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 expensive 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 clause 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.
The Armendariz case teaches us many lessons, many of which were apparent even before the decision:
Arbitration agreements, if imposed as a condition of employment, are lawful so long as they are fair and not overly harsh.
We continue to believe that arbitration in most cases is a preferable means to resolve employment disputes, from both the employer and employee's point of view, than court litigation.
If you currently use a mandatory arbitration agreement, review the agreement to insure it complies with the Armendariz standards.
In drafting an arbitration agreement, the employer should avoid attempting to overreach. The point of the agreement should be simply to change the forum from a court or jury trial to an arbitrator.
The agreement should contain provisions to ensure fairness and neutrality. Reference to the rules of a recognized arbitration tribunal, such as the American Arbitration Association, is one of the easiest ways to accomplish this goal.The agreement should not impose on the employee any costs unique to the arbitration.
The agreement should not attempt in any way to limit the scope of remedies that the employee (or employer) may recover in arbitration as opposed to in court.
The agreement should not attempt to shorten any statute of limitations that would otherwise apply.
The clause should bind both parties to arbitrate claims within its scope.
When imposing arbitration agreements on existing employees, care must be taken to avoid creating morale problems or a situation where the agreement could be attacked for lack of consideration.
Many larger companies have developed very sophisticated programs. Some of these programs do not require binding arbitration but simply a non-binding fact-finding hearing. The experience with these programs is that they resolve the great majority of claims, even if the final fact-finding hearing is not binding. The Armendariz decision does not address such non-binding programs; but we see nothing in the Armendariz decision that would invalidate such programs as long as the employee is not burdened with their cost.
Arbitration is not without its detractors. The chief arguments against arbitration are that (1) it can result in one-sided decisions that cannot be reviewed by a court,; and (2) it may in some cases encourage marginal claims. An employer considering adopting a program should discuss the pros and cons of the decision with its labor counsel.