The U.S. Supreme Court has agreed to review whether the Federal Arbitration Act (FAA) preempts a California state court rule on unconscionable provisions that is purportedly applied more stringently to arbitration agreements than to other contracts. Under the California rule, arbitration agreements with more than one unconscionable provision may not be enforced despite an express severability clause.

In MHN Government Services, Inc., et al. v. Zaborowski, et al., Case No. 14-1458 (cert. granted 10-1-15), the justices will consider the Ninth Circuit’s 2-1 opinion that denied arbitration of Fair Labor Standards Act (FLSA) and state court claims brought by consultants who offer short-term financial, child services, and victim-advocacy counseling at U.S. military installations.

The consultants filed a putative class action in district court against MHN Government Services, Inc. (MHN), contending they were incorrectly classified as independent contractors rather than employees, which denied them overtime pay and other benefits. MHN subsequently moved to compel arbitration under the Provider Services Task Order Agreements the named consultants had signed, which included mandatory arbitration provisions as well as an express severability clause.

Based on California law, the district court concluded that multiple provisions in the arbitration agreement were unconscionable; for example, the arbitration provision was placed as “paragraph 20 of 23” in the agreement, had a six-month statute of limitations, allowed MHN to select the pool of arbitrators, prohibited punitive damages, and would force plaintiffs to pay a $2,600 filing fee.

The district court thus concluded that the contract contained multiple substantively unconscionable provisions which allowed it to find that the agreement was “permeated by an unlawful purpose.” The court then held that the unconscionable provisions were not severable and denied MHN’s motion to compel arbitration despite the severability provision.

At the Ninth Circuit

On December 17, 2014, a divided Ninth Circuit affirmed, finding that the district court correctly held “multiple aspects of the arbitration provision [were] substantively unconscionable.” Zaborowski v. MHN Government Services, Inc., et al., No. 13-15671.

The appellate court agreed that five of the agreement’s clauses were substantively unconscionable. They included: (1) the arbitrator selection clause which “[g]ranted MHN near-unfettered discretion to select its three preferred arbitrators . . . .”; (2) the contract’s six-month limitation period which “[g]iven the nature of plaintiffs’ claims . . . works as a ‘practical abrogation of the right of action’”; (3) the cost- and fee-shifting clause which had the effect “to chill employees from seeking vindication of their statutory rights by pursuing claims in arbitration”; and (4) to a limited degree, the filing fees and punitive damage waiver were also substantively unconscionable. The fees (including a $2,600 filing fee) “hamper one party – the employee – much more than the other.” And, according to the majority, the punitive damages waiver improperly restricted statutory remedies provided to plaintiffs raising employment claims.

While the Ninth Circuit panel admitted it may have reached a different conclusion than the district court on whether the problematic clauses could be stricken, it could not say the conclusion was without support in the record. Finally, the appellate court denied that application of California unconscionability principles resulted in an analysis “impermissibly unfavorable to arbitration.”

Circuit Judge Gould, however, would have reversed the district court on the severance issue and would have left the arbitration agreement in force. Judge Gould differed with the majority in two respects. First, he felt the district court impermissibly relied on Armendariz v. Found. Health Psychcare Servs., Inc., 6 P.3d 669, 697 (Cal. 2000) which was decided more than 10 years before the U.S. Supreme Court’s decision in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1747 (2011). Accordingly, Armendariz’s reasoning that multiple unconscionable provisions renders an arbitration agreement’s purpose unlawful has “‘a disproportionate impact on arbitration agreements’ and should have been preempted by the Federal Arbitration Act.” Judge Gould then graphically illustrated that if all the unconscionable provisions of the arbitration agreement (as identified by the district court and affirmed by the majority of the panel) were removed, “the remainder of the arbitration agreement [could] still be enforced, and the district court need not ‘assume the role of contract author.’”

A Circuit Conflict?

MHN’s final substantive argument in the petition was that the Ninth Circuit’s holding conflicts with the opinions of at least four other circuits. Indeed, according to MHN, the Sixth, Eighth, and D.C. Circuits “recognize that enforcing a contractual severability clause not only respects the parties’ contractual agreement, but also adheres to the liberal federal policy favoring arbitration.”

No argument date has yet been set in the MHN case. This is the second California decision concerning arbitration in which the Supreme Court has granted certiorari. Oral argument took place in DirecTV, Inc. v. Imburgia, Docket No. 14-462, on October 6, 2015. DirecTV involves whether the California Court of Appeals erred by holding that a reference to state law in an arbitration agreement governed by the FAA requires the application of state law preempted by the FAA.

BOTTOM LINE:

The MHN case will give the U.S. Supreme Court the opportunity to consider whether the California rule regarding arbitration agreements with unconscionable provisions conflicts with the FAA.