On October 17, 2013, in Sonic-Calabasas A, Inc. v. Moreno, the California Supreme Court issued a 73-page decision (excluding concurrence and dissent) that attempted to construe the U.S. Supreme Court’s recent Federal Arbitration Act (“FAA”) decisions (Concepcion and American Express) as narrowly as possible so as to preserve the right of state courts to strike down arbitration agreements as unconscionable for any reason that does not “interfere with the fundamental attributes of arbitration.”
As further explained below, the new Sonic-Calabasas decision appears to recognize that the California Supreme Court has no power to strike down arbitration agreements merely because they preclude class or collective actions. However, the majority attempts to set up a standard that maximizes trial courts’ ability to strike down arbitration agreements for other reasons that might create “unfair” procedures that advantage the employer.
The Underlying Facts
The plaintiff’s arbitration agreement with his employer did not provide an exception from the general mandatory arbitration rule to allow an employee to bring an individual wage claim through an administrative action with the Labor Commissioner (a “Berman hearing”). A Berman hearing allows an employee to use a summary procedure without use of counsel to obtain a hearing and a ruling from the Labor Commissioner over a wage dispute. Both sides have the right to a de novo appeal in the trial court if they are dissatisfied with the results but the employer faces the risk of paying attorney’s fees if it loses at the administrative hearing stage, appeals, and does not prevail on appeal.
In the original Sonic-Calabasas decision, the California Supreme Court announced a per se rule that an arbitration agreement that did not allow for the employee to exercise the right to a Berman hearing was contrary to public policy and unenforceable. The case did not, however, couch its determination as one of “unconscionability.” The U.S. Supreme Court, after issuing the landmark FAA decision, AT&T Mobility, LLC v. Concepcion, summarily reversed and remanded the California Supreme Court’s decision for further consideration.
The Concepcion court set up a standard as to when the FAA preempts state law rules impacting arbitration agreements. The U.S. Supreme Court announced a rule that states cannot invalidate arbitration agreements by announcing rules that violate the “overarching purpose” of the FAA, which is to “ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings.” Although the FAA expressly allows states to continue to invalidate arbitration agreements on general unconscionability standards applicable to all contracts, the Supreme Court held that states cannot use unconscionability as a subterfuge that singles out arbitration agreements for special treatment or that otherwise interferes with the overarching purposes of the FAA.
More specifically, the U.S. Supreme Court held that California’s Discover Bank rule that effectively required consumer arbitration agreements to allow for class arbitration procedures to be enforceable interfered with the overarching purposes of the FAA. The U.S. Supreme Court also identified some other examples of rules that would be similarly preempted such as rules requiring strict compliance with the state discovery statutes or rules requiring a jury of twelve lay arbitrators to decide the dispute. On remand, the California Supreme Court had to determine how Concepcion impacted the original Sonic-Calabasas decision.
In addition, after oral argument last Spring, the U.S. Supreme Court issued American Express v. Italian Colors, which held that the fact that an arbitration agreement’s class action waiver rendered antitrust claims economically unfeasible was not a sufficient reason to strike down the mandatory arbitration agreement. American Express was not an FAA preemption decision, per se, but addressed a similar issue of when a federal statute should be interpreted to invalidate arbitration agreements requiring individual arbitration of disputes arising under that federal statute. The California Supreme Court considered the impact of the American Express decision as well before issuing its opinion in Sonic-Calabasas.
The California Supreme Court’s Holding
The majority opinion, written by Jerry Brown appointee, Justice Godwin Liu, undertook a detailed analysis of precedent and was primarily focused on identifying the contours of the limits the U.S. Supreme Court had placed on states’ ability to regulate arbitration and employment law more generally. Justice Liu recognized that the California Supreme Court had no power to ignore the U.S. Supreme Court or federal supremacy, but the decision appeared to look to carve out as large of a space as possible for the state to regulate employment law and arbitration without running afoul of U.S. Supreme Court precedent.
Justice Liu first staked out the aspect of federal precedent that he had no choice but to recognize. First, while state legislatures and courts cannot create rules that “interfere with the fundamental attributes of arbitration,” the only “fundamental attribute” that the majority recognized is that arbitration “facilitate[s] streamlined proceedings.” That means that states cannot force rules that delay resolution of disputes or set up cumbersome procedures inconsistent with the parties’ arbitration agreement. Justice Liu expressly recognized that requiring class action procedures was one such example. As relevant to the case at hand, he recognized that requiring an employee to have access to a Berman hearing before initiating arbitration was another because it created a delay.
The majority did not, however, give any broader meaning to the first part of the sentence in Concepcion that mentioned streamlined proceedings: “to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings.” (emphasis added). Justice Liu reasoned that the FAA allows states to enforce unconscionability laws, which means that its purpose cannot be reflexively to enforce all arbitration agreements according to their terms no matter what those are (e.g., an arbitration agreement that requires a biased arbitrator be appointed). While that is a valid logical assertion, it does not follow that the state is free to ignore the terms of arbitration agreements in all cases except where the state imposes rules that run contrary to “streamlined proceedings.” That is an optional, extremely narrow reading of Concepcion.
