United States: New Employment Arbitration Rules: The Armendariz Decision

In Armendariz v. Foundation Health Psychcare Servs., Inc. (2000) 24 C4th 83, 99 CR2d 745, the California Supreme Court at last has explained what it takes to make an employment arbitration agreement enforceable in California. At a minimum, an employer who seeks to arbitrate an employee’s statutory claims must now agree to a neutral arbitrator, adequate discovery, a written opinion subject to judicial review, must pay the arbitration costs, and must preserve the employee’s statutory remedies. Yet this case is about more than employees’ rights. Although it leaves some questions unanswered, Armendariz is actually a road map for any employer that wants its arbitration agreements enforced.

Background

Employees are routinely asked by employers to sign arbitration agreements as a condition of their employment. Appellate decisions in California reveal that many employers use these agreements to do more than move the case to an alternative forum. Some shorten the limitations period for employee claims, others ask employees to agree that their damages will be limited, and still others may require that only the employee’s (and not the employer’s) claims be subject to arbitration. Before the California Supreme Court ruled in Armendariz, employees who tried to challenge arbitration agreements and litigate in court usually had no idea what would happen, because different courts were using different rules. At least eight court of appeals decisions on this subject have been accepted for review. In a clear signal that Armendariz is intended to clarify the law in this area, the supreme court ordered consideration of those appeals deferred until Armendariz was decided.

Facts Of Armendariz

Two employees sued their employer under the Fair Employment and Housing Act (FEHA) (Govt C §§12900–12996) claiming that, because of their perceived heterosexual orientation, they were harassed by their supervisors and terminated from their positions at Foundation Health Psychcare Services (Foundation Health). The employees had signed the following arbitration agreement:

"I agree as a condition of my employment, that in the event my employment is terminated, and I contend that such termination was wrongful or otherwise in violation of the conditions of employment or was in violation of any express or implied condition, term or covenant of employment, whether founded in fact or in law, including but not limited to the covenant of good faith and fair dealing, or otherwise in violation of any of my rights, I and Employer agree to submit any such matter to binding arbitration pursuant to the provisions of title 9 of Part III of the California Code of Civil Procedure, commencing at section 1280 et seq. or any successor or replacement statutes. I and Employer further expressly agree that in any such arbitration, my exclusive remedies for violation of the terms, conditions or covenants of employment shall be limited to a sum equal to the wages I would have earned from the date of any discharge until the date of the arbitration award. I understand that I shall not be entitled to any other remedy, at law or in equity, including but not limited to reinstatement and/or injunctive relief."

At trial, Foundation Health moved to compel arbitration, but the judge denied the motion. She found that the arbitration agreement was an unconscionable contract of adhesion, that it was one-sided, and that it severely limited the employees’ damages. On appeal, the First District Court of Appeals agreed that the arbitration agreement contained one-sided provisions, and that the clause limiting the employees’ damages to back pay was unconscionable. But in the spirit of encouraging arbitration, it merely severed the unconscionable damages provision and granted the motion to compel arbitration as to the rest of the agreement.

The California Supreme Court sided with the employees. When statutory claims are at issue, the court said, arbitration agreements must meet minimum fairness standards. Employers must pay the costs of arbitration, provide for a written arbitration award, and preserve the employees’ rights to discovery and all damages under the statute. Not only did Foundation Health’s arbitration agreement fail to do those things, but it was also irretrievably unconscionable, and could not be preserved through severance. The ruling of the trial court was reinstated and the motion to compel arbitration denied.

Although it granted a victory to the employees, the court also found that nothing in the applicable arbitration statutes prevents enforcement of employment arbitration agreements. See the Federal Arbitration Act (FAA) (9 USC §§1–307); California Arbitration Act (CAA) (CCP §§1280–1294.2). It specifically rejected the Ninth Circuit’s rule prohibiting mandatory arbitration of employee discrimination claims under Title VII and the FEHA. See Duffield v Robertson, Stephens & Co. (9th Cir 1998) 144 F3d 1182. The court explained that under the CAA, an arbitration agreement, like any contract, cannot contravene public policy—here, the policy of preventing discrimination, as stated in the FEHA. Rights under the FEHA cannot be waived, so minimum fairness is required at arbitration.

