Anxious to make a good first impression, most new employees will sign onboarding paperwork without close examination. However, a mandatory arbitration provision now found in most employment contracts could waive employee rights to participate in a class action against the employer.
This article by TELG managing principal R. Scott Oswald and TELG principal & general counsel Nicholas Woodfield was published by Westlaw Journal Employment on March 4, 2014.
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The first day of work with a new employer is a day of butterflies. Anxious to make a good first impression and optimistic about this fresh start new employees will sign most on boarding “paperwork” without close examination. By doing so, they may sign away many rights.
Of particular concern is the mandatory arbitration provision now found in most employment contracts. In many cases, it waives an employee’s right to participate in a class action against the employer, instead requiring strict case-by-case arbitration for each individual’s grievances.
Until recently some states have declined to enforce such waivers, protecting employees via judicial doctrines such as California’s Gentry rule, which holds that class arbitration must be allowed if it would be “significantly more effective” than individual arbitration in vindicating employees’ statutory rights. Gentry v. Super. Ct., 42 Cal. 4th 443, 463 (Cal. 2007). Besides California, states that have opposed class waivers include New York, Florida and New Jersey.
On Feb. 24, however, the U.S. Supreme Court indicated that such pro-employee measures may be doomed.
In a direct slap at Gentry, the high court remanded CarMax Auto Superstores v. Fowler, No. 13-439, cert. granted (U.S. Feb. 24, 2014), a California wage-and-hour case, for evaluation under the strict standards of its 2013 Italian Colors ruling, which held that the Federal Arbitration Act requires enforcement of arbitration provisions unless Congress has created a specific exemption.
In effect, the court said in American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013), as long as a plaintiff still has some forum — even an inefficient one — in which to pursue justice, states can no longer invalidate arbitration provisions without the leave of Congress.
The bar just rose for plaintiffs’ attorneys who seek the advantage of a class action despite their clients’ waiver. A public policy argument will no longer suffice.
This commentary will discuss the effects of arbitration provisions on employees’ rights, the applicability of the Federal Arbitration Act to such provisions, the U.S. Supreme Court’s growing resolve to limit class actions by using the venerable FAA to preempt state law, and the strategies that
Most people are familiar with the concept of arbitration. Two parties are engaged in a dispute and, rather than settle the conflict through formal litigation, they submit the matter to a disinterested third party for resolution.
An arbitration agreement typically will identify the manner in which arbitration costs will be paid, the arbitrators selected, the location at which the arbitration shall take place and the rules of the proceedings. Some limited discovery is usually permitted and, after a hearing, the arbitrator issues a decision that is binding upon the parties.
Generally speaking, employers are fans of including mandatory arbitration provisions in their employment agreements. Settling claims with aggrieved employees through arbitration is less costly and time-intensive than courtroom litigation. In addition, arbitration allows an employer to avoid answering to juries and the possibility of bias against the employer or the jury making unpredictably high awards to the employee. Finally, arbitration tends to be less public than litigation, and employers are generally able to avoid the negative publicity associated with litigating through the courts.
While employer stend to favor such mandatory arbitration provisions, the opposite is true for aggrieved employees — especially when they might otherwise proceed via class-action litigation. In arbitration, employees have less power to leverage publicity in order to secure a pretrial settlement, they cannot pursue discovery to the same extent as in court and they cannot rely on a sympathetic jury at trial.
Despite these downsides, newly hired employees routinely waive their right to class arbitration for many reasons: good faith, blind faith, an imbalance of power with their employer, a lack of legal understanding, the press of time or — most of all — the sheer impracticality of picking a fight with a brand- new employer.
Regardless of why an arbitration agreement is signed, the Federal Arbitration Act, 9
U.S.C. § 2, enacted in 1925, requires that such a signed agreement “shall be valid, irrevocable, and enforceable, save upon Such grounds as exist at law or in equity for the revocation of any contract.” According to the Supreme Court, the FAA “reflects the fundamental principle that arbitration is a matter of contract” and evidences a “liberal federal policy favoring arbitration.” Rent-A- Center W. Inc. v. Jackson, 130 S. Ct. 2772, 2776 (2010); Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983).
The FAA is not ironclad, however. Because an arbitration agreement is a contract, Section 2 of the FAA allows it to be invalidated on the same grounds used “for the revocation of any contract.” Therefore, an employee may allege, for instance, that the agreement was entered into under duress or that its execution involved fraud by the employer.
In Brennan v. Bally Total Fitness, 198 F. Supp. 2d 377, 383 (S.D.N.Y. 2002), a federal judge found duress where an employer failed to provide employees adequate time to review an agreement, failed to inform employees that they could review the agreement with an attorney and threatened that those who refused to sign would not be promoted.