But that is essentially the interpretation the majority advanced. The majority identifies unconscionability as a state law doctrine that is alive and reaffirms that an arbitration agreement may be stricken down as unconscionable whenever it is “unreasonably favorable to the more powerful party” so long as the basis for finding the unconscionability does not require burdensome proceedings inconsistent with “facilitating streamlined proceedings.” Accordingly, while the state cannot invalidate an arbitration agreement for forbidding access to a Berman hearing, if the arbitration agreement does not set forth a procedure that a court finds allows for economical and speedy resolution of an individual wage claim, a court could still potentially strike down the arbitration agreement as unconscionable based on the “totality of the circumstances.” Furthermore, the totality of the circumstances could turn on such individual issues as the economic resources of the particular plaintiff, the causes of action at issue, and the nature of the underlying dispute.
The majority did, however, recognize that unconscionability is not supposed to be used any time a trial court dislikes a particular provision in an arbitration agreement. While the majority refused to reject or endorse a standard for unconscionability requiring a court to find that an arbitration agreement “shock the conscience,” it did state that unconscionability doctrine “is concerned not with a simple old-fashioned bad bargain” but rather with situations combining “an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.” Accordingly, the majority did not purport to overturn or elucidate on any existing unconscionability precedent (which is a bit of morass of conflicting decisions).
The majority’s analysis of American Express was similarly written in a way to construe the decision as narrowly as possible. Read broadly (and together with the preceding FAA cases), American Express can fairly be interpreted as announcing a rule that arbitration agreements cannot be set aside merely because there are certain claims that plaintiffs would find economically unviable if they had to go through individual arbitration to vindicate their claim. The U.S. Supreme Court makes mention of that point in both Concepcion and American Express.
The majority did not accept that broad reading of American Express, however, but instead limited American Express to addressing the question of when a federal statute should be interpreted to require the availability of class action procedures and preclude mandatory individual arbitration. Under that understanding, the antitrust laws were passed before class actions even existed, so there was no reason to believe Congress intended to mandate the availability of class actions to vindicate antitrust claims. Accordingly, if the state passes a law that cannot be effectively vindicated through a particular procedure set up in an arbitration agreement, a court can strike it down as unconscionable so long as it does not require burdensome procedures be built into the arbitration agreement that run counter to the directives (as narrowly construed) in Concepcion.
With that vague guidance, the California Supreme Court remanded the case to the trial court to re-examine the arbitration agreement and all the facts as a whole and to determine whether the Sonic-Calabasas arbitration agreement is enforceable or “unconscionable.”
Takeaways for Employers From The Decision
Employers can have some increased confidence from the decision that the California Supreme Court accepts that California has lost the battle forbidding class action waivers in arbitration agreements. There is no way that I can see to square the analysis in Gentry v. Superior Court (which had effectively barred class action waivers in employment arbitration agreements) with the interpretation of Concepcion set forth in this decision. It is worth noting, however, that the majority does not mention the word Gentry anywhere in its 73-page discursion, which I interpret as wanting to leave the door open to the theoretical possibility of saving Gentry (although I cannot see what the basis would be).
On the other hand, the tone of the decision appears to warn employers that they better think twice before setting up arbitration agreements that in any way dissuade employees from enforcing their state law rights. The majority clearly rejects the sentiment that was expressed in both Concepcion and American Express that arbitration agreements cannot be set aside merely because they result in smaller claims falling through the cracks. Employers should revisit their arbitration agreements to ensure that they do not contain any overreaching provisions that could give a trial court an excuse to invalidate them as “unconscionable” because they “unfairly advantage” the employer. For example, there is substantial risk if agreements do not provide for attorney’s fees as provided by underlying statutes and full statutes of limitations.
It is also worth noting that the majority’s discussion of unconscionability is premised on the agreement being offered with no meaningful choice to the employee. Such an description would not apt where employees have a chance to “opt out” of arbitration agreements, such as in the first 30 days of their employment. If the employee does not do so, it is hard to see how he can fairly argue that he or she had “an absence of meaningful choice” on the question of arbitration.
In addition, companies should look at their arbitration agreements and consider adding provisions that ensure that if a court finds that a particular protection is required under the given circumstances to allow enforcement of a claim and does not otherwise interfere with the fundamental attributes of arbitration, the employer should be given the opportunity to provide that required protection in the given case to avoid having its agreement otherwise stricken down as unconscionable. Since Sonic-Calabasas appears to call for an ad hoc determination in each case whether protections are required, it would seem entirely appropriate that an employer would have the chance to provide that protection to save an arbitration agreement.
Chance of U.S. Supreme Court Review?
Although this case provides a potential vehicle for the U.S. Supreme Court to further expand its rulings in Concepcion and American Express, the decision appears to be written in a way to avoid U.S. Supreme Court review. Even the dissent describes the entire majority discussion of unconscionability as an “advisory opinion.” The holding of the case was to reverse the earlier Sonic-Calabasas decision and remand for further proceedings as to whether the agreement was unconscionable. It is unclear if there is a suitable federal basis for the U.S. Supreme Court to take up the case, nor is it clear that the defendant will even seek review in advance of a ruling upon remand that the arbitration agreement is, in fact, unconscionable. If there is a procedural way to do it, however, it would be helpful for the U.S. Supreme Court to grant review to further clarify the “overarching purpose of the FAA” and whether it is limited solely to requiring “streamlined proceedings” or something broader.