Introduction

We now have the long-awaited decision from the US Supreme Court on the enforceability of arbitration provisions requiring disputes to be resolved on an individual basis only – otherwise known semi-pejoratively as “class action waivers.” In AT&T Mobility, LLC v. Concepcion, 563 US ____, 2011 WL 1561956 (April 27, 2011), a five-to-four majority of the Court nullified a key California law doctrine that had previously rendered many employment arbitration agreements unenforceable. This Legal Alert is intended for the corporate counsel considering the ramifications of AT&T Mobility in California, written by a practitioner who has litigated more than a dozen California trial and appeals court decisions to enforce employer arbitration agreements. Here, I avoid an extended discussion of the Supreme Court’s evolving interpretation of the Federal Arbitration Act, and California’s interpretation of that Act. Instead, I focus on the immediate impact of AT&T Mobility on California law, and how an employer can benefit from this common-sense, favorable decision by creating an arbitration policy that is both fair to employees and avoids the massive costs of litigating the wage-hour and other class actions that are so prevalent in California.

Summary of AT&T Mobility

AT&T Mobility is not an employment case, but rather involved consumers who sued AT&T because they were charged sales tax based on the value of a product advertised as “free,” when they received that product. The adhesive arbitration contract that AT&T used with consumers provided for arbitration of all disputes between the parties, but required that claims be brought in the parties’ “individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.” The Supreme Court’s majority opinion noted the details of AT&T’s fairly generous agreement at issue, which the company had revised over time:

[the arbitration] agreement provides that customers may initiate dispute proceedings by completing a one-page Notice of Dispute form available on AT&T’s Web site. AT&T may then offer to settle the claim; if it does not, or if the dispute is not resolved within 30 days, the customer may invoke arbitration by filing a separate Demand for Arbitration, also available on AT&T’s Web site. In the event the parties proceed to arbitration, the agreement specifies that AT&T must pay all costs for non-frivolous claims; that arbitration must take place in the county in which the customer is billed; that, for claims of $10,000 or less, the customer may choose whether the arbitration proceeds in person, by telephone, or based only on submissions; that either party may bring a claim in small claims court in lieu of arbitration; and that the arbitrator may award any form of individual relief, including injunctions and presumably punitive damages. The agreement, moreover, denies AT&T any ability to seek reimbursement of its attorney’s fees, and, in the event that a customer receives an arbitration award greater than AT&T’s last written settlement offer, requires AT&T to pay a $7,500 minimum recovery [later increased to $10,000] and twice the amount of the claimant’s attorney’s fees.

2011 WL 1561956 at *3.

Despite these pro-employee allowances, both the federal district court and Ninth Circuit applied California’s Discover Bank unconscionability test to strike down the class action waiver clause. The California Supreme Court had created and previously formulated this test, arising from California’s general law of unconscionability, as follows:

[W]hen the [class action] waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money, then . . . the waiver becomes in practice the exemption of the party ‘from responsibility for [its] own fraud, or willful injury to the person or property of another.’ Under these circumstances, such waivers are unconscionable under California law and should not be enforced.

Discover Bank v. Superior Court, 36 Cal. 4th 148, 162 (2005) (quoting Cal. Civ. Code § 1668). Since its formulation, the test had been used to strike down class action waivers in many different contexts.

The key question before the Supreme Court was whether the Federal Arbitration Act (9 U.S.C. §§ 1 et seq.; “FAA”) pre-empted the Discover Bank doctrine, reversing the decision below, and precluding future state and federal courts in California from using the doctrine to strike down class action waivers in arbitration agreements. As with several other FAA cases, the Court split on the proper interpretation of the “savings clause” coming at the end of Section 2 of the FAA.

A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.

9 U. S. C. § 2 (emphasis added).

Like the Ninth Circuit below, the AT&T Mobility dissent interpreted the Section 2 savings clause to mean that a state could permissibly ban any type of contract provision governing arbitration, as long as the same ban applied to contracts governing litigation. Moreover, the dissent reasoned that, because the Discover Bank doctrine arose from unconscionability – a generally permitted contract defense under the FAA – the doctrine itself also had to be permissible. This was the core of the dissent’s position. 2011 WL 1561956 at *17-*18, *20.

