In OTO, L.L.C. v. Kho, the California Supreme Court refused to enforce an employee’s arbitration agreement on the basis that it was unconscionable. Unconscionability has long been a common-law defense to contract enforcement. What makes OTO v. Kho problematic for employers is the court’s weakening of the traditional “Does the agreement shock the conscience?” standard. The court in this case invalidated the agreement because arbitration was a less affordable and less accessible dispute resolution mechanism than other potentially applicable state law mechanisms. Specifically, the court found the parties’ arbitration procedure to be less advantageous to the employee in the resolution of his wage claims than the “Berman” procedure, an administrative process through which an employee can receive substantial assistance in taking his wage claims before the state Labor Commissioner.

Background

Three years into his employment, the plaintiff, a mechanic for an auto dealership, was asked to sign an arbitration agreement, among a few other documents. The HR employee who handed him the paperwork stood waiting for him to sign it, suggesting—according to the plaintiff—he could not take time to read it over first. Without reading any of them, the employee signed and returned all the documents. One year later, after his employment ended, the former employee filed a wage claim with the Labor Commissioner. The company filed a motion to stay the matter and enforce the arbitration agreement and refused to attend the Labor Commissioner/Berman hearing, where the employee was awarded approximately $155,000 in wages and penalties. The company filed a de novo appeal with the superior court, which found the arbitration agreement unconscionable. The company appealed and the state court of appeal reversed, finding the employee did not prove unconscionability under the traditional standard.

When is an Agreement Unconscionable?

Unconscionability requires a showing of both procedural unconscionability (oppression or surprise in the negotiation and formation of the contract) and substantive unconscionability (the agreement is so one-sided and disadvantageous to the other side it shocks the conscience). All three courts in this case found the arbitration agreement to be procedurally unconscionable because the employee was not afforded time to review the agreement before signing, the agreement was a condition of continued employment, and he was not provided with a copy of the agreement, which was written in size 8.5-point font and contained lengthy and “opaque” sentences (though it clearly stated it was an arbitration agreement at the top and was only 1.25 pages long in total).

But on substantive unconscionability, California’s high court deviated from the lower courts’ analyses. Though conceding that the parties’ arbitration agreement may be appropriate in a wrongful termination case where no Berman procedure is available, the court found the arbitration agreement substantively unconscionable in the context of the employee’s wage claim because the arbitration process was less accessible and affordable than the state law procedure. Notably, the arbitration agreement endeavored to confer rights similar to those permitted by traditional litigation (a hallmark of substantively conscionable agreements under prior case law), including requiring a retired state court judge to act as arbitrator and the availability of all discovery and dispositive motion vehicles provided under state law. However, the court found these same provisions made the process more complex and lengthy, presenting an unfavorable contrast to the Berman procedure (see below chart). On this basis, the court found the arbitration agreement substantively unconscionable. In doing so, the court stressed that the arbitration agreement’s waiver of the Berman process was not in and of itself unconscionable (and indeed to hold otherwise would directly contradict AT&T Mobility LLC v. Concepcion 563 U.S. 333 (2011), but found the arbitration process must offer an accessible and affordable forum for resolving wage disputes in exchange for the employee’s waiver.

 

The court found support for its unconscionability analysis in its earlier opinion, Sonic-Calabasas A, Inc. v. Moreno (2013) 57 Cal.4th 1109, 1146 (Sonic II). In Sonic II, the court stated that a Berman waiver could be a factor in a court’s unconscionability analysis. However, as pointed out in Justice Chin’s dissent, Sonic II’s articulation of the standard for substantive unconscionability still required enforcement of the arbitration agreement as long as the arbitration would provide employees with an accessible, affordable process for resolving wage disputes that did not effectively block every forum for redress, including the arbitration itself. But, in OTO v. Kho, the court set the bar much higher, requiring the employer to show the arbitration procedure to be as affordable and accessible as the Berman procedure, at least for wage claims. Justice Chin opined that the majority’s holding violated binding principles under the Federal Arbitration Act, prohibiting courts from refusing to enforce arbitration on the basis that another forum was preferable or that arbitration would not be effective in vindicating a statutory right.

In other words, if this decision is appealed, the California Supreme Court could be heading for another reversal by the United States Supreme Court. In the meantime, employers might consider taking steps to ensure agreements are implemented in a way that does not suggest they are procedurally unconscionable. Without procedural unconscionability, courts cannot advance to the substantive unconscionability analysis in OTO v. Kho, as a showing of both types of unconscionability is required for a court to refuse to enforce an agreement on that basis. Employers can consider the following:

  • Provide the employee sufficient time to review the arbitration agreement.
  • If the agreement is distributed manually, consider implementing measures to establish the employee was given time to review, rather than asked to return the document immediately. For example, the documents could be retrieved some period of time after distribution or the person making the distributions could place a note in the employee’s file regarding the time afforded for review.
  • Provide a translation of the arbitration agreement if the employee cannot easily read English.
  • Provide a mechanism for employees to opt out of the agreement.
  • Make sure the document uses at least 12-point font and sentences are not lengthy.
  • Include a delegation provision in the arbitration agreement that requires the arbitrator decided challenges to enforceability—not the court.