United States: Ninth Circuit Puts Mandatory Employment Arbitration Agreements Back On The Menu

Once again, the California legislature's attempt to kneecap arbitration agreements in the employment arena has been swept aside by a federal court. As of February 15, 2023, California employers may continue to require mandatory arbitration as a condition of employment after a divided Ninth Circuit, in Chamber of Commerce of the U.S., et al. v. Bonta, et al., held that the Federal Arbitration Act (FAA) preempts Assembly Bill 51 (AB 51) after an almost three-year legal battle. As a result, California's effort to impose criminal and civil sanctions on employers who use mandatory arbitration agreements for their employees is no more.

AB 51: California's Latest Effort to Bar Mandatory Arbitration in the Employment Context

California has long sought to prevent employers from requiring employees to enter into arbitration agreements as a condition of employment. In a culmination of those efforts, Governor Gavin Newsom signed AB 51 into law in October 2019, adding Section 432.6 to the California Labor Code. That statute effectively prohibited an employer from requiring an employee or applicant for employment to enter into an agreement to arbitrate certain claims as a condition for being hired or for keeping a job. The bill also barred employers from using an employment contract that requires the employee to take an affirmative step in order to opt out of an arbitration agreement. Furthermore, AB 51 contained two penalty provisions. The first made it an "unlawful employment practice" for an employer to violate the statute, giving rise to civil liability. Second, AB 51 created criminal penalties, classifying each employer violation as a misdemeanor subject to imprisonment of up to six months, a fine of up to $1,000, or both.

Of course, courts have routinely found that the FAA preempts state laws that would otherwise prevent the enforcement of arbitration agreements, and with its long history of courts striking down prior legislation that did just that, the California legislature carefully crafted AB 51 in an effort to circumvent the FAA. As a result, Section 432.6 stated that if an employee did enter into a mandatory arbitration agreement, that agreement would nevertheless be enforceable. Paradoxically, then, an employer with a mandatory arbitration policy could be subject to criminal prosecution yet still be able to enforce agreements entered into under said policy.

A Federal District Court Enjoins AB 51 as Preempted by the FAA

In December 2019, a coalition of pro-business groups led by the U.S. Chamber of Commerce sought declaratory and injunctive relief on the grounds that the FAA preempted AB 51. Two days before Section 432.6 was to take effect, the Eastern District of California granted the plaintiffs' request for a temporary restraining order, enjoining California from enforcing the statute.

On February 7, 2020, the Eastern District issued a preliminary injunction, finding that AB 51 violated the FAA by unfairly singling out arbitration agreements, imposing a higher consent requirement, and levying criminal and civil penalties against employers. The State of California appealed.

Ninth Circuit Initially Finds the FAA Does Not Preempt AB 51 in Part Before Withdrawing the Decision

In September 2021, the Ninth Circuit issued a 2-1 decision reversing the Eastern District's injunction in part. In that decision, the Ninth Circuit concluded that the FAA preempts the civil and criminal penalties under AB 51, but does not preempt AB 51 itself, because the law does not invalidate fully formed arbitration agreements—exactly the failsafe the California legislature planned for in drafting AB 51's language holding that mandatory arbitration agreements remain enforceable. Instead, the Ninth Circuit held that AB 51 regulates conduct that takes place before the existence of any such agreement. In other words, Section 432.6 may lawfully regulate an employer's conduct prior to executing an arbitration agreement.

In dissent, Judge Sandra Ikuta compared the ruling to "holding that a statute can make it unlawful for a dealer to attempt to sell illegal drugs, but if the dealer succeeds in completing the drug transaction, the dealer cannot be prosecuted." That dissent turned out to be the canary in the coal mine; following a petition for review before the full Ninth Circuit, the Ninth Circuit later withdrew its original decision in favor of a panel rehearing.

Ninth Circuit Reverses Course, Deciding the FAA Preempts AB 51

On rehearing, Judge Ikuta—now writing for the majority—invoked the U.S. Supreme Court's "equal treatment" principle requiring courts to place arbitration agreements on an "equal footing with all other contracts." To that end, any "state rule interferes with arbitration if it discriminates against arbitration on its face or if it 'covertly accomplishes the same objective by disfavouring contracts that have the defining features of arbitration agreements."

The majority concluded that AB 51 violated that equal treatment principle by singling out arbitration agreements and deterring employers from entering into them with the imposition of civil and criminal sanctions. Moreover, unlike in its prior ruling, the Ninth Circuit declined to uphold certain parts of the statute and sever others, finding the entirety of AB 51 to be preempted by the FAA. In doing so, the Ninth Circuit firmly rejected the State of California's argument that AB 51 was intended only to prevent "forced" arbitration agreements, noting that even contracts of adhesion—the typical "take-it-or-leave-it" agreement presented at the start of one's employment, for example—are enforceable "unless certain other factors are present" (i.e., substantive unconscionability).

Key Employer Takeaways

While AB 51 may be subject to further appeals, California employers may continue to impose mandatory arbitration as a condition of employment for employees and job applicants. Employers that ceased requiring mandatory arbitration because of AB 51 and the Ninth Circuit's prior decision can revisit that requirement in light of the new, binding decision. Nevertheless, employer counsel should regularly review their arbitration agreement language for potential defenses to enforcement; the new Bonta decision, for example, reinforces the principle that arbitration agreements may continue to be invalidated on other contractual grounds, like unconscionability or fraud. And as always, counsel should monitor and give careful consideration to ongoing legal developments and challenges to the concept of mandatory employee arbitration agreements. The next salvo from the California legislature is certainly never far behind.

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