It is important to note that the fraud or duress must relate specifically to the arbitration agreement or clause, not just to the employment contract in general. An opinion out of the Eastern District of Kentucky hammers this point home. The court, in Newton v. Snap-on Tools Corp., 783 F. Supp. 1019, 1022 (E.D. Ky. 1991), found an
Arbitration agreement to be valid because “the fraud of which they [the plaintiffs] complain goes to their general agreements with the defendant, rather than to the arbitration clause.”
While individual plaintiffs may challenge arbitration provisions in specific employment contracts, many state legislatures and courts have sought as a matter of public policy to put broader limits on the enforcement of such provisions. Because of the Supremacy Clause of the U.S. Constitution, however, such efforts walk a delicate line.
The Supremacy Clause provides that “[t]his Constitution, and the Laws of the United States which shall be made in Pursuance thereof … shall be the supreme Law of the Land … any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.” Art. VI, cl. 2.
The Supreme Court therefore may hold that state laws and rulings are “preempted” by statutes such as the FAA: “We have long recognized that state laws that conflict with federal law are ‘without effect.’” Altria Group v. Good, 555 U.S. 70, 76 (2008).
Over the years, the Supreme Court has used preemption to strike down many states’ attempts to limit arbitration. In Preston v. Ferrer, 552 U.S. 346, 357-58 (2008), for instance, it decided that the FAA and its underlying priorities trumped a California law that required parties to exhaust all administrative remedies before proceeding to arbitration.
In the same vein, the Supreme Court recently has applied preemption to stop states from nullifying arbitration agreements that include a waiver of class actions. Before the Fowler decision, the Supreme Court did not link these efforts directly to employment contracts. Its precedents in Italian Colors and AT&T Mobility v. Concepcion, 131 S. Ct. 1740 (2011), involved adhesion contracts for credit card acceptance and cell phone service, respectively.
With Fowler, however, the court has made the workplace connection explicit. As a result, employees across the country will find it hard to avoid arbitration. We will consider the court’s developing doctrine on class waivers case-by-case.
Concepcion and contract claims
Vincent and Liza Concepcion entered into an agreement with AT&T Mobility LLC for the sale and servicing of cellular telephones. The contract contained a provision that required claims be brought by the parties in their “individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.” Concepcion, 131
In a revised agreement, AT&T provided the procedures whereby its customers could initiate arbitration. It also set forth the rules governing the arbitration proceedings, cost allocations and awards.
The Concepcion’s purchased service from AT&T, which was advertised as including free phones. AT&T charged the Concepcion’s
$30.22 in sales tax based on the phones’ retail value. Consolidating their own complaint with that of others in a putative class action, the Concepcion’s alleged that AT&T engaged in fraud and false advertising by charging sales tax on phones advertised as free.
The Concepcion’s filed their complaint in the U.S. District Court for the Southern District of California. AT&T moved to compel arbitration and the Concepcion’s opposed the motion, “contending that the arbitration agreement was unconscionable and unlawfully exculpatory under California law because it disallowed class wide procedures.” Id. at 1745. The District Court denied AT&T’s motion and the 9th U.S. Circuit Court of Appeals affirmed. Citing Discover Bank v. Superior Court, 36 Cal. 4th 148 (Cal. 2005), both the District Court and 9th Circuit found unconscionable the waiver of class proceedings within AT&T’s arbitration agreement.
The Supreme Court began by noting that, “Under California law, courts may refuse to enforce any contract found ‘to have been unconscionable at the time it was made,’ or may ‘limit the application of any unconscionable clause.’” Concepcion, 131 S. Ct. at 1746 (citing Cal. Civ. Code Ann. § 1670.5(a)).
Specifically, the court referred to the rule in question as the Discover Bank rule and noted that it “classified most collective- arbitration waivers in consumer contracts as unconscionable,” thus rendering such provisions unenforceable. Id. The court went on to discuss several specifics of the so-called Discover Bank rule. The court found that the rule allows any party to a consumer contract to demand class wide arbitration ex post, that damages be predictably small (noting that $4,000 is sufficiently small) and that the consumer allege a scheme to cheat consumers. Id. at 1750.
The question for the court, therefore, was whether California’s proscription against collective arbitration waivers interfered with arbitration. Ultimately, the Supreme Court concluded that it did. In so finding, the court first noted that the ability of the demanding party to switch from bilateral to class arbitration ex post impeded “the principal advantage of arbitration its informality,” and made the process “slower, more costly, and more likely to generate procedure morass.” Id. at 1751.
