Why it matters

Continuing California's long, complicated history with arbitration agreements in the employment context, an appellate panel ruled that an employer's arbitration agreement was both procedurally and substantively unconscionable, striking the arbitration provision from the agreement. Martha Carbajal filed suit asserting violations of state wage and hour law. CW Painting countered with a motion to compel arbitration based upon a provision found in her employment agreement. Affirming the trial court, the appellate panel found the provision unconscionable. Procedurally, the provision was part of an adhesion contract that CW Painting imposed on Carbajal as a term of her employment, and although it required the parties to arbitrate their disputes under the American Arbitration Association's rules, it did not identify which rules would apply and the employer failed to provide Carbajal with a copy of the applicable rules. The court also found several substantive deficiencies with the agreement, including a waiver by employees of their statutory rights to recover fees and the ability of the employer to obtain injunctive relief while workers were required to seek relief through arbitration. In another blow to the employer, the panel said it was not required to sever the unconscionable terms and enforce the remainder of the arbitration provision and instead struck the agreement in its entirety. The decision offers a valuable road map for employers about what not to include in arbitration agreements to avoid a similar fate.

Detailed discussion

CW Painting provides residential painting services for homeowners. The company hired Martha Carbajal during her university's on-campus solicitation program. During her interview, Carbajal was provided with an employment agreement that included an arbitration provision.

Under the heading, "LET'S TALK IT OUT," the arbitration provision required Carbajal and CW Painting "to submit any and all disputes to final and binding arbitration in accordance with the rules of the [American Arbitration Association]." The provision had a class action waiver requiring Carbajal to arbitrate any claims she asserted on an individual basis and provided that arbitration costs would be shared equally between the parties unless the law expressly required the employer to bear the entire cost. Each party was responsible for its own attorneys' fees.

The agreement also required Carbajal to keep CW Painting's trade secrets and other information confidential; if she broke this promise, she was required to pay the employer liquidated damages, and CW Painting reserved the right to obtain an injunction restraining her breach. Carbajal signed the documents.

After just a few months of work, Carbajal quit and filed a putative class action against CW Painting. She alleged multiple violations of state law, including the failure to provide meal periods and paid rest periods, minimum wage, and compensation for business expenses, as well as illegal deductions from wages and unfair business practices.

CW Painting moved to compel individual arbitration. A trial court denied the motion and the employer appealed.

As a threshold matter, the appellate panel rejected CW Painting's argument that the Federal Arbitration Act (FAA) governed the agreement and the motion to compel arbitration. As the party asserting FAA preemption, the employer shouldered the burden to establish that the arbitration agreement affected one of three categories of activity: the channels of interstate commerce, the instrumentalities of interstate commerce, or those activities having a substantial relation to interstate commerce.

CW Painting failed to meet its burden, the court said, presenting no evidence to establish any connection to interstate commerce. Carbajal worked in California while serving customers in the state. The employer's argument that she made "frequent" phone calls to customers and used a fax machine was "at most a trivial connection" to interstate commerce, particularly where no other relationship existed between the agreement and interstate commerce, the panel said.

"The evidence here does not show painting a house involves a channel or instrumentality of interstate commerce, and simply using phone lines intrastate to follow up with customers is not a substantial relationship to interstate commerce," the court said, concluding that the argument that the FAA preempted California statutes or case law lacked merit.

Next, the court evaluated the arbitration agreement for unconscionability.

The panel found several factors contributed to the agreement's procedural unconscionability, foremost because it was a contract of adhesion in the employment context. "CW Painting was an employer with superior bargaining power and the arbitration provision is part of a standardized, preprinted form CW Painting requires of all of its interns to sign," the court said. "Carbajal had to sign the Agreement if she wanted to work for CW Painting."

Pushing the level of procedural unconscionability from a modest degree to a moderate level, the employer left the applicable rules open to question. The agreement did not state which of the AAA's almost 100 different sets of active rules were applicable, the employer never provided Carbajal with a copy of the governing rules, and did not offer to explain the arbitration position, the court said. "Moreover, when Carbajal deposed CW Painting's person most knowledgeable about the Agreement and its arbitration provision, the designated person could not identify which set of AAA rules applied even when he was provided with a list of AAA's active and archived rules," the panel wrote.

Turning to substantive unconscionability, the court found three characteristics of the agreement problematic: the agreement allowed CW Painting to seek injunctive relief in court while limiting Carbajal to arbitration, permitted the employer to seek injunctive relief without posting a bond or other security, and waived her statutory right to recover attorneys' fees if she prevailed on her Labor Code claims.

Although the panel recognized that a contractual provision is not substantively unconscionable simply because it provides one side a greater benefit, CW Painting's agreement was unconscionable "on its face" and offered no justification for the "blatantly one-sided provision" permitting the employer to seek injunctive relief while forbidding it for Carbajal. The injunctive relief carve-out created further unconscionability by waiving CW Painting's need to post a bond to obtain an injunction, the court added.

Many of Carbajal's statutory wage claims would entitle her to recover attorneys' fees if she prevailed, the court said, and language in the provision that permitted an arbitrator to award "all types of relief that would otherwise be available to the parties in a court proceeding under State or Federal law" did not save this feature of the agreement. "The arbitration provision's plain language requires the parties to be responsible for their own attorney fees without any exceptions," the panel wrote. "Nothing in the provision's language suggests the parties intended to limit or qualify this provision by also granting the arbitrators broad authority to award all types of relief authorized by law."

"Based on the injunctive relief carve-out provision, the waiver of the injunction bond requirement, and the waiver of Carbajal's statutory right to recover attorney fees on her Labor Code claims, we conclude the Agreement's arbitration provision presents a moderate level of substantive unconscionability," the court said. "When that substantive unconscionability is combined with the moderate level of procedural unconscionability … the Agreement's arbitration provision is unenforceable."

The court's final blow to the employer was affirming the trial court's refusal to sever the unconscionable provisions of the arbitration agreement and instead tossing it in its entirety. Trial courts have the discretion to refuse to enforce a contract as a whole if it is "permeated" by the unconscionability, the panel wrote, if it contains more than one unlawful provision.

"Here, the Agreement contains three substantively unconscionable terms," the court said. "These provisions support the finding the Agreement's arbitration provision was permeated with unconscionability, and therefore we conclude the trial court did not abuse its discretion by refusing to sever these terms and enforce the remainder of the arbitration provision."

To read the opinion in Carbajal v. CWPSC, Inc., click here.