California Supreme Court Approves Mandatory Arbitration Agreements

San Diego Business Journal, Oct 2, 2000 by George S. Howard, Jr.

The California Supreme Court on August 24, 2000 issued an important ruling approving the concept of mandatory, employer-imposed arbitration agreements for resolution of employment disputes. The Court required that such agreements be bilateral (i.e., both the employer and the employee must be bound to arbitrate claims); required that the employer pay costs unique to arbitration (such as arbitrator's fees]; and required that the arbitration procedures contain protections to ensure fairness and neutrality. However, the court rejected arguments by employee advocates that arbitration is an inherently biased system or that an employer cannot require mandatory arbitration agreements as a condition of employment.

Our partner, William Gaus, of the firm's San Francisco office, represented the employer in the case, Foundation Health Systems, and argued the case both in the California Court of Appeals and before the California Supreme Court.

In recent years, given the escalating costs of defending claims of wrongful termination, harassment and discrimination, many employers have adopted mandatory arbitration programs, either for new hires or for all employees. There has been little consistency in the terms of the employer-imposed arbitration clauses, with some clauses containing overly harsh or one-sided terms. As a result, several recent court decisions ruled that clauses with oppressive terms are unenforceable. In some cases, the courts seemed hostile to arbitration generally. The United States Court of Appeals for the Ninth Circuit went so far as to hold that arbitration is not allowable for claims of race or sex discrimination. At the same time, a series of court opinions approved and enforced arbitration agreements that were bilateral (binding on both employer and employee), contained no harsh terms, and adopted rules which ensured a fair and neutral arbitration process. Arbitration, as opposed to court litigation, is quicker, less expensiv e for both parties, and rarely results in an appeal.

Employers who have adopted these programs generally have found that arbitration results in less overall cost and time to defend employment claims. Some commentators believe that arbitration programs have a disadvantage for employers in that, because of the relative lack of expense and faster resolution, they can encourage current or former employees to bring marginal claims. Also, the lack of appellate review can mean that an overly harsh award, against either party, is immune from judicial scrutiny.

The case before the Supreme Court, Armendariz v. Foundation Health Systems, involved a clause having harsh or unfair provisions: (1) a limitation on the damages the employee could recover; and (2) a feature that the employer could not be compelled to arbitrate its claims against the employee, but could require the employee to arbitrate his or her claims against the employer. The California Court of Appeal enforced the clause notwithstanding these features. The Court of Appeal ruled that the provision that subjected only employee claims to arbitration was not harsh or unfair because, realistically, employer claims were a remote possibility. The Court found that the damage limitation was unfair but eliminated the offensive provision (a process known as "severing" such a provision). However, the California Supreme Court found that the provision providing only for arbitration employee claims was unfairly unilateral. In the Court's view, that provision, together with the damage limitation, rendered the entire cla use unenforceable and illegal. In the Supreme Court's view, it was not proper to sever the offensive provisions since they permeated the entire agreement. The Supreme Court did acknowledge that, if a clause contained a single or relatively unimportant unlawful feature, it might be appropriate to sever that feature and enforce the underlying agreement to arbitrate.

Armendariz is an important victory for advocates of arbitration agreements, and provides considerable instruction to employers and employees in drafting and enforcing those agreements. But the case is not the end of the story. Trial lawyers and employee advocates, assisted by government agencies such as the Equal Employment Opportunity Commission, continue to attack mandatory arbitration agreements. Last year a statute very nearly was enacted in California that would have essentially banned such agreements if imposed as a condition of employment. That bill was re-introduced this year but died in the Legislature. Similar legislation has been introduced in Congress but has not been enacted.

Even if legislation was enacted in California, there is considerable doubt whether it could outlaw mandatory arbitration agreements where the employer and employee are engaged in interstate commerce. The Federal Arbitration Act requires courts to enforce arbitration agreements where the employer and employee are in interstate commerce. The United States Supreme Court next term is scheduled to hear a case to decide whether ordinary employment contracts between employees and multi-state employers are covered by the Federal Arbitration Act. If so, the Federal Act's coverage would preempt inconsistent state statutes. The United States Supreme Court has repeatedly ruled in favor of arbitration as a faster and less expensive means of resolving disputes than court litigation. We hope, therefore, that the high Court will recognize federal preemption of hostile state decisions or statutes and therefore lessen the impact of any state legislation that may be adopted.