Overruling Gentry v. Superior Court, 42 Cal. 4th 443 (2007) as preempted by the Federal Arbitration Act (“FAA”), the California Supreme Court upheld the validity of class action waivers in employment arbitration agreements. Iskanian v. CLS Transportation Los Angeles, LLC, No. S204032  (Cal. Jun. 23, 2014).  Declining to follow D.R. Horton, 357 NLRB No. 184 (Jan. 3, 2012), the Court also rejected that class action waivers are unlawful under the National Labor Relations Act (“NLRA”).  However, the Court further ruled that employers could not require waivers of representative actions under the California Private Attorney General Act (“PAGA”) as contrary to public policy and unwaivable as a matter of state law and were not preempted by the FAA.  Accordingly, the Court reversed the judgment of the Court of Appeal and remanded the case for further proceedings.

Background

Arshavir Iskanian (“Iskanian”) worked as a driver for CLS Transportation Los Angeles, LLC (“CLS”).  Iskanian signed an agreement requiring that all claims arising out of his employment to be submitted to binding arbitration.  The agreement also included a provision precluding class and representative actions in the arbitration proceeding.  Iskanian filed a class action against CLS, for alleged unpaid overtime and other Labor Code violations.  Iskanian also sought civil penalties, in a representative capacity, for Labor Code violations under the PAGA.

CLS asked the trial court to order arbitration, and the trial court granted CLS’ motion, ordered arbitration and dismissed Iskanian’s class claims under AT&T Mobility LLC v. Concepcion, 563 U.S. __, 131 S. Ct. 1740  (2011).  The California Court of Appeal affirmed, concluding that Concepcion overruled Gentry.  With respect to the PAGA claim, the Court of Appeal concluded that the FAA precluded states from withdrawing claims from arbitration and that PAGA claims must be argued individually.  The California Supreme Court granted review.

Applicable Law

Arbitration agreements are enforced according to their terms, in the same manner as other contracts. Concepcion, 131 S. Ct. at 1745.  The FAA’s “saving clause” permits revocation of an arbitration agreement if “generally applicable contract defenses, such as fraud, duress, or unconscionability” apply.  In Concepcion, the U.S. Supreme Court addressed whether the FAA prohibited California’s rule conditioning the enforceability of certain consumer arbitration agreements on the availability of class-wide arbitration procedures set forth in Discover Bank v. Superior Court, 36 Cal. 4th 148, 153 (2005).  The Supreme Court found that, although the savings clause preserved generally applicable contract defenses, “nothing in it suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.”  Concepcion, 131 S. Ct. at 1748.  On this basis, the Supreme Court overruled Discover Bank as preempted because the rule interfered with the FAA’s overarching purpose:  “to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings.”  Id.

In Gentry v. Superior Court, 42 Cal. 4th 443 (2007), the California Supreme Court ruled that the right to receive overtime pay is unwaivable and that, under certain circumstances, a class action waiver would “impermissibly interfere with employees’ ability to vindicate unwaivable rights and to enforce the overtime laws.”   Gentry, 42 Cal. 4th at 457.  The Gentry Court held that a class action waiver must be invalidated if, after applying various factors, a court determines that 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.”  Gentry, 42 Cal. 4th at 463.

In D.R. Horton, 357 NLRB No. 184 (Jan. 3, 2012), the National Labor Relations Board (“NLRB”) held that “employers may not compel employees to waive their NLRA right collectively to pursue litigation of employment claims in all forums, arbitral and judicial.”

Under the PAGA, an aggrieved employee may bring a civil action personally and on behalf of other current or former employees to recover civil penalties for Labor Code violations.  Cal. Lab. Code § 2699(a).  Of the civil penalties recovered, 75% goes to the Labor and Workforce Development Agency, leaving the remaining 25% for the aggrieved employees. Cal. Lab. Code § 2699(i).  “An employee plaintiff suing . . . under the [PAGA] does so as the proxy or agent of the state’s labor law enforcement agencies.”  Arias v. Superior Court, 46 Cal. 4th 969, 985 (Cal. 2009).  Further, an action under the PAGA “is fundamentally a law enforcement action designed to protect the public and not to benefit private parties.”  People v. Pacific Land Research Co., 20 Cal. 3d 10, 17 (Cal. 1977).

