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Can Employees Waive Class Actions in Arbitration Agreements?

Employers understand employment litigation in court entails expense, delay, and uncertainty. Seeking to avoid a jury’s evaluation of workplace decisions, some employers have turned to alternative dispute resolution programs (called “ADR”). ADR can involve internal complaint procedures, mediation, and arbitration. In principle, both employers and employees can benefit from the faster and less formal procedures associated with ADR.

In recent years, class action claims have increased against employers, particularly in the wage and hour area. Class actions are particularly high-stakes forms of litigation, as one employee can assert claims on behalf of hundreds or thousands of workers who may not even know there is a problem.

Understandably, employers have sought to use arbitration agreements to lessen the risk of class actions. In fact, some agreements require arbitration of disputes, but do not permit employees to make claims on behalf of anyone other than themselves. Recent Court of Appeal decisions have employers and their lawyers on the edge of their seats wondering whether the courts will allow employees to waive their ability to bring complaints in the form of class actions.

The History of Arbitration Agreements

Congress strongly favored ADR when it passed the Federal Arbitration Act in 1925, which made arbitration awards enforceable in court and prohibits states from passing laws discriminating against arbitration agreements as compared to other types of contracts. The California Arbitration Act passed into state law two years later.

Under both federal and California law, arbitration agreements are valid, irrevocable, and enforceable, unless grounds as exist at law or in equity for revocation. The U.S. Supreme Court reaffirmed this rule in Doctor’s Associates, Inc. v. Casarotto (1996) and the California Supreme Court considered it in Armendariz v. Foundation Health Psychcare Services, Inc. (2000).

In Armendariz, the California Supreme Court held that there was no logical reason to exempt anti-discrimination laws from arbitration, so long as the arbitration agreement applies the full force of the anti-discrimination laws. So, an employer may not use an arbitration agreement to ask an employee to waive the anti-discrimination and harassment laws. On the facts of that case, the court found that the arbitration agreement was not enforceable because it limited potential recovery and required employees to pay for the services of the private judge-arbitrator. The court ruled that the agreement was unconscionable because it was a one-sided condition of employment and limited employees’ rights with no parallel limitation on the employer.

In addition to substantive rights, Armendariz requires that an arbitration agreement must include some discovery because discovery of relevant facts is essential to protecting employees’ substantive rights. Rather than invalidate all the arbitration agreements that had been written without reference to discovery, the court held that it would presume that the parties intended to provide for discovery as a matter of law if the arbitration agreement was otherwise silent. Other essential elements of an arbitration agreement include a written award, a provision requiring employers to pay for the administration costs of arbitration that exceed litigation in court, and mutuality, such that both employers and employees are required to arbitrate their claims.

Arbitration Agreements and Class Actions

In Szetela v. Discover Bank, the California Court of Appeal held arbitration agreements prohibiting class actions in consumer contracts are unconscionable, and therefore unenforceable. That case involved an arbitration clause in a credit card agreement. The agreement itself was an “adhesion contract,” a take-it-or-leave-it offer which was not negotiated between the credit card account-holder and the bank.

ome six years after one cardholder opened his account, the bank sent a notice requiring all cardholders to arbitrate disputes with the bank and not to participate in class actions. If a cardholder disagreed with the arbitration clause, the cardholder could close the account and paying off any balance under the former terms.

One cardholder disagreed with the $29 over-the-limit fee and joined a class action proceeding already in progress. The court ordered him to arbitration based on the cardholder agreement. He prevailed at arbitration and was awarded $29. On appeal, the court considered whether the referral to arbitration was erroneous. Citing the rule that an unconscionable contract is one that “shocks the conscience,” the court found that prohibiting class actions through fine print stuffed into a credit card bill was so one-sided as to be “oppressive.” The court noted the influential role of class-actions in a consumer economy and pointed out that while few customers will be interested in expending the time and resources to pursue a $29 award in arbitration, Discover Card could potentially bilk millions out of customers in fraudulent and improper charges.

The California Supreme Court agreed with the holding in Szetela in its 2005 Discover Bank v. Superior Court decision. However, the Court did not hold that all class action waivers are necessarily unconscionable. The Court limited its opinion to “consumer contract[s] of adhesion” that “predictably involve small amounts of damages.”

