Mcle Self-study: a Year of Turmoil in California Arbitration Law

By Steven B. Katz

Steven B. Katz is a partner at Constangy, Brooks, Smith & Prophete, LLP, where he specializes in complex employment litigation and appeals.

In 2019, employers saw sweeping new developments in California arbitration law. Employers and counsel should review their programs now in light of these changes, and consider making necessary revisions.

The year started with two important U.S. Supreme Court arbitration rulings, amounting to a split in terms of arbitration politics: one win for proponents of arbitration and one win for opponents. Later, it added a third important ruling. Any perceived "split" is superficial. All three decisions speak with one voice to announce a clear shift in the way the Court is going to interpret federal law in the future: "Statutory originalism" has firmly arrived.

The first of these decisions was the first ever from the newest justice, Brett Kavanaugh. In Henry Schein, Inc. v. Archer & White Sales, Inc.,¹ he wrote for a unanimous court that held when the parties to an arbitration agreement delegate "gateway" arbitrability questions to an arbitrator, the courts must send the dispute to arbitration, even if it is indisputably not arbitrable. Although the Court squarely held in Rent-A-Center, West, Inc. v. Jackson² that parties may delegate "gateway" arbitrability questions to an arbitrator, so long as there is "clear and unmistakable" evidence of the delegation, some circuits held a district court need not do so, if compelling arbitration would be "wholly groundless" because the underlying dispute was clearly inarbitrable. Justice Kavanaugh rejected the idea that a "wholly groundless" exception could be read into the FAA. First, as always, because "courts must enforce arbitration contracts according to their terms." Second, because "[w]e must interpret the Act as written." Third, "the Act contains no 'wholly groundless' exception, and we may not engraft our own exceptions onto the statutory text."

The second decision was authored by Justice Neil Gorsuch, also writing for a unanimous Court. New Prime, Inc. v. Olveira,³ held that the FAA does not cover certain transportation workers—whether the worker is an employee, an independent contractor, or something else.

The FAA generally favors arbitration of disputes and provides that arbitration agreements should be enforced. Section 2 of the FAA broadly extends the generous enforcement of arbitration agreements to any "contract evidencing a transaction involving commerce." But there are exceptions. Section 1 exempts "contracts of employment of seamen, railroad workers, or any class of workers engaged in foreign or interstate commerce." In order to keep Section 1 from completely erasing Section 2, the Supreme Court held in Circuit City Stores, Inc. v. Adams⁴ that "any class of workers engaged in foreign or interstate commerce" refers to "transportation workers"—in other words, those "actually engaged in the movement of goods in interstate commerce."

In New Prime, the Supreme Court turned to the meaning of "contracts of employment." Before New Prime, most courts looked at the FAA's Section 1 language through 21st century eyes: A "contract of employment" meant a contract that created an employer-employee relationship. If a transportation worker was truly an independent contractor, then the contract could not be one "of employment." If he or she was truly an "employee," then it was. But the Court held that "contract of employment" must be interpreted instead through "1920's eyes." The Court's analysis was largely devoted to examining, in detail, what the word "employment" meant when the FAA was enacted in 1925. The Court concluded that the meaning of "employment" was "broader than may be often found in dictionaries today." In 1925, "employ" "usually meant nothing more than an agreement to perform work."

Thus, the Court held, even if the plaintiff, an interstate trucker, was an independent contractor, his contract fell within the Section 1 exemption, and New Prime could not compel him to arbitrate his wage and hour class action.

In a 2018 decision, Epic Systems Corp. v. Lewis,⁵ the Supreme Court held that class arbitration cannot be ordered when the agreement is "silent" about class arbitration. In Lamps Plus, Inc. v. Varela⁶ it turned to the question of whether it may be ordered if the agreement is not "silent," but rather "ambiguous"—and general state contract law would require the ambiguity to be interpreted against the defendant and in favor of class arbitration. The answer, unsurprisingly, is "no."

At the heart of the Lamps Plus ruling is the notion that "traditional individual arbitration" enjoys a special status in the FAA, and that departures from that form of arbitration are not to be permitted unless all parties unambiguously agree. This idea is implicit in Justice Elena Kagan's dissenting observation: "[H]ow treacherously the Court has strayed from the principle that 'arbitration is a matter of consent, not coercion.'" It is more explicit in the other dissents. Justice Stephen Breyer wrote in Stolt-Nielsen S.A. v. AnimalFeeds International Corp.⁷: "We did not hold that class arbitration is not arbitration at all." Justice Sonia Sotomayor wrote that "[t]his Court went wrong years ago in concluding that a 'shift from bilateral arbitration to class-action arbitration' imposes such 'fundamental changes' . . . that class-action arbitration 'is not arbitration as envisioned by the . . . FAA."

The one-two punch of Epic Systems and Lamps Plus means that defendants can safely avoid all mention of class arbitration in their agreements and still feel confident that they cannot be compelled to arbitrate class claims. They are finally relieved of the risk that imperfectly-executed class waiver language will expose them to potential class liability. Agreement to arbitration is ipso facto waiver of class relief.

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This is especially a boon to California defendants, where claims under the Labor Code Private Attorneys General Act (PAGA) brought on a (non-class) representative basis have become a common alternative to class relief. State courts—and the Ninth Circuit—have held that the FAA does not preempt state-law rules which declare representative relief waivers in arbitration agreements unconscionable. Thus far, the U.S. Supreme Court has declined to take up the issue. In this environment, inartfully drafted class relief waivers have been construed as unconscionable representative relief waivers, causing the courts to deny all enforcement of the arbitration agreement. After Lamps Plus, California defendants can avoid this risk by keeping their arbitration agreements silent on both class and representative relief. Such silence prevents the imposition of class relief in arbitration, and cannot be construed as a bar to representative relief.

In August, in OTO, LLC v. Kho,⁸ the California Supreme Court held—in the words of the dissenting justice—that an arbitration agreement is substantively unconscionable—and therefore unenforceable—precisely because it prescribes procedures that, according to the majority, have been 'carefully crafted to ensure fairness to both sides.'⁹ OTO breaks new ground in California arbitration law and could be interpreted to call into question the enforceability of many employer arbitration programs in the state.

In Armendariz v. Foundation Health Psychcare Services, Inc.,¹⁰ the California Supreme Court adopted five indispensable factors for the enforcement of an agreement to arbitrate employment-related...