The AT&T Mobility majority differed sharply, holding that the FAA contained not just nondiscrimination rules but also substantive, normative protections of arbitration agreements, which were equally important to the FAA’s statutory purpose. While the majority agreed with the dissent that “courts must place arbitration agreements on an equal footing with other contracts” under the FAA, the majority did not view that as the sole requirement of the FAA. Instead, the majority also held that “[t]he ‘principal purpose’ of the FAA is to ‘ensur[e] that private arbitration agreements are enforced according to their terms.’” Id. at *8 (citing Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U. S. 468, 478 (1989) and Stolt-Nielsen S. A. v. AnimalFeeds Int’l Corp., 559 U. S. ___, ___ (2010) (slip op., at 17)). The Court referred to another recent decision overturning a California statute under the FAA, noting that “[a] prime objective of an agreement to arbitrate is to achieve ‘streamlined proceedings and expeditious results…’” Id. at *9 (citing Preston v. Ferrer, 552 U. S. 346, 357–358 (2008)). The majority determined that the Section 2 savings clause thus did not “suggest[] an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.” Id. at *7 (cite omitted).

Taking this view of Section 2 of the FAA, the Court held that “California’s Discover Bank rule similarly interferes with arbitration.” The Court noted that the Discover Bank rule “allows any party to a consumer contract to demand [class-wide arbitration] ex post” and that the self-ascribed “limitations” to the rule were not limitations at all. “The rule is limited to adhesion contracts [cite omitted] , but the times in which consumer contracts were anything other than adhesive are long past.” Id. at *9 (cites and note omitted). The rule’s requirement “that damages be predictably small” was “toothless and malleable.” Id. And, its requirement “that the consumer allege a scheme to cheat consumers” really “has no limiting effect, as all that is required is an allegation.” Id.

In noting how imposition of class arbitration would thwart the purposes of the FAA, the Court made some notable comments for the in-house counsel perspective. The Court noted that “the switch from bilateral to class arbitration sacrifices the principal advantage of arbitration — its informality — and makes the process slower, more costly, and more likely to generate procedural morass than final judgment.” Id. at *10. Second, the Court noted that, due to the extensive arbitration rules tending to mimic Rule 23, “class arbitration requires procedural formality” contrary to the FAA’s intent Id. (emphasis in original). Third, the Court noted that “class arbitration greatly increases risks to defendants” in that they may be required to settle unmeritorious claims out of the sheer gravity of exposure. Id. at *10-11.

The Court majority also attacked the dissent’s “claims that class proceedings are necessary to prosecute small-dollar claims that might otherwise slip through the legal system” with some very important and pointed language: “…States cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.” Id. at *13 (emphasis added). Secondarily, the Court noted that “the arbitration agreement provides that AT&T will pay claimants a minimum of $7,500 and twice their attorney’s fees if they obtain an arbitration award greater than AT&T’s last settlement offer” was reason to believe that claims against AT&T were “unlikely to go unresolved.” Id.

The Court’s ultimate holding, repeated at different points in the opinion, not only disposed of Discover Bank, but was a shot across the bow of other California doctrines that have been deployed to prevent the enforcement of arbitration agreements with class action waivers:

The overarching purpose of the FAA, evident in the text of §§2, 3, and 4, is to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings. Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA….

***

California’s Discover Bank rule is preempted by the FAA.

Id. at *8, 13 (emphasis added).

AT&T Mobility Should Spell The Doom of Gentry’s Public Policy Test Against Class Action Waivers in Employment Arbitration Agreements

As many in-house counsel know, the other prevalent doctrine that has been deployed to knock down class action waivers, specifically in employment class actions, hails from Gentry v. Superior Court (Circuit City), 42 Cal. 4th 443 (2007). Gentry was not directly addressed in AT&T Mobility, because AT&T Mobility was not an employment case that would necessarily implicate the Gentry doctrine. Moreover, the Gentry public policy doctrine differs from Discover Bank in that the Gentry doctrine does not stem from traditional unconscionability principles, but is judge-made public policy arising from the California Labor Code itself. However, this difference makes the public policy doctrine in Gentry (a four-to-three decision authored by now-retired Justice Carlos Moreno) an even stronger candidate for pre-emption than Discover Bank.

In Gentry, the California Supreme Court relied on two rationales to create its public policy test against class action waivers: (1) that “under some circumstances such a provision would lead to a de facto waiver [of overtime rights] and would impermissibly interfere with employees’ ability to vindicate [those] unwaivable rights and to enforce the overtime laws,” and, secondarily (2) “that class action waivers in wage and hour cases and overtime cases would have, at least frequently if not invariably, a[n] exculpatory effect…” See 42 Cal. 4th at 457.