The Return of the Employment Arbitration Agreement

The Discover Bank cases involved credit card agreements, and addressed the nature of the negotiation that takes place between a customer and a credit card company—that is, usually none at all. Consequently, those cases did not resolve the question of whether employees could be required to agree to a waiver of class action remedies in an arbitration agreement. Unlike credit card holders, employees’ disputes with their employers are usually over amounts greater than $29. For that reason, employees generally have greater incentive to assert claims than credit card customers.

In Gentry v. Superior Court (Circuit City Stores, Inc.), the California Court of Appeal considered a case in which an employee was given the option of accepting or rejecting a class action waiver in an arbitration clause. The employee accepted it, and later brought a class action lawsuit claiming that he and all other customer service managers were owed overtime wages. The Ninth Circuit Court of Appeals had already held several times that this particular arbitration agreement was not unconscionable. Because the employees had the option to opt out of the agreement, it was not a take-it-or-leave-it adhesion contract and, therefore, not procedurally unconscionable.

Because the employees had an option to accept the class action waiver and the amount of damages claimed were significant enough to motivate individual employees to bring their own actions if they felt they were entitled, the Gentry court held that the class action waiver was valid. The California Supreme Court has granted review of Gentry, putting it off-limits for practicing lawyers to cite in court and fueling speculation about whether the high court will disagree with the outcome.

Meanwhile, back at the Court of Appeal, in Konig v. U-Haul Company of California, the court again ruled that the Discover Bank cases do not bar class action waivers in employment claims. Like Gentry, Konig brought a class action against his employer for a variety of alleged wage and hour violations on behalf of himself and a class of U-Haul employees.

U-Haul moved the court to compel Konig to arbitrate his claims based on an arbitration agreement he signed, which included the following language: “I understand that final and binding arbitration will be the sole and exclusive remedy for any such claim or dispute against [defendant]… and that, by agreeing to use arbitration to resolve my dispute, both [defendant] and I agree to forego any right we each may have had to a jury trial on issues covered by the [U-Haul Arbitration Policy], and forego any right to bring claims on a representative, class member basis, or as a private attorney general.”

Contracts may be invalidated under California law if they are unconscionable. Generally, both procedural and substantive unconscionability must be present. However, the California Supreme Court has adopted a sliding scale analysis: the more a contract term is procedurally unconscionable, the less evidence need be presented of substantive unconscionability, and vice versa. Unlike Circuit City’s contract in Gentry, the U-Haul arbitration agreement was a non-negotiable condition of employment, which makes it an adhesion contract under the Armendariz standard. As an adhesion contract, the court had a basis to conclude it was procedurally unconscionable.

Adhesion contract notwithstanding, the Konig court held that the arbitration clause was not substantively unconscionable and that it could be enforced because the amount at issue was not “predictably small” as in Discover Bank. Konig argued that U.S. Department of Labor statistics showed that the average amount of back pay wrongfully withheld is $620.80. However, because the statistics were presented for the first time on appeal, the court declined to consider whether $620 is “predictably small” or sufficient to justify individual enforcement.

In something of a double-edged sword for employers, the court did note that the penalties provided by the California Labor Code would amount to $1,000 per month, which, when considered over the course of a potential four-year statute of limitations, would seem to provides a substantial incentive to for employees to sue their employers. The comment was dictum and probably cannot be relied on by employees in claiming the maximum amounts for penalties in future wage and hour claims.

The Future of Arbitration Agreements

As a practical matter, class actions are a huge headache for employers, not necessarily because of flawed personnel practices, but because of the sheer scope of the litigation and the large numbers of employees involved. With sufficient leverage, one can move the world. In litigation, one employee can leverage settlements easier when the potential exposure is multiplied by hundreds of potential claimants, regardless of the case’s actual merit.

Many employers would probably prefer to use class-action waivers if they are found to be enforceable. For now, however, they will have to wait and see what the California Supreme Court decides in Gentry. In the meantime, there is no substitute for careful adherence to the Labor Code and the Industrial Welfare Commission’s Wage Orders in an effort to avoid the violations that lead to large class action awards.