As the United States Supreme Court held nearly a decade ago, agreements requiring employees to arbitrate federal statutory claims can be upheld, but only if the employee may effectively "vindicate" the statutory cause of action in the arbitral forum. Gilmer v Interstate/Johnson Lane Corp. (1991) 500 US 20, 26, 114 L Ed 2d 26, 37, 111 S Ct 1647. In Armendariz, the California Supreme Court crafted a list of the minimum requirements for that vindication.

COMMENT: Even with its substantial protections for employees, and its requirement that the defendant must pay the arbitration costs, Armendariz may actually be more of an advantage to employers. The case declares that employers can compel employees to arbitrate their statutory employment and discrimination claims as a condition of employment, if minimum standards are met. As long as arbitration continues to move more quickly and cheaply than court, and to result in lower awards, employers will have an incentive to meet those standards of fairness and draft enforceable agreements.

Minimum Fairness Requirements For Arbitration Arguments

Fair Allocation Of The Costs Of Arbitration

The Court in Armendariz held that if arbitration is offered as a condition of employment, employees cannot be required to pay for any type of expense that they would not be required to bear if they were free to bring the action in court. An employer who offers an arbitration agreement as a condition of employment must be prepared to pay all costs "unique" to arbitration.

The supreme court emphasized the financial burdens of arbitration (24 C4th at 108, quoting Cole v Burns Int'l Sec. Servs. (DC Cir 1997) 105 F3d 1465, 1485):

"Arbitration will occur in this case only because it has been mandated by the employer as a condition of employment. Absent this requirement the employee would be free to pursue his claims in court without having to pay for the services of a judge. In such a circumstance...arbitrator's fees should be borne solely by the employer."

COMMENT: Employers who want to arbitrate should be prepared to front the forum costs, the arbitrators' fees, meeting room charges, and any other costs that would not have been involved if the case were in court. Employees who are not paying will likely suggest multiple arbitrators as a way of ensuring neutrality, employers will tout the efficiency of hearings before a single arbitrator.

Adequate Discovery

Employee access to adequate discovery is a minimum requirement in determining whether an arbitration agreement is enforceable. The court left the term "adequate" only partially defined, however. Absent express contrary language, parties who agree to arbitrate implicitly agree to "such procedures as are necessary to vindicate that claim." At the very least, said the court, employees are entitled to "access to essential documents and witnesses, as determined by the arbitrator." 24 C4th at 106. The supreme court based its holding requiring discovery rights on a general reference in the Armendariz arbitration agreement to the CAA. In order to find that the reference included discovery rights, the supreme court had to confirm that the employee' employment discrimination and harassment claims stated causes of action for "personal injuries," thereby triggering the discovery provisions of the CAA under CCP §1283.05. 24 C4th at 105.

COMMENT: With the supreme court's admonition that discovery must be adequate, employees who seek to vindicate statutory rights, and employers who seek to keep costs down, should move early to define the scope of discovery. Under Armendariz, the question of how much discovery is "adequate" now will be up to the arbitrator. Because of the court's reference for the discovery provisions of the CAA, it may be wise for employers to specify in employment arbitration agreements that CCP §1283.05 applies, but that the arbitrator will retain his or her statutory discretion under the section to limit the number and scope of depositions.

Access To Full Remedies

Throughout the Armendariz decision, the supreme court made it plain that employment discrimination plaintiff's access to full statutory remedies is fundamental. An agreement to arbitrate FEHA claim, the court held, automatically implies that the remedies of the statute will be available. 24 C4th at 103.

Like many arbitration agreements in use today, however, the agreement drafted by Foundation Health allowed no front pay or punitive damages. The court held this provision unconscionable and contrary to public policy.