Based on this reasoning, the California Supreme Court listed several factors for a trial court to consider in a putative class action wage-hour case that involved a class action waiver: “the modest size of the potential individual recovery, the potential for retaliation against members of the class, the fact that absent members of the class may be ill informed about their rights, and other real world obstacles to the vindication of class members’ right to overtime pay through individual arbitration.” Id. at 463. Then, if the trial court “concludes, based on these factors, that a class arbitration is likely to be a significantly more effective practical means of vindicating the rights of the affected employees than individual litigation or arbitration, and finds that the disallowance of the class action will likely lead to a less comprehensive enforcement of overtime laws for the employees alleged to be affected by the employer’s violations, it must invalidate the class arbitration waiver .... The kind of inquiry a trial court must make is similar to the one it already makes to determine whether class actions are appropriate.” Id.

As one can plainly read, the state-policy-driven considerations behind Gentry should be held invalid under AT&T Mobility for various reasons. First and foremost, writing a class action waiver right out of an arbitration agreement does not accord with the FAA’s “principal purpose” — as held by AT&T Mobility — of “ensuring that private arbitration agreements are enforced according to their terms.” AT&T Mobility, 2011 WL 1561956 at *8. In AT&T Mobility, the Unites States Supreme Court has already ruled that “[r]equiring the availability of classwide arbitration interferes with fundamental attributes of arbitration” ipso facto is “creating a scheme inconsistent with the FAA.” Id. That alone should spell pre-emption of the Gentry public policy test.

Moreover, all three of the advantages of arbitration that the U.S. Supreme Court noted were frustrated by Discover Bank are also frustrated by Gentry, especially when one considers that Gentry requires an additional threshold inquiry “similar” to class certification even before the parties are burdened with the “procedural formality” of class certification. Next, the exculpatory contract rationale behind Gentry was expressly rejected in AT&T Mobility. Finally, the various policy factors that Gentry created to judge the validity of a class action waiver (modest class size, retaliation, etc.) are all unrelated to streamlined enforcement of arbitration agreements and thus are impermissible considerations under AT&T Mobility. Id. at *13 (“...States cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.”)

Given the strong language in AT&T Mobility, a neutral decisionmaker would be hard pressed to find that the public policy test from Gentry still survives, although that portion of the Gentry opinion directed toward unconscionability in general may continue on. As a result, the option of creating arbitration agreements requiring individual determinations rather than class actions is once again realistically open to California employers.

New Arbitration Vistas for California Employers

Discover Bank is now gone, and Gentry should be in the future, although that may take some time, given some state courts’ resistance in FAA preemption decisions. Whether and how to implement arbitration agreements with employees that contain a class action waiver is again an important issue in California. Unlike some commentators, I do not suggest that an employer is now allowed to implement whatever agreement it wants under the “enforce according to its terms” rationale of AT&T Mobility. This would not be fair to employees, or desirable from the perspective of fully and fairly resolving their disputes, which is what all employers of good faith actually seek to achieve with arbitration. I also do not recommend immediately rushing to draft and implement any agreement containing a class action waiver without careful consideration, although the benefit for any employer of restraining unmeritorious lawyer-driven California class litigation is apparent.

Employers who wish to use an arbitration agreement in California must either review the current agreement to make sure it complies with post-AT&T Mobility California rules, or draft one from scratch. Drafting a valid provision is a relatively straightforward task, but missteps can be costly. Few things are more disagreeable for an employer than to litigate a petition to compel arbitration, requiring significant time and resources, and then ultimately be told by a judge that the arbitration agreement is unenforceable. Thus, an extensive review by counsel is always recommended.

The mechanics of drafting a program are something that an employer can accomplish with the help of counsel. But the employer itself must decide several key policy questions before creating any of the arbitration documents or language. In the post-AT&T Mobility era, the following are important policy or drafting issues to consider when drafting arbitration programs, especially if a class action waiver is included:

  • Drafting to satisfy other public policy tests besides Discover Bank and Gentry: The groundbreaking case setting forth the basic public policy standards in California is the California Supreme Court’s earlier decision in Armendariz v. Foundation Psychcare Srvcs., 24 Cal. 4th 83 (2000), which was not litigated in or overturned by AT&T Mobility.1 In fact, the case’s discussion of unconscionability in general was cited in the majority opinion. 2011 WL 1561956 at *5. The five minimum requirements of Armendariz are: a neutral arbitrator; no limits on statutory remedies; a written arbitration decision to permit judicial review; adequate (although not unlimited) discovery; and the employer bearing any type of arbitration cost except costs that an employee would have to bear in the judicial forum (i.e., a modest filing fee).

Arbitral discovery does not have to be co-extensive with the discovery statutes under this standard. It is unsettled just how much discovery is enough as a bright line rule. However, restricting depositions to a very low number, restricting interrogatories/document requests to the ten to twenty range, and allowing an arbitrator to increase discovery limits only if “absolutely necessary” are restrictions that may be struck down. An employer should not create an arbitration procedure, like typical union contract arbitration agreements, where discovery is very limited and the return of discovery requests occurs at the hearing itself.

