California employers can require arbitration of employees’ California Fair Employment and Housing Act and Labor Code claims as a condition of employment, according to a recent circuit court ruling.

In a 2-1 decision, the US Court of Appeals for the Ninth Circuit recently affirmed a district court’s order blocking the enforcement of California Assembly Bill 51 (AB 51), codified as Labor Code Section 432.6, as applied to arbitration agreements covered by the Federal Arbitration Act (FAA). [1] AB 51 prohibits and criminalizes mandatory arbitration of California Fair Employment and Housing Act (FEHA) and Labor Code claims as a condition of employment or continued employment, but does not prohibit enforcement of the agreement if governed by the FAA.

After vacating a prior opinion that found the law was only partly preempted, the Ninth Circuit held that the FAA fully preempts AB 51 because a state law that discriminates against the formation of an arbitration agreement is preempted, even if the agreement is ultimately enforceable. The court therefore held that the district court did not abuse its discretion when it granted a preliminary injunction prohibiting enforcement of AB 51.

AB 51

AB 51 was to go into effect on January 1, 2020, applying to contracts entered into, modified, or extended on or after that date. It adds a section to the California Labor Code that prohibits employers from requiring arbitration of claims for violation of FEHA or the Labor Code as a condition of employment or continued employment, even if the employee can opt out of the agreement or receives a benefit by accepting the agreement. Cal. Lab. Code § 432.6(a).

In addition, it prohibits an employer from threatening, retaliating, or discriminating against or terminating an applicant or employee because of a refusal to agree to arbitration. It also adds Labor Code Section 433, which makes the violation of Section 432.6 a misdemeanor. In an attempt to avoid FAA preemption, the law states that it is not intended to invalidate a written arbitration agreement that is otherwise enforceable under the FAA, and it contains a severability clause.

Case History

The US Chamber of Commerce challenged AB 51 in federal district court, and the district court first temporarily enjoined enforcement of the law as to arbitration agreements governed by the FAA. Then on February 7, 2020, it issued a preliminary injunction finding it likely that the Chamber of Commerce would prevail in its argument that the FAA preempts Section 432.6 of AB 51.

The State of California appealed, and on September 15, 2021, a divided Ninth Circuit issued an opinion vacating the preliminary injunction and ordering the district court to issue a narrower preliminary injunction that enjoins only enforcement of civil and criminal sanctions for violation of Section 432.6. The court reasoned that except for those sanctions, Section 432.6 did not conflict with the FAA because it merely regulates pre-agreement employer behavior and does not invalidate or render unenforceable executed arbitration agreements governed by the FAA.

The Chamber of Commerce filed a petition for rehearing en banc, which the Ninth Circuit deferred considering it until the US Supreme Court decided another FAA preemption case, Viking River Cruises v. Moriana. After the Supreme Court issued its decision in Viking River, the Ninth Circuit panel withdrew its prior opinion and granted rehearing.

Majority Opinion

In the new opinion filed on February 15, 2023, the same panel of judges that issued the prior opinion ruled in a 2-1 decision that the FAA preempts all of AB 51 as applied to arbitration agreements governed by the FAA. The majority found that consistent with Supreme Court precedent, “the FAA’s preemptive scope is not limited to state rules affecting the enforceability of arbitration agreements, but also extends to state rules that discriminate against the formation of arbitration agreements,” even if those agreements are ultimately enforceable.

The Ninth Circuit agreed with Fourth and Fifth Circuit decisions finding laws to be preempted that discourage or prohibit the formation of an arbitration agreement. The court applied these principles and found that AB 51 “deters an employer from including non-negotiable arbitration requirements in employment contracts by imposing civil and criminal penalties on any employer who does so.” The court concluded: “Because the FAA’s purpose is to further Congress’s policy of encouraging arbitration, and AB 51 stands as an obstacle to that purpose, AB 51 is therefore preempted.”

The court rejected the argument that AB 51 could escape preemption because it regulated conduct before an arbitration agreement is formed, as the law still impeded the ability to form arbitration agreements. The court also rejected the argument that California could bar “forced” employment arbitration agreements because “an employee can ‘consent’ to an employment contract by entering into it, even if the contract was a product of unequal bargaining power and even if it contains terms (such as an arbitration provision) that the employee dislikes, so long as the terms are not invalid due to unconscionability or other generally applicable contract principles.”

Implications for Employers

California employers whose arbitration agreements are subject to the FAA can continue to require employees to agree to arbitrate covered disputes as a condition of employment because AB 51 cannot be enforced as to agreements covered by the FAA.

Employers that stopped requiring mandatory arbitration because of AB 51 and the prior Ninth Circuit Bonta decision can revisit that issue in light of the new decision.

As the decision confirms, employment arbitration agreements can still be challenged on grounds of unconscionability or other generally applicable contract terms, and California courts have an expansive view of what is an unconscionable arbitration agreement. Therefore, even without AB 51, California employers should continue to review the terms of their arbitration agreements and consult with counsel about legal developments that may affect their enforcement.

[1] Chamber of Commerce of the U.S., et al. v. Bonta, et al., No. 20-15291 (9th Cir. Feb. 15, 2023).

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