Class Action Waivers Enforceable, but Not Waivers of Representative Claims under PAGA

Class Action Waivers

Iskanian argued that Gentry survived Concepcion because its rule against class action waivers was narrower than the Discover Bank rule challenged in Concepcion.  The Court rejected Iskanian’s argument.  The California Supreme Court observed that the “the high court in Concepcion made clear that even if a state law rule against consumer class waivers were limited to “class proceedings [that] are necessary to prosecute small-dollar claims that might otherwise slip through the legal system,” it would still be preempted because states cannot require a procedure that interferes with fundamental attributes of arbitration “even if it is desirable for unrelated reasons.”  Iskanian, No. S204032, slip op. at 7 (citing Concepcion, 131 S. Ct. at 1753).  Further, the Court noted that, “in practice,” Gentry’s rule “regularly resulted in invalidation of class waivers.”  Iskanian, No. S204032, slip op. at 10 (citations omitted) prior to Concepcion.  This was not “surprising,” the Court continued, since it was “unlikely that an individual action could be designed to approximate the inherent leverage that a class proceeding provides to employees with claims against a defendant employer.”  Id.  Accordingly, the Court ruled that in light of Concepcion, the FAA preempted Gentry.

Iskanian further argued that, even if the FAA preempted Gentry, the class action waiver was invalid under the NLRA.  D.R. Horton, 357 NLRB No. 184 (Jan. 3, 2012).  The Court also rejected this argument, relying on the U.S. Court of Appeals for the Fifth Circuit’s analysis in D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir. 2013).  The Court agreed with the Fifth Circuit that, in light of Concepcion, the NLRB’s rule was not arbitration neutral and not covered by the FAA’s savings clause.

PAGA Representative Claims

The Court next examined whether the waiver of representative actions under the PAGA was enforceable.  The Court concluded that it was not because it undermined the state’s interest in enforcing the Labor Code.   Further, the Court noted that “a single-claimant arbitration under the PAGA for individual penalties will not result in the penalties contemplated under the PAGA to punish and deter employer practices that violate the rights of numerous employees under the Labor Code. That plaintiff and other employees might be able to bring individual claims for Labor Code violations in separate arbitrations does not serve the purpose of the PAGA, even if an individual claim has collateral estoppel effects.”  Iskanian, No. S204032, slip op. at 36 (citing Arias, 46 Cal. 4th at 985–987).  Thus, the waiver of representative actions under the PAGA was against public policy and unenforceable under California law.

The Court then addressed whether the FAA nevertheless preempted this rule and concluded that it did not.  The Court reasoned that PAGA actions do not involve the employer-employee relationship; rather, they involve a dispute between the employer and the state.  The employee serves as the state’s representative in a PAGA action, collecting penalties on behalf of the state.  The Court concluded that “California’s public policy prohibiting waiver of PAGA claims, whose sole purpose is to vindicate the Labor and Workforce Development Agency’s interest in enforcing the Labor Code, does not interfere with the FAA’s goal of promoting arbitration as a forum for private dispute resolution.”  Thus, the California Supreme Court reversed the judgment enforcing the arbitration agreement in its entirety and returned the case to the trial court for further proceedings.

Practice Note

This case is a significant development for California employers and confirms that employers may develop and enforce employment arbitration agreements with class action waivers barring employees from bringing class actions in court or arbitration.  However, employers cannot require employees to waive their right to a “representative” action under the PAGA for Labor Code penalties.  In addition, this decision did not alter California’s evolving jurisprudence regarding unconscionability, and arbitration agreements remain subject to challenge on those grounds.  It remains to be seen whether the U.S. Supreme Court will review this case to further address issues involving the interplay of state law and the FAA.