California Supreme Court OKs Arbitration Agreements with Class Action Waivers, but Exempts PAGA Claims

by Perkins Coie
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The California Supreme Court has ruled that arbitration agreements with class action waivers are generally enforceable, but it refused to compel the waiver of representative claims brought under California’s Private Attorney General Act (PAGA).  See Iskanian v. CLS Transp. L.A., LLC, No. S204032 (Cal. June 23, 2014).  In its much anticipated ruling, the court endeavored to harmonize conflicting state and federal interpretations of the preemptive effect of the Federal Arbitration Act (FAA) following the U.S. Supreme Court’s decisions in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011).  In Iskanian, the California Supreme Court held:

  • Concepcion invalidated Gentry v. Superior Court, 42 Cal. 4th 443 (2007), meaning that an employer can condition employment on an employee’s agreement to waive the right to litigate employment claims as a class action.
  • Class action waivers in arbitration agreements do not violate the concerted activity provisions of the National Labor Relations Act (NLRA), contrary to an earlier decision by the National Labor Relations Board (NLRB) in another case.
  • An employee’s right to bring a representative action for civil penalties under PAGA is “unwaivable.” 

The California Supreme Court’s opinion in Iskanian brings California into alignment with federal law by finding that arbitration agreements with class action waivers are generally enforceable, but their enforcement remains subject to contract defenses such as fraud, duress, and unconscionability.  It also clarifies that arbitration agreements in California will be unlawful as against public policy if they purport to preclude employees from bringing representative claims when they act as a proxy for the state, such as where employees assert PAGA claims seeking civil penalties for violation of various labor laws.   

Summary of Iskanian v. CLS Transportation Los Angeles, LLC

In December 2004, a limousine driver signed an arbitration agreement providing that “any and all claims” arising out of his employment would be submitted to binding arbitration.  The agreement further provided that “class action and representative action procedures will not be asserted, nor will they apply, in any arbitration.”   

In August 2006, the employee filed a wage and hour class action against his employer and later added a claim for PAGA penalties on behalf of current and former employees.  The trial court granted the employer’s motion to compel arbitration.  Soon after the trial court ordered arbitration, the California Supreme Court held in Gentry v. Superior Court that even a substantively and procedurally conscionable class waiver in an arbitration agreement should not be enforced if “class arbitration would be a significantly more effective way of vindicating the rights of affected employees than individual arbitration.”  After the court of appeal ordered the trial court to reconsider its order granting the motion to compel arbitration, the employer voluntarily withdrew its motion to compel arbitration.  A class was subsequently certified.

The U.S. Supreme Court’s ruling in AT&T Mobility LLC v. Concepcion

Three months before trial, the U.S. Supreme Court issued its decision in AT&T Mobility LLC v. Concepcion, holding that the rule set forth in Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005)—that class action waivers in consumer contracts of adhesion are categorically unenforceable, whether the consumer is being asked to waive the right to class action litigation or the right to classwide arbitration—was preempted by the FAA.  The Court reasoned that although the FAA “preserves generally applicable contract defenses” (e.g., fraud, duress, and unconscionability), “nothing in it suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.” 

Following Concepcion, the trial court granted the employer’s renewed motion to compel arbitration and dismissed the employee’s previously certified class claims.  The U.S. Court of Appeals for the Second Circuit affirmed, holding that Concepcion invalidated Gentry.

The California Supreme Court’s Decision in Iskanian

In Iskanian, the California Supreme Court held that Gentry was preempted by the FAA post-Concepcion.  The court noted that after Concepcion, “a class waiver is not invalid even if an individual proceeding would be an ineffective means to prosecute certain claims.”   

The Court joined the U.S. Court of Appeals for the Fifth Circuit in declining to follow the NLRB’s recent decision, which found that arbitration agreements with class waivers constituted an unfair labor practice by violating employees’ rights to engage in concerted activities under the NLRA.

The California Supreme Court also held that an employee’s right to bring a representative action for civil penalties under PAGA is not waivable or preempted by the FAA.  The court reasoned that PAGA—which it characterized as a type of qui tam action—authorizes plaintiffs to bring enforcement actions on behalf of the Labor and Workforce Development Agency, and therefore, such a “claim lies outside the FAA’s coverage because it is not a dispute between an employer and an employee arising out of their contractual relationship.”  Although the court ruled that the employee “must proceed with bilateral arbitration on his individual damages claims,” it left open the question of where the plaintiff may prosecute his representative PAGA claims (before the court or the arbitrator) and remanded the case for further proceedings.

Impact of Iskanian

After Iskanian, companies doing business in California can mitigate the risk of facing class action litigation by including class waivers in properly drafted arbitration agreements.  However, enforcing these agreements will still pose challenges.  Arbitration agreements must satisfy the substantive and procedural unconscionability standards set forth in Armendariz and Sonic-Calabasas, and class action waivers will be deemed ineffective if they purport to waive claims, like those brought under PAGA, where the waiver extends beyond private disputes.  Companies that use, or would like to use, mandatory arbitration agreements with class action waivers should consult with their counsel to ensure that these agreements comply with the latest legal developments in this complex and rapidly evolving area of the law. 

The implications of the Iskanian court’s holding that PAGA claims are “unwaivable” remain uncertain.  Employers may have to pick their poison by deciding whether they want to litigate wage and hour issues in multiple proceedings.  For instance, employers may opt to arbitrate individual claims and litigate an employee’s representative PAGA claims in court, to litigate all claims in court, or to attempt to arbitrate all claims (although it is unclear whether this option is lawful or desirable).  The filing of PAGA claims, which are frequently asserted along with substantive Labor Code violations to increase potential exposure, are likely to surge after Iskanian, with employers facing the potential threat of repetitive claims.    

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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