Also, the court found that class arbitration requires procedural formality and that Congress, in passing the FAA, could not have intended for an arbitrator to decide the procedural requirements associated with class arbitration.
Finally, the court opined upon the more limited appeal rights associated with arbitration as compared to traditional class litigation. “The absence of multilayered review makes it more likely that errors will go uncorrected. Defendants are willing to accept the costs of these errors in arbitration, since their impact is limited to the size of individual disputes, and presumably outweighed by savings from avoiding the courts.” Id. at 1752.
In light of all of the above, the court concluded that California’s Discover Bank rule was preempted because it “stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress [as set forth in the FAA].” Id. at 1753 (citing Hines v. Davidowitz, 312 U.S. 52, 67 (1941)).
Two years later, the Supreme Court decided Italian Colors, which centered on an antitrust dispute between American Express and the merchants who accept its cards. The merchants alleged that American Express used monopoly power to force them to accept rates 30 percent higher than the fees for competing credit cards. Italian Colors, 133 S. Ct. at 2308.
An agreement between the parties required that all disputes be resolved through arbitration and that “there shall be no right or authority for any claims to be arbitrated on a class action basis.” Id.
After the merchants filed a complaint in U.S. District Court for the Southern District of New York, American Express moved to compel arbitration under the FAA. The merchants’ argument proceeded on the theory that individually arbitrating their antitrust claims would exceed the potential recovery and, as such, the waiver of class arbitration was unconscionable. Indeed, the merchants asserted that the cost of an expert to analyze the antitrust claims would be somewhere between several hundred thousand dollars and $1 million.
Putting aside the procedural history, the case made its way to the Supreme Court, where the justices were asked to consider whether the Federal Arbitration Act “permits courts to invalidate arbitration agreements on the ground that they do not permit class arbitration of a federal law claim.” Id.
The Supreme Court began its opinion by discussing the law’s deference to the enforcement of arbitration agreements. It went on to state that such deference “holds true for claims that allege a violation of a federal statute, unless the FAA’s mandate has been ‘overridden by a contrary congressional command.’” Id. (emphasis added) (citing CompuCredit Corp. v. Greenwood, 132 S. Ct. 665, 667 (2012)).
Thus, in order for the waiver of class arbitration to be unenforceable, the petitioners would need to find a “congressional command” that requires the Supreme Court to reject the waiver of class arbitration. Id. at 2309. The court examined the antitrust laws and found that they “do not evince an intention to preclude a waiver of class-action procedure.” Id.
The court went on to discuss the “effective vindication” exception that would allow it to “invalidate, on public policy grounds, arbitration agreements that ‘operate … as a prospective waiver of a party’s right to pursue statutory remedies.” Id. The court noted a distinction between the right to pursue a remedy and the fact that a remedy may not be worth the expense of proving.
The court concluded with a nod to the Concepcion decision and found that neither the antitrust laws nor the “effective vindication” doctrine would permit the merchants to initiate class arbitration against American Express.
Fowler: Does Italian Colors preempt state law?
Fowler provided the Supreme Court with a good test of the scope of Italian Colors. The court responded with a five-line summary disposition, showing that it needs no further rationale to apply Italian Colors broadly across both federal and state law — including employment law.
In Fowler two employees of a California CarMax affiliate filed putative class actions against their employer in state court in 2008, despite having signed agreements that waived their right to do so.
Among other things, they alleged violations of rules on payment of wages, provision of breaks and unfair competition. CarMax initially took part in the proceedings, but ultimately sought to dismiss the claims and compel arbitration based on the U.S. Supreme Court’s intervening ruling in Concepcion.
The trial court agreed and ordered arbitration — and further held that, in light of Concepcion, California’s so-called Gentry rule no longer applied. That rule, related to the Discover Bank rule and promulgated by the state Supreme Court in Gentry, held that in employment cases a court may invalidate a class waiver if, among other things, class arbitration would be “a significantly more effective practical means of vindicating the rights of the affected employees than individual litigation or arbitration.” Gentry, 42 Cal. 4th at 463.
The plaintiffs appealed to the state’s 2nd District Court of Appeal, which reversed in March 2013. Fowler v. CarMax Inc., No. B238426, 2013 WL 1208111 (Cal. Ct. App., 2d
Dist. Mar. 26, 2013). Even though Concepcion had overruled Discover Bank, the court said, Gentry remained good law. “Gentry established that an arbitration agreement between an employer and an employee required a different analysis than Discover Bank’s rule of substantive unconscionability,” it explained. Id. at *7.
