A recently issued opinion of the Fifth Circuit Court of Appeals made clear that employers wishing to implement mandatory arbitration of employment disputes are best advised to do so in the context of a separate arbitration agreement, rather than attempting to include that agreement in an employee handbook. In Nelson v. Watch House International, LLC, No. 15-10531 (5th Cir. Mar. 2, 2016), Michael Nelson had sued his former employer, security firm Watch House International, LLC. Nelson argued that his coworkers harassed him based on his religion and race for being an interracial relationship and that, 15 days after reporting the alleged harassment to Watch House, he was terminated.

In responding to these allegations, Watch House relied upon the arbitration agreement contained in its Employee Handbook and asked the court to compel the parties to arbitration. The district court agreed, ordered the parties to arbitration, and dismissed Nelson’s federal lawsuit.

Nelson appealed the district court’s decision, drawing the Fifth Circuit Court of Appeals’ attention to a provision contained in Watch House’s Employment Handbook: “[This Agreement] 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 the Applicant/Employee of its terms… Any change… will only be effective upon notice to the Applicant/Employee and shall only apply prospectively.” (emphasis added).

The Fifth Circuit held that Texas law allows employers to retain amendment and/or termination power as to arbitration agreements, provided that the arbitration provision satisfies a three-part test. This test, as articulated in Lizalde v. Vista Quality Markets, 746 F.3d 222 (5th Circ. 2014), requires thatchanges to arbitration agreements: (1) only apply to prospective claims, (2) apply equally to the employer and employee’s claims, and (3) are accompanied by the employer’s advance notice to the employee that the change will be taking place. Arbitration provisions that do not meet these criteria are considered illusory and, thus, unenforceable­.

Even though Watch House’s “Power to Amend” language attempted to limit changes to prospective claims (the first prong) and applied equally to the Employee and the Company (the second prong), the Fifth Circuit held that Watch House’s Agreement was illusory because changes to the arbitration provision became “immediately effective upon notice” to the employee (the third prong). As a result, the Fifth Circuit overturned the District Court’s decision to send the parties to arbitration and remanded the case so that Nelson could pursue his claims against Watch House in federal court.

Texas employers must closely review their current arbitration policies with the Watch House holding in mind. We strongly recommend that agreements to arbitrate be separate standalone agreements and not part of an Employee Handbook. Likewise, employers should consider whether their “power to amend” language makes changes to the arbitration agreement effective only for prospective claims, applies equally to the employer and employee, and requires advance notice before changes take effect.