A defective cost-sharing provision, if it stands alone, can often be saved by severing the clause from the agreement. Luckily for employers, silence on costs in an agreement will typically be interpreted by courts as conformance with the rule.

  • Avoiding one-sided provisions to avoid substantive unconscionability: California courts routinely characterize substantively unconscionable provisions as “one sided.” Many types of provisions have been challenged as substantively unconscionable. However, one commonly found substantively unconscionable provision is the arbitration coverage provision itself. Arbitration coverage, if it extends to employee claims at all, should also typically extend to all the kinds of disputes that could be brought by the employer as well. Therefore, aside from provisions allowing parties to obtain a preliminary injunction in aid of arbitration, an employer should not “carve out” certain causes of action (e.g., trade secrets type actions) for resolution through litigation, while requiring employee claims in their entirety to be arbitrated. An employer should avoid provisions that shorten the statute of limitations or that limit remedies available.
  • Informing employees of the differences between the arbitration program and court procedures, without overbearing advocacy of the arbitration program: These are both important elements of Gentry’s unconscionability analysis, an analysis that may survive AT&T Mobility. During the “roll-out phase” of the individual arbitration program, each significant difference between the arbitration program and the “default” rules for civil litigation should be highlighted to employees considering the program. This would include the class action waiver. The discussion of arbitration versus litigation should be even-handed, without the employer taking a strong advocacy position. This comparison is probably not required for programs that lack a class action waiver.
  • Avoid forced employee participation that will provoke claims of unconscionability: Many employers prefer to make arbitration agreements a condition of employment, but that gives away part of the defense to unconscionability. Some courts will invalidate a mandatory arbitration provision even if there are only a few substantively unconscionable provisions in the agreement. The easiest way an employer can avoid accusations of procedural unconscionability (i.e. “surprise”) is to make clear that a document is a binding arbitration agreement, and by using attention-getting devices (underscoring, large size/color font, or graphics) to help point that out and also the existence of the class action waiver. A state law requirement of such devices was implicitly approved as consistent with the FAA by AT&T Mobility. 2011 WL 1561956 at *9 n. 6.
  •  Method of agreement and notice to employees of the program: Opt-out agreements, versus traditional affirmatively signed agreements, may increase employee participation. However, opt-out agreements without acknowledgement of both receipt and the “rules for opting out” (if any) will create potentially cumbersome fact issues for litigation. This is an area where counsel needs to be involved.
  • Predispute versus postdispute arbitration agreements: The vast majority of employers prefer predispute arbitration agreements. Most plaintiffs’ counsel are unlikely to enter into a postdispute arbitration agreement, either as a matter of principle or simply in the hope that a jury will award far greater damages.
  • Informing employees of their employment law rights generally and their ability to enforce them in arbitration: This is an important factor under the unconscionability analysis and discussion in Gentry, which may yet survive, but an employer can reasonably satisfy it if the employer takes steps to distribute the various government-authored notices of legal employment rights, any of its own explanatory materials, and obtain acknowledgments of the same.
  • Considering a preliminary internal step prior to arbitration: Employers frequently have some sort of formal or informal internal dispute resolution system, and it makes sense to incorporate this system at least as a gateway that employers expect employees to pass before entering into formal arbitration. Employers should be advised, however, that there is no legal mechanism to compel compliance with informal pre-arbitration steps.
  • Implementing anti-retaliation mechanisms: An employer should have a process that eliminates or at least surfaces and successfully resolves complaints of retaliation by employees who use the arbitration system. “Customer satisfaction” surveys from employees who used the arbitration program are one way to show evidence that no retaliation is occurring.
  • Selecting the service provider: The number of employment specialists on the arbitration provider’s panel needs to be examined, so that true, neutral employment law specialists are available.
  • Creating an organization to run the arbitration system: Employers who create permanent internal positions to monitor and manage the internal side of the arbitration system will be far better prepared than those that rely only on the arbitration provider’s case managers. Internal personnel can also assist in getting witnesses and documents in a rapid-fire arbitration proceeding geared up for hearing.
  • Preparing your business for challenges to the arbitration program: The unfortunate truth is that the majority of California plaintiffs’ attorneys are still going to challenge an arbitration agreement with a class action waiver, even after AT&T Mobility. Even though an arbitration agreement may be enforceable in the end, they are frequently challenged in California and other popularly-frequented employment jurisdictions, and there are litigation costs involved. Obtaining some enforcement victories can create helpful leverage to cause plaintiffs’ attorneys to stipulate to arbitration in other cases.