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Mandatory Employment Arbitration Program Held to Be Unconscionable by U.S. Court
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July 2, 2007
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Thelen Reid Brown Raysman & Steiner LLP
The 9th U.S. Circuit Court of Appeals delivered a blow to California employers seeking to enforce employee arbitration programs when it invalidated an arbitration agreement covering all employees of an international law firm on grounds that it was procedurally and substantively unconscionable under California law. Davis v. O'Melveny & Myers, 485 F.3d 1066 (9th Cir. 2007).
In the process, the court offered guidance to employers on what types of provisions are improper in a mandatory employment arbitration agreement.
The decision contributes to a rising tide of hostility to such programs even though the Federal Arbitration Act favors arbitration as a means of resolving disputes and pre-empts inconsistent state law.
The Decision
Jacqueline Davis was a paralegal in O'Melveny & Myers' Los Angeles office in 2002 when the law firm instituted its mandatory Dispute Resolution Program. The program required nearly all employment-related disputes by and against O'Melveny employees to proceed through an informal resolution process that culminated in a final and binding arbitration. Both employees and the firm were precluded from initiating any lawsuit or administrative action other than filing a charge with the Equal Employment Opportunity Commission, California Department of Fair Employment and Housing or an equivalent state agency. Excluded from the mandatory arbitration provisions were employee claims for certain benefits and claims by the firm for "injunctive relief and/or other equitable relief for violations of the attorney-client privilege or work product doctrine, or the disclosure of other confidential information.." Such claims could be asserted in a lawsuit in state or federal court.
The program required employees to provide notice of any claims and start the resolution process within one year of the employee learning of the claim (or when the claim should have been known to the employee with reasonable effort). If the employee failed to provide notice within the one-year deadline, the claim was waived and lost forever.
The program also contained a broad confidentiality provision that precluded the parties and their agents from disclosing the existence of any dispute and the contents of, for example, any pleadings, hearings, trials or awards except to the extent necessary to enter a judgment upon the award or as required by law.
The program was distributed to all employees 90 days before becoming effective but on a "take it or leave it" basis. Employees did not have the option of opting out of the program and still keeping their jobs.
Ms. Davis resigned her employment in 2003 after the program had gone into effect. Seven months later, she initiated a lawsuit in U.S. District Court claiming violations of the federal Fair Labor Standards Act and other state and federal labor statutes for failure to pay overtime and denial of rest and meal periods. She also asserted claims for unfair business practices under Business and Professions Code §§17200 et seq. The complaint sought damages and declaratory and injunctive relief.
The U.S. District Court upheld the program and granted O'Melveny's motion to compel arbitration. The 9th Circuit reversed, largely relying on California law. It held that the program was both procedurally and substantively unconscionable, refusing to sever the offending provisions so the remainder of the program could be enforced.
The 9th Circuit found that the program was procedurally unconscionable because it was presented on a "take it or leave it" basis, denying Ms. Davis any opportunity to negotiate terms. Instead, O'Melveny presented her with only two options: Either accept the program as drafted by O'Melveny or quit her job and forego the security and benefits that went with it. The 9th Circuit found that this was not a meaningful choice and rejected O'Melveny's argument that the program was not unconscionable because employees had other "market alternatives" and could work elsewhere. It also rejected O'Melveny's argument that the three months' notice of the terms of the program provided to employees somehow cured its procedural unconscionability. Time to study the program did not change the fact that employees had no choice but to accept the program as a condition of employment or find a new job.
The 9th Circuit also found that four of the provisions were substantively unconscionable: (1) the one-year "notice" provision; (2) the confidentiality provision; (3) the "business justification" provision, which allowed the firm to seek injunctive relief and avoid the program's mandatory arbitration provisions; and (4) the limitation on administrative actions.
The 9th Circuit found the one-year notice provision to be substantively unconscionable because it shortened the limitations period for certain claims and, in the process, would have prevented employees from relying on the "continuing violation doctrine" to assert claims beyond the statute of limitations. Relying on California law holding that a mandatory arbitration provision that imposes a shortened limitations period is oppressive, the 9th Circuit struck down the notice provision.
The court found the confidentiality provision to be substantively unconscionable because, even though it applied to all parties, it favored O'Melveny and had the effect of denying employees the ability to discuss their disputes with other employees, investigate their claims and conduct discovery. The 9th Circuit noted that the restrictions would place O'Melveny in a " 'far superior legal posture' by preventing plaintiffs from accessing precedent, while allowing O'Melveny to learn how to negotiate and litigate its contracts in the future." The restrictions also could chill enforcement of California Labor Code §232.5 (forbidding employers from prohibiting discussion of working conditions among employees and retaliating against employees who do so). However, the court did not hold that all confidentiality provisions in arbitration agreements are per se unconscionable. Confidentiality provisions protecting sensitive employee information (such as Social Security numbers) or other issue-specific matters might be permissible.
The 9th Circuit found the provision allowing O'Melveny to bring a lawsuit to seek injunctive relief was overbroad and unenforceable. While O'Melveny might have had a legitimate business justification for the carve-out to seek injunctive relief to protect attorney-client information, the clause went too far when it allowed O'Melveny to access the courts to protect "other confidential information." Finding the provision to be one-sided and substantively unconscionable, the court held that it was unenforceable.
Finally, the court struck down the program's prohibition against asserting most administrative actions. Noting that employment rights under the FLSA and California Labor Code are "public rights" and subject to enforcement by state agencies through an injunction on behalf of the general public, the court found that a mandatory arbitration agreement was incompatible with such public rights, rendering the program unenforceable. The program also failed to include an exclusion allowing employees to file a complaint with state enforcement agencies.
Because the clauses found to be unconscionable went to the heart of the program, the court declined to sever the offending provisions and found the entire agreement to be unenforceable under California law.
Tips for Employers
|  | Consider carefully whether to present mandatory arbitration agreements to employees on a "take it or leave it" basis. While California law still supports the notion that doing so does not automatically make an arbitration agreement procedurally unconscionable, O'Melveny suggests a contrary rule in employment contexts. Employers would be well served to: (1) provide employees sufficient notice of a mandatory arbitration program before it becomes effective; (2) make personnel available to answer questions; and (3) consider providing employees with the opportunity to opt-out of the mandatory arbitration requirement. Employers should consult with counsel before implementing any mandatory arbitration program.
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| | Do not shorten the limitations period for claims to be asserted. Instead, apply the applicable statute of limitations. Requiring employees to bring an arbitration claim before the statute of limitations runs likely will be found unconscionable.
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| | Limit any confidentiality provisions to information that is protected by law as private, such as employee Social Security numbers or trade secrets. Employers cannot prevent employees from discussing their claims or potential claims with others, investigating or conducting discovery.
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| | Narrowly tailor any arbitration agreement carve-outs to include only those claims that cannot be arbitrated, such as injunctions, or to claims that are equally likely to be brought by either the employee or the employer. Try to avoid carve-outs for claims that, as a practical matter, are only brought by employers.
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| | Do not limit the ability of employees to file a complaint with a government administrative agency.
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| | Include a robust severability clause in any arbitration agreement so that the court can sever any unconscionable provisions and enforce the rest of the agreement. |
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For more information about the issues covered in this report, please contact Linda S. Husar in our Los Angeles office at 213-576-8017 or at lshusar@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2007 Thelen Reid Brown Raysman & Steiner LLP
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