Although it has been around since at least the 1600’s, arbitration has grabbed headlines recently. Debate over arbitration is nothing new. In 1925, Congress enacted the Federal Arbitration Act (“FAA”) “[t]o overcome judicial resistance to arbitration,” and to declare “äóÖa national policy favoring arbitration’ of claims that parties contract to settle in that manner.” Under the FAA, all arbitration agreements in contracts “involving commerce” are “valid, irrevocable, and enforceable.”

Resistance to arbitration still exists. Congress recently passed an amendment to a defense appropriations bill limiting the scope of arbitration agreements used by defense contractors. Some consumer advocates question the fairness of arbitration entirely. Despite the long history and expressed judicial approval of arbitration, both the California and U.S. Supreme Court issued decisions affecting the enforceability of arbitration agreements last month, with more to come.

U.S. Supreme Court Declines to Impose Class Arbitration

The U.S. Supreme Court in of Stolt-Nielsen v. AnimalFeeds, Inc. addressed whether class-action arbitration is required by the FAA. Stolt-Nielsen is a shipping line. AnimalFeeds is a supplier of animal feed ingredients such as fish oil. AnimalFeeds’ ingredients shipped internationally on Stolt-Nielsen’s vessels. The parties’ contract, called a “charter party” in maritime law, included an arbitration clause. AnimalFeeds believed that Stolt-Nielsen engaged in illegal price fixing and demanded arbitration on behalf of itself and all other Stolt-Nielsen’s customers with arbitration agreements. Stolt-Nielsen argued it would arbitrate its dispute with AnimalFeeds, but not as part of a class action.

The parties selected a panel of arbitrators and stipulated that the arbitration clause was “silent” with respect to class arbitration. The dispute first went to the panel, which decided it could hear the class action. Stolt-Nielsen went to court to vacate the arbitration panel’s decision and prohibit the class arbitration on the grounds that the panel exceeded the scope of the agreement to arbitrate.

Although courts normally give considerable deference to arbitrators’ decisions on matters submitted to arbitration by mutual agreement, the trial court agreed with Stolt-Nielsen and vacated the class action. AnimalFeeds appealed, and the case ended up in the Supreme Court.

The Supreme Court ruled there was no evidence the parties had agreed to arbitrate class actions. The charter party contract did not say anything about class arbitration, and there was no widespread practice in maritime law or the shipping industry of allowing class arbitration. Therefore, the Court determined that “[a[n implicit agreement to authorize class-action arbitration . . . is not a term that the arbitrator may infer solely from the fact of the parties’ agreement to arbitrate.” Absent an express agreement, a “party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.”

The Supreme Court noted that arbitration between only two parties is different from arbitration with an entire class. For example, in an ordinary two-sided dispute, one party “may logically chose to give up its right to appeal to obtain a final decision more quickly. But the relative benefits of class-action arbitration are much less assured, giving reason to doubt the parties’ mutual consent to resolve disputes through class-wide arbitration.” Even if class arbitration may be a better way to resolve disputes, the Court said “the task of an arbitrator is to interpret and enforce a contract, not to make public policy.”

The California Supreme Court Expands Basis for Vacating Arbitration Awards

In California, the courts will not enforce an arbitration agreement in which an employee supposedly agrees to give up “unwaivable statutory rights.” Just as employees may not agree to work for less than minimum wage or to be discriminated against because of their race, for example, they cannot agree to waive the right to sue over certain labor and employment law violations.

In Pearson Dental Supplies, Inc. v. Superior Court (Turcios), an employee with an arbitration agreement was terminated and complained of age discrimination. The arbitration agreement contained a one-year time limit on the employee’s ability to request arbitration. The employee went to court less than one year from his date of termination, and the employer responded without mentioning the arbitration agreement.

Three months later, now outside the contractual limitations period, the employer moved the court to compel arbitration. After the court sent the case to arbitration, the employer asked the arbitrator to dismiss the entire action because the request for arbitration was not filed within one year of the termination. The arbitrator agreed, but only because he miscalculated the tolling provisions that applied to a motion to compel arbitration under California law. Had the arbitrator correctly applied the tolling statute, the employee had about three months left to request arbitration.

Normally, an arbitrator’s simple error of law is not reviewable through a petition to vacate an arbitration award. One of the primary goals of arbitration is finality. It works both ways, in that employers cannot seek to overturn awards because they disagree with an arbitrator’s legal reasoning. As courts have said, “arbitrators do not exceed their powers merely because they assign an erroneous reason for their decision.” Otherwise, “a litigant could always contend the arbitrator erred and thus exceeded his powers.”

But the trial court vacated the arbitration award, reasoning that the arbitrator’s award created a waiver of the employee’s unwaivable statutory rights, because the employee never received a hearing on the merits of his discrimination case. The Court of Appeal reversed, finding that the arbitrator simply applied the law incorrectly, which is not grounds to vacate an arbitration award.

On review, the California Supreme Court could not understand how the arbitrator concluded the arbitration was not timely demanded. (That have been because the arbitrator’s decision was only one sentence and contradicted by arithmetic.). As a result of the arbitrator’s error, “through no fault of the employee or his attorney, the employee [was] unable to receive a hearing on the merits of his [discrimination] claims in any forum. Nor can it be plausibly argued that plaintiff merely received the justice he bargained for. . .” because the employee never bargained for the arbitration agreement.

Consequently, the court found an exception to the rule that legal error does not require vacating an arbitration award. A trial court may now vacate an arbitration award “when, as here, an employee subject to a mandatory employment arbitration agreement is unable to obtain a hearing on the merits of his [discrimination] claims, or claims based on other unwaivable statutory rights, because of an arbitration award based on legal error.” In a dissenting opinion, Justice Baxter criticized the decision for expanding the scope of judicial review of arbitration and for burdening arbitration agreements with a requirement not imposed on other types of contracts.

Consider Arbitration Agreements Carefully

Both decisions discussed above change the law regarding the enforceability of arbitration agreements. Stolt-Nielsen calls into question whether courts may force parties to litigate class actions. The California courts have ruled that arbitration agreements cannot preclude class-wide arbitration, even when they are silent. The U.S. Supreme Court’s decision will require California courts to revisit this issue. State laws cannot conflict with the FAA, upon which the Stolt-Nielsen decision rests.

If Stolt-Nielsen overturns California decisions such as Gentry v. Circuit City and Discover Bank v. Superior Court, then two-party arbitration agreements may preclude class-wide arbitration absent an express agreement to allow them. If that occurs, employers seeking relief from the seemingly endless barrage of wage and hour class actions may re-discover the benefits of arbitration.

Pearson Dental, on the other hand, undermines one of the few remaining distinctions between litigating in court and arbitration: finality. The decision itself permits court review only when the arbitrator disposes of a claim before a hearing on the merits. But court decisions after this one may well expand Pearson‘s holding to other circumstances, such as when the arbitrator grants summary judgment, dismissal as a discovery sanction, or failure to follow the rules governing the parties.

The message for employers is to carefully consider whether the benefits of arbitration (primarily avoiding a jury and some court procedures) outweigh the costs of arbitration, including payment of the administration and arbitrators’ fees, and the extra costs of administering and revising arbitration agreements with employees. This is by no means an easy decision, and will depend in great part on the nature of the business and the types of claims most often litigated.