COMMENT: Causes that limit statutory remedies in one way or another have been very popular in arbitration agreements drafted by employers. Such clauses limit attorney fees to the victor and take away the arbitrator's right to award punitive and other damages. But even courts that have upheld arbitration agreements generally have stricken those clauses. There is no excuse for including them in any future California employment arbitration agreement.

Written Arbitration Awards

Arbitration agreements in FEHA disputes must provide for written awards that can be judicially reviewed. 24 C4th at 106. The review may be limited, but it is necessary to ensure that the arbitrator complies with the rules of the statute. See Shearson/American Express, Inc. v McMahon (1987) 4832 US 220, 232, 96 L Ed 2d 185, 197, 107 S Cr 2332. IN stating this minimum requirement the Armendariz court did not modify its decision in Moncharsch v Heily & Balse (1992) 3 C4th 1, 11 832 P2d 899, which held that arbitrators' awards may not be reviewed for errors of fact or law. Instead, it pointed to dicta in that case, holding that judicial review nevertheless may be appropriate when confirming an arbitrator's award would be inconsistent with protection of a party's statutory rights." 3 C4th at 32.

COMMENT: Judicial review is the biggest question left open by Armendariz. Code of Civil Procedure §1283.4 requires only that an arbitration award be written and signed by the arbitrator. Arbitrators who work in this area now have a strong incentive to provide reliable legal and factual justification for their decisions, for the time being, remains limited to the provisions of CCP §1286.2 (vacating the award) and CCP §1286.6 (correcting the award). Section 1286.2 gives the court discretion to vacate only in specific limited circumstances, including when the arbitrator exceeded his or her powers.

Unless the Legislature addresses the question, trail courts, and appellate courts in their wake, will have to craft their approaches based on the statutory authority. If trail courts must consider statutory claims as exceptions to the Moncharsch rule, they may seek to expand CCP § 1286.2. But the expansion will raise further questions. Does the arbitrator who makes an incorrect conclusion of law in an FEHA action actually exceed his or her powers? Or, under Armendariz, is any "error of fact or law' in an FEHA case now contrary to the provisions of the CAA and therefore reviewable? The trial courts will have to balance their Armendariz duty to protect statutory rights against their obvious need to prevent turning petition hearings into trials.

Neutral Arbitrator

The CAA already requires that arbitrators disclose conflicts of interest. CPP §1281.9. This was not at issue in Armendariz, but it has been a concern of employees for years. Employers hire and deal with arbitrators repeatedly, while an employee might do so only once. Now that employers are required to pay the arbitration fees under Armendariz, there is reason for concern that arbitrators could favor the payor.

COMMENT: Some employment arbitration agreements include language that permits the parties to attempt to agree on a neutral arbitrator. Instead of such provisions, the arbitration agreement can provide for an established arbitration service to select the arbitrator or arbitrators, with each party entitled to veto on disclosure of the arbitrator's past decisions.

Unconscionability

With its minimum requirements for fairness listed, the Armendariz court turned to questions that were the focus of the lower court decisions and numerous other cases in this area: Was the agreement to arbitrate unconscionable? If so, could the unconscionable provisions be severed and the remainder enforced?

Generally, arbitration agreements weighted so heavily in favor of employer that they are inherently unfair will not be enforced. Stirlen v Supercuts, Inc. (1997) 51 CA4th 1519, 1522, 60 CR2d 138. The question of whether an employment contract is so unfair, or unconscionable, is determined on the same grounds as for revocation of any contract. CCP §1281. Arbitration agreements are classified as unconscionable only if they are both (1) based on unequal bargaining positions or hidden terms (procedurally unconscionable) and (2) include harsh or oppressive terms (substantively unconscionable). 51 CA4th at 1533.

AThe Armendariz employees argued that their arbitration agreement with their employer, offered as a condition of employment, with no right to negotiate, was a classic contract of adhesion, and therefore procedurally unconscionable. The supreme court agreed that there was little dispute on that issue. 24 C4th at 114.

