Arbitration agreement is unenforceable where a party retains the right to make unilateral modifications effective upon notice to the other party.
“You can’t always get what you want … but if you try sometimes, you just might find you get what you need.” This wisdom, courtesy of The Rolling Stones, is good advice when drafting contracts as part of an enterprise risk management strategy.
A starting point is to identify the transactional risks to be addressed in the contract and the entity’s needs that must be achieved. Often, drafters opt for a “belt and suspenders” approach, which is not only a terrible fashion faux pas but may result in an overreach nullifying the effectiveness of the risk management strategy.
An example of the danger of how an attempt by an employer to get what it wanted in excess of what it needed is presented in Nelson v. Watch House Int’l, LLC, ___ F.3d ___ (5th Cir. March 2, 2016). Watch House Int’l is a March 2016 Fifth Circuit decision based on Texas law holding that the arbitration provision incorporated in a pre-employment agreement rested on illusory consideration.
In Watch House Int’l, the employer sought to require arbitration of all employment-related disputes. The agreement incorporating the arbitration provision gave the employer unilateral authority to modify the agreement, providing that any changes would be effective only upon notice to the employee. Further, modifications applied solely to prospective claims. To the extent that the employer decided to terminate the requirement that employment-related disputes be submitted to arbitration, the modification would not apply retroactively to disputes that arose before the modification.
Many courts have found that mutuality of obligation to arbitrate disputes is sufficient consideration to make an arbitration provision enforceable. In Watch House Int’l, the trial court found that the arbitration provision was enforceable because there was a mutuality of obligation to submit employment-related claims to arbitration even though the employer retained the unilateral right to modify the arbitration provision. However, the trial court noted that the employer’s modifications were not effective until the employee received notice of those changes and only applied to prospective claims. The modifications did not apply retroactively to disputes arising before an employee received notice of the changes. Consequently, the trial court concluded that the consideration offered by the employer for the arbitration provision — the obligation to submit employment-related disputes to arbitration — was not illusory because the employee would have an opportunity to arbitrate disputes that arose prior to the employer’s termination of the arbitration provision.
However, the Fifth Circuit reversed, recognizing that since the termination of the provision was effective upon notification to the employee, as a practical matter, it gave the employer the opportunity to deprive employees the benefit of the consideration – the right to compel arbitration. Consequently, the Fifth Circuit found that the consideration supporting the arbitration provision was illusory.
The Fifth Circuit distinguished this case from others where the changes imposed unilaterally by the employer were not effective until some period of time after notice was given. Under those circumstances, employees were in a position to avail themselves of the agreements, as they accepted them before the changes being effective. However, the Fifth Circuit held that since any changes imposed unilaterally by the employer in Watch House Int’l were effective on notice, the consideration for the arbitration agreement — mutuality of obligation to arbitrate disputes — was illusory.
As a consequence, in Watch House Int’l, even though the employer had notactually modified the arbitration provision, the Fifth Circuit found that the employer’s retention of the right to unilaterally eliminate the arbitration provision with the changes to be effective on notice made the arbitration provision unenforceable. The employer could have gotten the benefit it sought — requiring all employment disputes to be arbitrated until such time as arbitration did not meet its needs — if it built in some buffer zone of protection for the employee’s reciprocal right. Through its overreach, however, it lost any right to require arbitration.
The takeaway: Watch House Int’l is a prime example of a case in which the employer failed to achieve its objective by overreaching. It could have achieved its objective — compelling arbitration of employment-related disputes — by narrowly scaling back its own ability to opt out of arbitration. But by purporting to hold complete control in a way that effectively had the potential to negate the consideration it gave, the employer lost all control over its choice of dispute resolution mechanisms. This lesson is not limited to the issue of arbitration provisions but has application to contracts, generally.