where he would reverse state law unconscionability decisions that would have a “disproportionate impact” on arbitration agreements.

The California Courts Push Back Against The Supremes

Surely then, California courts can now recognize that in many of its decisions, the “peculiar” application of unconscionability to arbitration agreements has resulted in a “disproportionate impact” on arbitration agreements.  In fact, it is worth asking whether Armendariz itself survives judicial scrutiny.  After all, the Armendariz decision is expressly premised on balancing the advantages of arbitration against its disadvantages – a balancing act that Justice Scalia made quite clear was not permitted given the strong federal policy favoring arbitration.  Does that holding not raise the specter that Armendariz is no longer good law?

Apparently not.  In three separate post-Concepcion decisions, the Courts of Appeal have found that Armendariz remains good law despite Concepcion.  Not only that, but they continue to strike down arbitration agreements for lack of perfect mutuality or because agreements did not attach a copy of arbitral rules.

That might seem like enough to get the U.S. Supreme Court fired up about California’s arbitration jurisprudence.  But it gets even more complicated.  Since Concepcion was decided, several panels of the Courts of Appeal have seemingly thumbed their noses at the case, finding that class action waivers in employment agreements were still unconscionable.

One post-Concepcion case where the Court of Appeal upheld a class action waiver in an arbitration agreement has wound its way to the California Supreme Court.  In Iskanian v. CLS Transportation Los Angeles, LLC, the plaintiff’s bar has asked the California Supreme Court to reconcile Concepcion with Gentry, a case whose logic was at best undermined by Concepcion and at worst completely invalidated by it.

Will The U.S. Supreme Court Wipe Out Years Of Unconscionability Law?

Whether it is Iskanian or some other case, the U.S. Supreme Court is bound to weigh in on this sooner or later.  There are already five decisions from the U.S. Supreme Court overruling California state courts on arbitration agreements, so they are not bashful to do so.

If the composition of the U.S. Supreme Court does not change, it would not be at all surprising if it takes California courts to task for their attempts to circumvent Concepcion.   The only question may be how much California law gets overruled the next time.  Will it just be Gentry that falls (as many believe it already has) or will Armendariz itself or some its progeny also face their death knell.

Only time will tell.  The conservative justices who joined Justice Scalia in the majority in Concepcion famously avoid broad pronouncements of law and limit themselves to deciding no more than the narrow questions presented to them.  But in this case, they may not be able to resist.




Category: Arbitration,