In July 2013, California’s Supreme Court declined to review this decision — leaving Gentry intact and unpreempted by the FAA. Yet in the meantime the U.S. Supreme Court had ruled on Italian Colors, and a few months later CarMax petitioned that court for review. It was a savvy move.
The court granted the petition Feb. 24 and summarily vacated the California decision, remanding the case “for further consideration in light of American Express Co. v. Italian Colors Restaurant.”
While the Supreme Court did not explicitly preempt Gentry, its message is clear enough to invalidate a class waiver, plaintiffs now must meet the Italian Colors standard.
This is a high hurdle.
Even before Fowler, at least one federal appeals court has begun to apply Concepcion and Italian Colors in the context of employment law. Sutherland v. Ernst & Young, 726 F.3d 290, 293 (2d Cir. Mar. 20, 2013), provides a useful preview of what’s ahead albeit a disheartening view for plaintiffs.
Stephanie Sutherland was a “low level” accountant making $55,000 at Ernst & Young. She did not receive any overtime pay, even when she worked in excess of 40 hours per week. When she accepted employment with E&Y, Sutherland signed an agreement that stated, “Neither the firm nor an employee will be able to sue in court in connection with a covered dispute” and “covered disputes pertaining to different employees will be heard in separate proceedings.” Id. (emphasis added).
Covered disputes included, “claims based on federal statutes such as … the Fair Labor Standards Act,” “claims based on state statutes and local ordinances, including state and local anti-discrimination laws,” and “claims concerning wages, salary, and incentive compensation programs.” Id.
Despite this language, Sutherland filed a class action in the U.S. District Court for the Southern District of New York. When E&Y filed a motion to compel arbitration, Sutherland responded that the agreement was unenforceable because it prevented her from “effectively vindicating” her rights under the FLSA. She noted that the cost of arbitrating her claims would likely exceed $160,000 all for a potential recovery of less than $2,000.
Persuaded, the trial court denied E&Y’s motion. E&Y appealed to the 2nd U.S. Circuit Court of Appeals and then, just three months after oral arguments and a few weeks before a decision, the Supreme Court handed down its ruling in Italian Colors.
Clearly Italian Colors made a difference; in a per curiam decision, the 2nd Circuit explicitly applied its analysis. First, the court sought to determine whether the FLSA contained a “contrary congressional command” that might bar waivers of class arbitration. Then it examined Sutherland’s argument that she could not effectively vindicate her rights through individual arbitration.
According to the 2nd Circuit, the FLSA does not contain a “contrary congressional command.” The court noted that the law requires an employee with an FLSA claim to opt in affirmatively to any collective action.
Then it quoted the 8th Circuit’s opinion in Owen v. Bristol Care Inc., 702 F.3d 1050, 1055 (8th Cir. 2013): “Even assuming Congress intended to create some ‘right’ to class actions, if an employee must affirmatively opt in to any such class action, surely the employee has the power to waive participation in a class action as well.”
Finally, relying directly on the stringent standard from Italian Colors¸ the 2nd Circuit concluded that Sutherland could not avail herself of the “effective vindication doctrine” simply because “her claim is not economically worth pursuing individually.”
CONCLUSION AND TAKEAWAYS
Based on the Italian Colors line of cases, including the brand-new Fowler disposition, an employee’s signed waiver of class-action litigation and class arbitration now must be presumed enforceable. The FAA will preempt state statutes and doctrines to the contrary.
To nullify a waiver and proceed with a class action, a would-be plaintiff has but two viable paths left: contract law and the intent of Congress.
A class waiver still may be found void under contract law — if it was fraudulently induced or signed under duress, for instance. The Brennan case cited above, for instance, may provide a template. Classic contract arguments remain untouched by Italian Colors, as long as they hew to well-respected precedent, and could enable both federal and state actions.
Alternatively, plaintiffs may argue that an applicable federal law disallows a waiver of class actions. The Supreme Court does not require such a ban to be explicit: “If such an intention exists, it will be discoverable in the text of the … [statute], its legislative history, or an ‘inherent conflict’ between arbitration and the … [statute’s] underlying purposes.” Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 26 (1991).
This argument failed with regard to the FLSA in Sutherland, but plenty of other statutes and other courts remain. Attorneys must be prepared to pore over statutes and legislative reports to discover the right angle or, failing such discovery, ready the plaintiff for individual arbitration.
It is a hefty price to pay for signing “paperwork” in the happy flush of a first day at work — for a signature, furthermore, that most employees will find impossible to refuse. Yet for now, at least, the Supreme Court says it will not step in.
