Employers often require their employees to arbitrate to reduce the costs of lawsuits and obtain finality because, most of the time, arbitration decisions are not subject to appeal like judicial decisions. But a recent decision of the California Supreme Court has undermined these advantages of arbitration.

Pearson Dental Supplies, Inc. v. The Superior Court of Los Angeles County (Turcios)(April 26, 2010)

In Pearson Dental, the California Supreme Court ruled that a judge may throw out an arbitration award if an employee subject to a mandatory arbitration agreement is “unable to obtain a hearing on the merits of” statutory discrimination claims because of “an arbitration award based on legal error.” Although the scope of this decision is unclear, it is evident that more California employees are likely to challenge arbitration agreements and arbitration awards.

Background

The plaintiff, Luis Turcios, was employed as a janitor by Pearson Dental Supplies until his termination on January 31, 2006, at age 67. He had signed an agreement requiring him to arbitrate employment discrimination claims and stating that claims had to be submitted to arbitration within one year after a dispute arose. After exhausting his administrative remedies, on October 2, 2006, Turcios filed a civil complaint in the Superior Court alleging age discrimination in violation of the California Fair Employment and Housing Act (FEHA). Five months later, Pearson Dental filed a motion to compel arbitration, which was granted orally by the trial court on April 12, 2007, and confirmed by a written decision on May 2, 2007. On May 31, 2007, Turcios’ request for extraordinary review in the appellate court was denied, and on June 13, 2007, he and Pearson Dental selected an arbitrator.

Before the arbitrator, Pearson Dental filed a motion for summary judgment. The company argued that Turcios’ claims were time-barred under the arbitration agreement’s requirement that claims must be submitted to arbitration within one year after a dispute arises. Turcios opposed the motion on two grounds: first, that the one-year statute of limitations in the arbitration agreement was unenforceable because it provided for a shorter limitations period than the FEHA; and second, that even if valid, the one-year limitations period was tolled under the California Arbitration Act (CAA), which tolls the limitations period “from the date the civil action is commenced until 30 days after a final determination by the court that the party is required to arbitrate the controversy ... .” Turcios lost the argument and the arbitrator dismissed Turcios’ claims.

The trial court threw out the arbitration award, however, ruling that the arbitrator had made a clear error of law by misinterpreting the CAA’s tolling provisions. In addition, the trial court ruled that, under the California Supreme Court’s landmark decision in Armendariz v. Foundation Health Psychcare Services, Inc., the court was obligated to overturn the arbitrator’s decision because it was necessary to “protect the plaintiff’s unwaivable statutory rights arising from his FEHA claims.” The Court of Appeal reversed. Although it agreed with Turcios that the arbitrator had “misapplied the tolling period” under the CAA, the appellate court said it could not fix the mistake. Under long-standing precedent, the erroneous arbitration decision was “insulated from judicial review,” the appellate court ruled.

California Supreme Court Vacates Arbitrator’s Award

The California Supreme Court disagreed and vacated the arbitrator’s award. It first found as a matter of law that the arbitrator had misapplied the CAA’s tolling provision. The Court reasoned that once you excluded the period of time between the date on which Turcios filed his lawsuit and the date 30 days after the trial court had ruled on petition to compel arbitration, as the CAA required, the arbitration proceeding had been commenced within one year after Turcios’ termination. Thus, the limitations period in the arbitration agreement had been satisfied.

Finding that the arbitrator made a legal error was not the end of the case. The Supreme Court also had to deal with its decision in Moncharsh v. Heily & Blase, 3 Cal. 4th 1 (1992), where it decided that, as a general rule, a court may not vacate an arbitration award based on errors of law. But that decision “recognized ‘that there may be some limited and exceptional circumstances justifying judicial review of an arbitrator’s decision’ such as when ‘granting finality to an arbitrator’s decision would be inconsistent with the protection of a party’s statutory rights.’” Such exceptional circumstances were not present in Moncharsh. The Court stated that its Armendariz decision helped to define what kinds of “exceptional circumstances” would warrant overturning an arbitrator’s decision. Specifically, it noted that Armendariz states that “we concluded that ‘it is evident that an arbitration agreement cannot be made to serve as a vehicle for the waiver of statutory rights created by the FEHA ... because the enforcement of such rights was for the public benefit and was not waivable.’”

Applying Armendariz, the court ruled that “as a result of the arbitrator‘s legal error, [Turcios’] claim was incorrectly determined to be time-barred.” The court concluded that this was a “paradigmatic example” of how an arbitrator’s legal error could violate a party‘s statutory rights: Turcios’ timely lawsuit was booted out of court to arbitration, and then the arbitrator wrongly ruled that the arbitration claim was time-barred, thus precluding Turcios from receiving a hearing on the merits of his claims in any forum.

Although the Court said that it was not rendering a sweeping decision that “all legal errors are reviewable,” its ultimate holding suggests otherwise. The Court held that, “when, as here, an employee subject to a mandatory employment-arbitration agreement is unable to obtain a hearing on the merits of his FEHA claims, or claims based on other unwaivable statutory rights, because of an arbitration award based on legal error,” such an award may be vacated. In other words, the Court found that “in light of the Legislature‘s intent that employees be able to enforce their right to be free of unlawful discrimination under FEHA,” an arbitrator whose legal error precludes an employee from obtaining a hearing on the merits of a claim based on such a right has exceeded his statutory powers and the arbitrator’s decision may be vacated.

Court Reaffirms Other Arbitration Principles

At the same time, the Court reaffirmed important principles regarding employment arbitration. First, as noted, arbitration agreements can be imposed as a condition of employment. Second, an arbitration agreement, if drafted properly, can lawfully restrict an employee from seeking “administrative” remedies, such as before the California Labor Commissioner. However, the Court declined to rule on whether the arbitration agreement could limit the statute of limitations period under the FEHA, finding that this issue had not been properly raised by the parties at the trial level or in the petition for review.

At bottom, the Court did not fully define the employee’s broad “right to have a hearing on the merits” that it announced and applied. And, the decision creates tension in the law. Armendariz recognized the right of an employer to require an employee to arbitrate employment claims as a condition of employment, but Pearson Dental seems to undercut that right – substituting the decision of a court for the decision of an arbitrator for which the parties had contracted. Future decisions will determine how Armendariz and Pearson Dental – and the competing policies of support for arbitration and vindication of statutory rights – will be harmonized. It is likely, however, that there will be more challenges to arbitration agreements before arbitration and more challenges to arbitration awards. California employers can expect the Pearson Dental decision to limit the benefits provided by mandatory arbitration agreements.