United States: California Law Employment Edition ~ September 2000

On August 24, 2000, the Supreme Court held that claims under California's Fair Employment and Housing Act (FEHA) may be subject to mandatory arbitration as long as the parties' arbitration agreement permits an employee to vindicate his or her statutory rights and the agreement is bilateral. Armendariz v. Foundation Health Psychcare Services, Inc., 2000 Cal. Lexis 6120 (2000).

The Supreme Court emphasized that the employer cannot limit the statutory remedies (such as punitive damages and attorneys' fees) and that the agreement must meet certain other minimum requirements. Specifically, the agreement must provide for a neutral arbitrator, adequate discovery, a written decision that would permit a limited form of judicial review, and limitations on the costs of arbitration. The Court cautioned that where an agreement is unconscionable, it might be more appropriate for a court to refuse to enforce the arbitration agreement as a whole, rather than to strike the offending provisions and to enforce the remaining arbitration provisions.¹

The underlying action in Armendariz arose out of claims by two former employees of Psychcare who alleged that they were sexually harassed and discriminated against, and that their termination of employment was due to their perceived and/or actual heterosexual orientation. The employees alleged a violation of FEHA and three other causes of action for wrongful termination based on tort and contract theories of recovery; they filed in superior court, despite the fact that they had executed an employment application form requiring arbitration of any claims of wrongful termination as well as a separate employment arbitration agreement containing the same arbitration clause.

Psychcare filed a motion for an order to compel arbitration. The trial court denied the motion on the ground that the arbitration agreement was an unconscionable contract, finding that the agreement was an "adhesion contract" and that several provisions of the agreement (such as a limitation of damages to back pay and a preclusion of discovery) were "so onesided as to 'shock the conscience.'"

The Court of Appeal reversed. Although it agreed that the arbitration agreement was an "adhesion contract" which employees had no choice but to sign, and that the damages provision was unconscionable, it held that the agreement was otherwise enforceable. It also determined that because the agreement incorporated the California Arbitration Act, Code of Civil Procedure §§ 1280 et seq. (the "CAA"), adequate discovery was available under Code of Civil Procedure §1283.05. ²

The Supreme Court first rejected the reasoning of a recent federal case from the Ninth Circuit, Duffield v. Robertson Stephens & Co., 144 F.3d 1182 (9th Cir. 1998), which specifically held that the Civil Rights Act of 1991 prohibits the enforcement of mandatory employment agreements to arbitrate claims under Title VII of the Civil Rights Act of 1964 or equivalent state antidiscrimination statutes such as FEHA.

The Supreme Court then noted that under both state and federal law, "arbitration agreements are valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract. In other words, . . . an arbitration agreement may only be invalidated for the same reasons as other contracts." Thus, the focus of the opinion was on whether grounds existed for voiding the arbitration agreement.

The Court held that an arbitration agreement that results in the waiver of statutory rights under FEHA cannot be enforced. To ensure that such rights are not waived, the Court imposed five requirements essential to the enforcement of a mandatory employment arbitration agreement involving FEHA claims:

• The agreement must provide for a neutral arbitrator.
• The agreement must provide for more than minimal discovery. The Supreme Court held that employees must be "at least entitled to discovery sufficient to adequately arbitrate their statutory claim, including access to essential documents and witnesses, as determined by the arbitrator(s) and subject to limited judicial review . . . ."
• The arbitrator's decision must be in writing. The Supreme Court also held that an arbitrator in a FEHA case must issue a written arbitration decision that reveals the essential findings and conclusions on which the award is based. The Court noted that a FEHA arbitration agreement that does not preclude such written findings will be interpreted to provide for such findings.
• The agreement may not limit any relief that would otherwise be available in court. The Supreme Court made it clear that an arbitration agreement may not limit statutorily imposed remedies such as punitive damages and attorneys' fees. Because the agreement at issue limited the employees' remedies to an award of back pay, the Court found it to be unlawful.
• The agreement may not require employees to pay either unreasonable costs or any arbitrator's fees or expenses. The Supreme Court held that "when an employer imposes mandatory arbitration as a condition of employment, the arbitration agreement or arbitration process cannot generally require the employee to bear any type of expense that the employee would not be required to bear if he or she were free to bring the action in court." Thus, the Court held that any mandatory employment arbitration agreement applicable to FEHA claims implicitly obliges the employer to pay all types of costs that are unique to arbitration; it does not require the employer to pay the employee's attorneys' fees. The purpose of this rule is to ensure that employees would not be deterred from bringing FEHA claims because of costs greater than those they would have incurred had they brought an action in court.

In addition to these minimum requirements, the Supreme Court concluded that a mandatory employment arbitration agreement must be bilateral. If the employee must submit all employment-related claims to arbitration, but such a requirement does not exist for the employer, the agreement is unconscionable and thus unenforceable without "at least some reasonable justification for such onesidedness."

Finally, the Supreme Court considered whether the unenforceable provisions in a mandatory employment arbitration agreement could be "severed" from the agreement, leaving the arbitration requirement intact. In Armendariz, the Court found that because the agreement had two, separate, unlawful provisions—namely, an unlawful damages provision (i.e., limiting damages to an award of back pay) and a unilateral arbitration provision—it was unenforceable. The Court explained that the agreement indicated a "systematic effort to impose arbitration on an employee . . . as an inferior forum that works to the employer's advantage."

The Court did not decide whether the unlawful damages provision by itself was enough to invalidate the entire agreement, although it strongly implied it was. Additionally, it found that the agreement could not be cured by simply severing the unilateral arbitration provision; reformation of the contract by adding additional terms would be necessary to make it bilateral. Because California law does not authorize such augmentation, the Court held that the arbitration provision could not be enforced.

The Armendariz decision spells out what must be provided in a mandatory employment arbitration agreement to ensure its enforceability. Even though the Supreme Court's decision imposes significant burdens on an employer who wishes to enforce an arbitration agreement, the advantages of arbitration (e.g., speed, certainty, lower costs and avoiding the risks inherent in a jury trial) still outweigh the burdens of arbitration.

1. The opinion applies only in the context of mandatory employment arbitration agreements; it does not address situations in which the employee and employer voluntarily enter into an arbitration agreement after a dispute has arisen.

2. Under the CAA, parties to an arbitration involving "any injury to, or death of, a person caused by the wrongful act or neglect of another" are automatically entitled to written discovery as if the action were brought in superior court, and are entitled to depositions as granted by the arbitrator, pursuant to Code of Civil Procedure §§1283.05 and 1283.1(a). In all other actions, the parties are entitled to such written discovery and depositions only if the arbitration agreement so provides. Code of Civil Procedure §1283.1(b). The Supreme Court did not decide whether a FEHA claim constitutes an "injury" to a person automatically encompassing the full range of discovery provided under the CAA, but instead held that parties agreeing to arbitrate a statutory claim implicitly agree to such basic discovery as is necessary to arbitrate their claim.