Declining to enforce a representative action waiver contained in an arbitration agreement, the Ninth Circuit Court of Appeals, in San Francisco, has held that the Federal Arbitration Act (“FAA”) does not preempt California’s “Iskanian rule,” which prohibits waiver of representative claims under the state Private Attorneys General Act of 2004 (“PAGA”), Cal. Lab. Code § 2698 et seq. Sakkab v. Luxottica Retail North America, Inc., No. 13-55184 (9th Cir. Sept. 28, 2015).

The PAGA “authorizes an employee to bring an action for civil penalties on behalf of the state against his or her employer for Labor Code violations committed against the employee and fellow employees, with most of the proceeds of that litigation going to the state.” Iskanian v. CLS Transportation Los Angeles, LLC, 59 Cal.4th 348, 360 (2014). Thus, a PAGA claim is a type of government enforcement action where the representative employee acts as the state’s proxy.

Iskanian Rule

The California Supreme Court in Iskanian held that class action waivers in arbitration agreements are enforceable under the FAA, as interpreted by the U.S. Supreme Court in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011), but that representative PAGA claims are unwaivable under California law. The California Supreme Court reasoned that waivers of representative PAGA claims were against public policy, because they would “disable one of the primary mechanisms for enforcing the Labor Code,” and a private agreement may not contravene a law established for a public reason.

Split Resolved

California state courts have been following Iskanian, as required. Several federal district courts in California, however, declined to follow Iskanian, ruling that the FAA preempted it. Sakkab resolved this split between federal and state courts, at least for the moment, in favor of the bar of representative PAGA waivers.

In upholding the Iskanian rule, the Court noted that while the FAA permits arbitration agreements to be invalidated by “generally applicable contract defenses, such as fraud, duress, or unconscionability,” it does not permit invalidation of such agreements on account of state law contract defenses that apply only to arbitration or “derive their meaning from the fact that an agreement to arbitrate is at issue” (quoting Concepcion). Even if a state-law rule is “generally applicable,” the Court said, it is preempted if it “stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress” (quoting Concepcion), which is to enforce arbitration agreements according to their terms.

The Court held that the FAA does not preempt the Iskanian rule because it is a generally applicable contract defense. That is, PAGA representative action waivers are unenforceable in any type of contract, not just arbitration agreements. The Court further held that the rule does not conflict with Congress’ objectives for the FAA because it does not interfere with arbitration. PAGA claims can be arbitrated. The rule prohibits only a waiver of the right to bring a representative PAGA claim in any forum.

The Court distinguished a state law prohibition on a class action waiver, which the FAA preempts, from a PAGA representative action waiver, which the FAA does not preempt. A class action is a procedural device for resolving the claims of absent parties on a representative basis, it said. Class procedures, which are required to protect the due process rights of the absent parties, sacrifice “the principal advantage of arbitration — its informality — and makes the process slower, more costly, and more likely to generate procedural morass than final judgment” (quoting Concepcion). In contrast, the Court said, representative PAGA claims do not require these features because they do not vindicate the absent employees’ claims. Instead, PAGA claims seek penalties, not damages, which are measured by the number of state Labor Code violations. While this may increase the complexity of a PAGA claim, it does so because of the measure of the recovery, not required procedures that the parties can limit with their arbitration agreement (e.g., discovery limitations). The Court held, “[a]n agreement to waive ‘representative’ PAGA claims — that is, claims for penalties arising out of violations against other employees — is effectively an agreement to limit the penalties an employee-plaintiff may recover on behalf of the state.” Therefore, the Court held that the PAGA waivers are unenforceable.

Dissent

Judge N. Randy Smith would have applied Concepcion to PAGA representative action waivers in the same manner as it applies to class action waivers. Judge Smith would have held Iskanian’s PAGA waiver ban is preempted by the FAA.

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For now, PAGA representative action waivers will not be enforced in both state and federal courts in California. The Iskanian rule applies unless and until there is an en banc or U.S. Supreme Court ruling reversing the decision. Although the Supreme Court has declined review in two cases, including Iskanian, it may have been waiting for the Ninth Circuit to opine on the issue. Now that the Ninth Circuit has done so, a Supreme Court review may be more likely.

Meanwhile, employers should consider reviewing their employment arbitration agreements with counsel.