As to substantive unconscionability, the employees' damages were limited, and the employer still could decline to arbitrate its claims, while the employees could not. The supreme court explained that a sliding scale applies when an arbitration agreement is evaluated in the context. The more substantively oppressive the terms, the less evidence of procedural unconscionability will be required, and vice-versa. 24 C4th at 114.

That said, it was the one-sided character of the agreement that was key in Armendariz. If the employer thought arbitration was so fair, the court queried, then why didn't the employer take its own claims to arbitration? The unconscionable character of the agreement was compounded by its limits on damages available to the employees. The employer was bound by no comparable limits.

The real question for the supreme court, however, was what to do about its finding of unconscionability.

Should Unconscionable Provision Be Severed?

The court of appeal in Armendariz had held that the strong public policy in favor of arbitration compelled severance of objectionable clauses, but that the arbitration agreement as a whole should be saved. The court of appeal severed what it termed the only unconscionable clause - the clause limiting employees' remedies.

In reversing the court of appeal, the supreme court found that merely severing the limits on remedies did not produce an agreement that was within the employees' reasonable expectations By severing the contract, the court of appeal was granting the arbitrator extra posers to rewrite the agreement. Moreover, the possibility of severance is an incentive for an employer to continue to offer unconscionable provisions in an arbitration agreement.

The court reasoned that if the agreement had contained illegal terms, those could be served to prevent an undeserved benefit to a party and to conserve the contract, but only as long as the severance did not preserve some illegal scheme. 24 C4th at 122. Severance is only proper when the illegality is collateral.

In the employment context, the court said, the rules are generally the same. Multiple unconscionable provisions definitely taint a contract by suggesting a systematic effort to impose arbitration as an inferior forum. 24 C4th at 124. Further, in the Armendariz agreement, there was no single provision that could be struck to remove the unconscionable taint.

COMMENT: The supreme court's unconscionability calculus still leaves a great deal of room for lower courts to disagree about whether to sever unconscionable clauses. Some principles emerge, however. A one-sided lack of mutuality is likely to permeate an arbitration agreement that contains more than one unconscionable provision because those objectionable provisions indicate a scheme to evade duties under the protective statute.

Employment Arbitration After Armendariz

In the short run, Armendariz should mean open season for challenges to arbitrations already in progress. The supreme court made a point of stating that even though Foundation Health might have been willing to make the agreement mutual, or to return remedies to employees, the agreement as written remained unconscionable and could not be resuscitated. 24 C4th at 125. For those involved in similar pending actions, the court has refused to state any policy to preserve and enforce their agreements. Trail courts have the power to reform arbitration agreements with respect to the method of selecting arbitrators, but not to reform unconscionable ones. When one-sided agreements limit monetary remedies and discovery and require the plaintiff to pay arbitration costs, many ongoing arbitration cases may be forced into court.

In the long run, however, this decision will guide employers drafting arbitration agreements. Provided that its rules are followed. Armendariz could mean more employment arbitration than ever. Employers now have the rule book. And they no longer have an incentive to add unconscionable clauses to their arbitration agreements because they risk voiding the entire agreement.

As far as state courts are concerned, Armendariz is the end for the Duffield rule prohibiting mandatory arbitration of Title VII and FEHA claims. Duffield was certiorari, though, and until another case raises the issue in the United State Supreme Court, employees who can state a Title VII claim for their discrimination or harassment allegations may shop the federal forums and try to avoid arbitration when the employers' arbitration agreements otherwise comply with Armendariz.

Finally, fair arbitrators might still get the boot from employers. If an arbitrator awards substantial damages in favor of a discrimination plaintiff, it remains likely that he or she will not be accepted by employers for further employment cases, particularly when those employers are paying the bills.

Conclusion

Armendariz saves employees money and makes arbitration of their statutory employment disputes more like judicial adjudication than ever before. But Armendariz also provides a useful set of rules. Responsible employers who already heeded the advice of numerous appellate courts probably have incorporated most of its minimum requirements in their arbitration agreements. Now others should follow. It will be most interesting to see how trial courts review the resulting arbitration awards.