Round 2: Arbitration Agreements v. California Supreme Court

by Manatt, Phelps & Phillips, LLP

Why it matters: Sonic-Calabasas A, Inc. v. Moreno (“Sonic II”) presents a mixed bag for employers. While the California Supreme Court reversed itself, acknowledging that the waiver of a Berman hearing is not per se unconscionable, the Court adopted a narrow interpretation of Concepcion and Italian Colors. Although a broader enforcement of arbitration agreements is likely, employers should be prepared for continued challenges based upon an unconscionability argument from employees, which the Court left the door open for. In addition, as noted in both Justice Chin’s dissent and a concurring opinion by Justice Carol A. Corrigan, the majority’s attempt at formulating a test for determining unconscionability will likely leave trial courts scratching their collective heads as to which standard to use. Future battles over the appropriate standard to apply are likely.

Detailed Discussion
Employers may preempt certain statutory rights pursuant to the Federal Arbitration Act, the California Supreme Court acknowledged late last week [OCTOBER 17], reevaluating arbitration agreements in the context of employment disputes.

But in a 105-page opinion authored by Justice Goodwin Liu, the majority refused to categorically rule that courts should always compel arbitration when an employee objects, instead holding that trial courts should conduct a review of the relevant terms and conditions for unconscionability prior to granting an employer’s motion to compel.

The decision in Sonic II was the Court’s second time addressing the case. In 2011 the Court found it contrary to public policy and unconscionable for employers to require employees to waive their right to a Berman hearing. So-called Berman hearings are named for the lawmaker who sponsored the state statute instituting a dispute resolution forum to assist employees in recovering wages allegedly owed by employers.

In Sonic I the Court said the prohibition on Berman waivers did not violate the Federal Arbitration Act because if one of the parties were dissatisfied with the results of the Berman hearing, it could move to arbitrate the wage dispute.

But the United States Supreme Court granted certiorari, vacated the judgment, and remanded the case back to California in light of its decision in AT&T Mobility LLC v. Concepcion.

Taking the hint, the California Supreme Court reversed itself in Sonic II last week, holding that the FAA preempts the Sonic I categorical rule prohibiting waiver of a Berman hearing in an employment arbitration agreement.

However, the Court refused to back down completely, emphasizing that “state courts may continue to enforce unconscionability rules that do not ‘interfere[] with fundamental attributes of arbitration.’” To that end, a court may refuse to enforce an arbitration agreement imposed on an employee as a condition of employment if it finds the agreement “unreasonably one-sided in favor of the employer.”

“As we explained in Sonic I and reiterate below, the Berman statutes confer important benefits on wage claimants by lowering the costs of pursuing their claims and by ensuring that they are able to enforce judgments in their favor,” Justice Liu wrote. “There is no reason why an arbitral forum cannot provide these benefits, and an employee’s surrender of such benefits does not necessarily make the agreement unconscionable. The fundamental fairness of the bargain, as with all contracts, will depend on what benefits the employee received under the agreement’s substantive terms and the totality of circumstances surrounding the formation of the agreement.”

The case began in 2006 when Frank Moreno filed an administrative wage claim with the Labor Commissioner for unpaid vacation pay after he left employ with Sonic-Calabasas A, Inc., an entity that owns and operates an automobile dealership.

Pursuant to an agreement Moreno signed as a condition of his employment, Sonic moved to compel arbitration of his wage claim. The trial court sided with Moreno, a decision reversed by the Court of Appeal, reversed again by the California Supreme Court in Sonic I, and then vacated by the U.S. Supreme Court.

Berman hearings offer statutory protections that benefit employees with wage claims, the Court explained, and are “designed to provide a speedy, informal, and affordable method of resolving wage claims.” A waiver of Berman rights appears to be an attempt by employers to gain an advantage in the dispute resolution process, the Court said.

However, as construed by the high court in Concepcion, the FAA preempts a categorical rule prohibiting waiver of a Berman hearing. But relying upon the FAA’s savings clause, the California Supreme Court found room in Concepcion – and the later-decided American Express Co. v. Italian Colors Restaurant, which the Court distinguished as not addressing the waiver of statutorily provided rights – to retain the ability of state courts to evaluate arbitration agreements for unconscionability.

“[U]nconscionability remains a valid defense to a petition to compel arbitration” post-Concepcion, the Court said, as “it has long been the proper role of courts enforcing the common law to ensure that the terms of a bargain are not unreasonably harsh, oppressive, or one-sided.” Instead, Concepcion clarified the limits the FAA placed on state unconscionability rules pertaining to arbitration agreements, the Court wrote.

Holding that Moreno raised unconscionability as an affirmative defense, the Court remanded the case to the trial court for a determination of whether the particular arbitral scheme at issue survived judicial scrutiny.

On remand, the trial court should consider the waivability of a Berman hearing as a factor, the Court noted – just not the sole factor. “As with any contract, the unconscionability inquiry requires a court to examine the totality of the agreement’s substantive terms as well as the circumstances of its formation to determine whether the overall bargain was unreasonably one-sided.” In addition to the features the arbitration agreement eliminates, the Court should also evaluate the features it contemplates – like who shall conduct the arbitration, the parameters of discovery, or the review process.

“We emphasize that there is no single formula for designing an arbitration process that provides an effective and low-cost approach to resolving wage disputes,” the Court said. “There are potentially many ways to structure arbitration, without replicating the Berman protections, so that it facilitates accessible, affordable resolution of wage disputes.

“[I]n the context of a standard contract of adhesion setting forth conditions of employment, the unconscionability inquiry focuses on whether the arbitral scheme imposes costs and risks on a wage claimant that make the resolution of the wage dispute inaccessible and unaffordable, and thereby ‘effectively blocks every forum for the redress of disputes, including arbitration itself.’”

In a scathing dissent, Justice Ming W. Chin said the Court’s opinion is inconsistent with the FAA, stands in opposition to state law, and is contrary to Concepcion.

“In Concepcion, the high court, in invalidating another of this court’s unconscionability rules for refusing to enforce arbitration provisions, first noted that ‘judicial hostility’ towards arbitration has ‘manifested’ itself in ‘a great variety’ of ‘devices and formulas,’” he wrote. “Then, in the very next sentence, it commented: ‘And although these statistics are not definitive, it is worth noting that California’s courts have been more likely to hold contracts to arbitrate unconscionable than other contracts.’”

“Ignoring the high court’s clear message and undeterred by yet another reversal, the majority ‘formula[tes]’ ‘yet another’ ‘device’ for invalidating arbitration agreements: a case-by-case, hopelessly vague, subjective, and indeterminable assessment.”

The majority did precisely what the U.S. Supreme Court said not to do, Justice Chin argued – by establishing minitrials on unconscionability, the Court created “‘an obstacle to the accomplishment and execution of the full purposes and objective of Congress’ in passing the FAA.”

Justice Chin also took issue with the majority’s shifting standard of what constitutes an unconscionable agreement, with references to the “so one-sided as to ‘shock the conscience’” standard – his preferred level of review – as well as “unreasonably one-sided” and “unreasonably favorable to one party.” The suggestion to courts to consider whether the arbitral forum offers a “speedy, [information], and affordable resolution” of Moreno’s wage claim is “hopelessly vague, uncertain, and subjective,” Justice Chin added.

To read the decision in Sonic-Calabasas A, Inc. v. Moreno, click here.

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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