The Federal Arbitration Act (“FAA”) evinces a national policy favoring arbitration.  The law provides for strong, uniform, and broad enforcement of arbitration agreements when it applies. It preempts state laws and court decisions that disfavor arbitration.  For example, the United States Supreme Court has rejected efforts to outright prohibit arbitration of particular types of claims, as well as laws and court decisions that single out arbitration for disfavored treatment on grounds that appear to be neutral.

However, recent court decisions reminds employers that the FAA’s coverage is not unlimited.  Under what circumstances will the FAA not apply, and what happens in those cases?

Generally, the FAA applies to written agreements to arbitrate disputes arising out of transactions involving interstate commerce.  “Commerce” is construed broadly to encompass transactions within the flow of commerce among states. The nexus to interstate commerce need not be substantial or central to the parties’ relationship. The party seeking enforcement of an arbitration agreement has the burden of establishing that the FAA applies. 

Section 1 of the FAA further limits the law’s scope such that it does not apply to all employment relationships in interstate commerce. The FAA does not cover employment contracts involving “seamen,” “railroad employees”, or “any other class of workers engaged in foreign or interstate commerce.”  The United States Supreme Court has explained the latter exception excludes from the FAA’s reach arbitration agreements between “transportation workers” and their employers engaged in foreign or interstate commerce.

But what counts as a “transportation worker” engaged in the requisite commerce? Courts have addressed this issue in recent cases, generally involving truck drivers.  For example, in New Prime Inc. v. Oliveira, the United States Supreme Court applied the FAA’s exception to independent contractors.  The Court held that interstate truck drivers operating as independent contractors are “workers engaged in… interstate commerce” and, consequently, the FAA did not apply to their contracts. 

Two California Courts of Appeal recently held that “interstate commerce” includes the intrastate transport of goods, when that transport occurs “in the flow of interstate commerce.”  Therefore, truck drivers may be “engaged in… interstate commerce” under the FAA, even if they don’t cross state lines, when their deliveries are “part of a continuous stream of interstate travel.” As a result, the FAA did not apply to these drivers’ arbitration agreements with their employers.

The FAA, then, may not apply to certain classes of workers. And the law also will not protect an arbitration agreement if it does not satisfy the requirements for a valid contract under state law.  For example, generally applicable contract defenses, such as lack of consideration, fraud, duress, or unconscionability, may be asserted against an arbitration agreement, but only to the same extent these defenses are applied to any other contract. Defenses to contract enforceability cannot be specially applied only to arbitration, or derive their meaning from the fact that an agreement to arbitrate is at issue.  For example, an arbitration agreement is not “unconscionable” – a standard defense to contract enforceability – because it requires arbitration of certain types of claims for which state laws prescribe a jury trial.

When the FAA does not apply, state law will determine if the agreement to arbitrate is enforceable.  The California Arbitration Act (“CAA”) applies to arbitration agreements in California.  Unlike the FAA, for example,  the CAA gives courts discretion to refuse to enforce an arbitration agreement, when there is a possibility that arbitration may produce a result that conflicts with the outcome of related litigation with a third party arising out of the same transaction.

Additionally, when the FAA does not apply, arbitration-hostile state rules will govern. For example, Labor Code section 229 flat-out prohibits arbitration of many wage-hour law claims. But in Nieto v. Fresno Beverage Company, the court decided that the FAA was inapplicable because Nieto was an excluded transportation worker. Therefore, the truck driver’s wage-hour class action could proceed in court despite his otherwise-enforceable arbitration agreement.

Courts have more latitude to invalidate arbitration agreements based on public policy, or stretched notions of “unconscionability” without the FAA’s involvement. Class action waivers, protected by the FAA, may not be enforceable, although this issue is not yet clear. Courts may hold that certain arbitration provisions are unconscionable under state law, even though other contracts would not be held to the same standard. The Legislature could pass a statute excluding discrimination or harassment claims, for example, if the FAA is inapplicable.

Arbitration is not a panacea for employers, even when the FAA applies.  Employers and their lawyers must carefully consider the potential risks and rewards when deciding whether arbitration is appropriate for their organizations.  If possible, employers should draft arbitration agreements to best ensure FAA coverage. Their lawyers must affirmatively establish that coverage when filing motions to compel arbitration as well.

Without the FAA’s protections, the benefits of arbitration may be reduced in the employment law context. Employers not covered by the FAA nevertheless may wish to use arbitration agreements, but with the understanding that certain claims will be excluded. These agreements must be drafted carefully to ensure they are enforceable under state law. Given the recent case law developments, transportation industry employers in particular should assess how their agreements will be enforced if the FAA does not apply.