In Nelson v. Watch House International, L.L.C., (No. 15-10531), the Fifth Circuit Court of Appeals reversed a district court decision dismissing an employee’s lawsuit against his employer and compelling arbitration. The Fifth Circuit held that the employer’s arbitration agreement, contained within its employee handbook, failed to include a Halliburton-type savings clause that required advance notice before termination of an arbitration agreement became effective—and thus the agreement was illusory and unenforceable.

Background

On March 18, 2010, Watch House International offered plaintiff Michael Nelson a position in its Federal Air Marshal Program. That same day, Watch House sent Nelson an electronic copy of its employee handbook that contained Watch House’s “Arbitration Plan.” The plan included the following language:

As a condition for reviewing your application for employment and if employed, continued employment . . . [Company] and the Applicant/Employee designated below mutually agree to arbitrate claims relating to his/her being considered for employment and subsequent employment, if any, as specified below . . .

This agreement is issued with the authority of the Company and is binding on the Company.  This Agreement may not be altered except by consent of the Company and shall be immediately effective upon notice to Applicant/Employee of its terms, regardless of whether it is signed by either Agreeing Party.  Any change to this Agreement will only be effective upon notice to Applicant/Employee and shall only apply prospectively.

Nelson was employed from March 31, 2010 until March 12, 2014. He alleged that, during this time period, his coworkers harassed him based on his religion and his race. Approximately fifteen days after Nelson reported the comments, Watch House discharged him.

Nelson filed suit against Watch House asserting various federal and state law claims. Watch House moved to compel arbitration pursuant to its arbitration plan. Nelson opposed the motion, arguing inter alia, that the plan was unenforceable because it was illusory under In re Halliburton Co. in that it failed to include a “savings clause” related to existing claims and disputes and requiring advance notice of termination. The district court disagreed, granting Watch House’s motion to compel arbitration and dismissing Nelson’s lawsuit without prejudice. Nelson appealed.

The Fifth Circuit’s Decision

Under Texas law, an arbitration clause is illusory if one party can “avoid its promise to arbitrate by amending the provision or terminating it all together.” In Halliburton, 80 S.W.3d 566 (Tex. 2002), the seminal Texas arbitration case, an employee argued that an arbitration agreement was illusory because it purported to grant an employer the unilateral right to terminate or modify the arbitration agreement. In concluding that the arbitration agreement was not illusory, the Supreme Court of Texas relied upon two key provisions: First, the agreement provided that “no amendment shall apply to a Dispute of which . . . [employer] had actual notice on the date of amendment”; and second, the agreement stated that “termination shall not be effective until 10 days after reasonable notice of termination is given to Employees or as to Disputes which arose prior to the date of termination.” Because of these two provisions, the Halliburton court held that the employer could not “avoid its promise to arbitrate by amending or terminating [the arbitration agreement] all together.”

Following Halliburton, the Fifth Circuit fashioned a three-part test to determine whether a Halliburton-type savings clause sufficiently restrains an employer from having a unilateral right to terminate its obligation to arbitrate. In Lizalde v. Vista Quality Markets, 746 F.3d 222 (5th Cir. 2014), it held that “retaining termination power does not make an agreement illusory so long as that power (1) extends only to prospective claims, (2) applies equally to both the employer’s and employee’s claims, and (3) so long as advance notice to the employee is required before termination is effective.”

Applying the three-prong test, the Fifth Circuit noted that there was no dispute that Watch House’s arbitration plan satisfied the second prong of Lizalde by applying equally to claims made by both parties. However, the court found that the plan failed to include a Halliburton-type savings clause that requires advance notice of termination. The Fifth Circuit compared the language of the arbitration agreement approved in Lizalde and the language of Watch House’s plan. InLizalde, the parties’ agreement provided that “Company shall have the right to prospectively terminate [the Arbitration Agreement]. Termination is not effective for Covered Claims which accrued or occurred prior to the date of the termination. Termination is also not effective until ten (10 days) after reasonable notice is given to Claimant.”

In contrast, Watch House’s plan provided that Watch House may make unilateral changes to the plan, purportedly including termination, and that such changes “shall be immediately effective upon notice to” employees. As such, Watch House’s retention of this unilateral power to terminate the plan without advance notice rendered the plan illusory under a plain reading of Lizalde. Accordingly, the Fifth Circuit reversed the district court’s grant of Watch House’s motion to compel, and remanded Nelson’s claims for further proceedings.

Key Takeaways

Although Texas courts tend to enforce arbitration agreements contained within employee handbooks, Texas employers must still comply with the requirements set forth in Lizalde and Halliburton. Texas employers should review their arbitration agreements to ensure that such agreements (1) only apply prospectively, (2) apply equally to the employer’s and employee’s claims, and (3) require advance notice of termination to the employee. To ensure that their arbitration agreements will be upheld, employers should make sure all three prongs of Lizalde are satisfied.