United States: Preemption Battles Over Arbitration Agreements Loom. Are You Prepared?

The #MeToo movement, now two years along, has sent reverberations through boardrooms and the social fabric of the country, creating a crucible for legislative change. One such area of scrutiny is the use of mandatory arbitration agreements to resolve employment disputes. Critics have argued that arbitration deters employees from pursuing claims of harassment and gives companies the means to sweep alleged misdeeds under the rug. In response, several states (including Maryland, New Jersey, Vermont and Washington) have recently passed laws prohibiting companies from requiring employees to give up the right to a jury trial for claims of sexual harassment.

Just a few weeks ago, California significantly one-upped these states, prohibiting any claim – including allegations of discrimination, harassment, and retaliation – arising under the state’s Fair Employment and Housing Act from being subject to mandatory arbitration agreements. Of particular note to employers, the law, which becomes effective January 1, 2020, criminalizes the use of mandatory arbitration agreements by making such a practice a misdemeanor offense.

The potentially significant problem with these state actions – at least from a purely legal and technical point of view – is that they appear to directly conflict with the Federal Arbitration Act (FAA) and clear federal policy favoring arbitration. A legal showdown on the constitutionality of California’s recent law – and probably those of other states – undoubtedly looms.

The U.S. Supreme Court has devoted significant attention to reminding states of the predominance of federal policy regarding arbitration, having repeatedly struck down efforts to undermine the use of arbitration. These rulings include the significant decisions in AT&T Mobility LLC v. Concepcion and Epic Sys. Corp. v. Lewis, in which the Court established the use of arbitration agreements as a firewall against class action litigation. What the Court has repeatedly affirmed through a chain of largely consistent opinions is that, even though the FAA preserves traditional state law defenses to arbitration, the FAA preempts state laws that “stand as an obstacle to the accomplishment of the FAA’s objectives.” 

In light of this Supreme Court authority, it may be hard to imagine how state laws categorically excluding prohibiting arbitration of employment-related claims can survive FAA preemption. In fact, California’s previous governor twice called the state legislature to task on this precise point. Specifically, in both 2015 and 2017, then-Gov. Jerry Brown vetoed bills prohibiting arbitration for employment-related and wage and hour claims, commenting both times that the bills violated federal law by expressly conflicting with the FAA. In apparent response, California’s most recent law contains a “savings clause” of sorts, noting that nothing in the law “is intended to invalidate a written arbitration agreement that is otherwise enforceable under the Federal Arbitration Act.”

So how does California – or any other state – reach a conclusion that carving out whole categories of legal claims from arbitration does not conflict with or stand as an obstacle to the FAA’s objectives?  This author’s best guess is that creative attorneys will argue that laws like California’s establish a state policy that arbitration is inherently unfair for certain types of claims. In other words, the states will argue that an arbitration agreement covering such claims is effectively a contract that is void as a matter of public policy. And, as such a void contract, it falls within the FAA’s savings language, which  preserves traditional state law defenses to arbitration agreements arising out of contract formation. 

The potential problem with this argument, however, is that the underlying state policy established by the statute appears to directly conflict with the FAA’s underlying purposes, making the policy itself unconstitutional. And that an unconstitutional policy should not void a contract whose terms are consistent with federal policy regarding dispute resolution.  

Academic and legal conjecturing about how such laws survive constitutional scrutiny aside, what does seem clear is that the #MeToo era has created the next arena for a showdown over the preemptive sweep of the FAA, and a legal battle in California and other states will almost certainly begin in early 2020. Employers that have implemented mandatory arbitration agreements, or are considering doing so, should be paying very close attention to how these issues develop and what legal strategies might be viable if and when their agreements are challenged.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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