Why it matters: The California Supreme Court continued its complicated relationship with employment agreements and arbitration on June 23 when it issued Iskanian v. CLS Transportation. On the one hand, the majority upheld the general enforceability of class waivers in mandatory employment arbitration agreements, finding that a prior decision to the contrary (Gentry v. Superior Court, 42 Cal. 4th 443 (2007)) had been abrogated by more recent U.S. Supreme Court precedent. But the court also carved out an exemption for employees to bring representative actions under the California Labor Code's Private Attorneys General Act (PAGA), holding that “an arbitration agreement requiring an employee as a condition of employment to give up the right to bring representative PAGA actions in any forum is contrary to public policy.” The decision truly presents a mixed bag for California employers.

Detailed Discussion

The case involved Arshavir Iskanian, a former driver for CLS Transportation. During his time with the company, Iskanian signed an agreement providing that “any and all claims” arising out of his employment were to be submitted to binding arbitration before a neutral arbitrator. Among other features, the arbitration agreement also included a class and representative action waiver.

Iskanian filed a class action complaint against CLS alleging that the company failed to pay overtime, provide meal and rest breaks, reimburse businesses expenses, provide accurate and complete wage statements, or pay final wages in a timely manner. A trial court justice granted CLS’s motion to compel arbitration based on the agreement.

While Iskanian’s appeal was pending, the California Supreme Court issued its decision in Gentry, holding that class action waivers in employment arbitration agreements are invalid under certain circumstances. In light of the ruling, CLS voluntarily withdrew its motion and the parties proceeded to litigate, with the trial court certifying a class over CLS’s objection.

The U.S. Supreme Court then issued its 2011 decision in AT&T Mobility v. Concepcion (131 S. Ct. 1740), which expressly invalidated a California Supreme Court decision restricting consumer class action waivers in arbitration agreements in Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005). Relying on Concepcion, CLS renewed its motion to compel arbitration. The trial court ordered Iskanian into individual arbitration and dismissed the class claims with prejudice. He appealed.

The California Supreme Court addressed three primary issues: the validity of Iskanian’s class waiver and the viability of Gentry in the wake of Concepcion; whether CLS waived its right to compel arbitration by withdrawing its motion in light of Gentry; and the intersection of the Federal Arbitration Act (FAA) and California’s PAGA.

First, the court worked its way through its history of arbitration decisions. The Discover Bank ruling was invalidated by Concepcion, but what about Gentry? Iskanian told the court the Gentry decision survived the high court’s opinion because it did not set forth a categorical rule against class action waivers, but established factors for a court to consider when evaluating whether a class action waiver might be unenforceable. The court disagreed.

“Contrary to these contentions, however, the fact that Gentry’s rule against class waiver is stated more narrowly than Discover Bank’s rule does not save it from FAA preemption under Concepcion,” the majority wrote. “Concepcion holds that even if a class waiver is exculpatory in a particular case, it is nonetheless preempted by the FAA. Under the logic of Concepcion, the FAA preempts Gentry’s rule against employment class waivers.”

The court distinguished last year’s ruling in Sonic-Calabasas A, Inc. v. Moreno (better known as Sonic II), which involved the waiver of employee rights under the Berman statute, including a special hearing, fee-shifting provisions, and other protections, but not a class waiver.

Sonic II recognized that the FAA does not prevent states through legislative or judicial rules from addressing the problems of affordability and accessibility of arbitration,” Justice Goodwin Liu wrote for the court. “But Concepcion held that the FAA does prevent states from mandating or promoting procedures incompatible with arbitration. The Gentry rule runs afoul of this principle.”

The majority also rejected Iskanian’s contention that the class action waiver was invalid under the National Labor Relations Act (NLRA). Following the Fifth U.S. Circuit Court of Appeals’ line of reasoning in D.R. Horton, Inc. v. NLRB, the court said the NLRB rule – like the rule in Discover Bank – was not arbitration neutral and would instead “significantly undermine arbitration’s fundamental attributes by requiring procedural formality and complexity, and by creating greater risks to defendants.”

Turning to the issue of waiver, the court determined that Iskanian did not meet the heavy burden of proof to argue CLS waived its right to arbitration, particularly given the procedural history of the case. “The fact that a party initially successfully moved to compel arbitration and abandoned that motion only after a change in the law made the motion highly unlikely to succeed weighs in favor of finding that the party has not waived its right to arbitrate,” Justice Liu wrote.

CLS did not engage in unexcused delay and Iskanian’s litigation costs did not establish that he was prejudiced. “[T]he delay was reasonable in light of the state of the law at the time and Iskanian’s own opposition to arbitration,” the court explained. “Where, as here, a party promptly initiates arbitration and then abandons arbitration because it is resisted by the opposing party and foreclosed by existing law, the mere fact that the parties then proceed to engage in various forms of pretrial litigation does not compel the conclusion that the party has waived its right to arbitrate when a later change in the law permits arbitration.”

Finally, at the intersection of the FAA and PAGA, the court turned in the direction of employees. Emphasizing the history behind the law’s enactment to deputize employees as private attorneys general because of the government’s shortage of resources to pursue enforcement of the Labor Code, the majority said two sections of the Civil Code were in play. The first, Civil Code section 1668, forbids contracts “whose object, directly or indirectly, is to exempt [their] parties from violation of the law.”

“Thus, an agreement by employees to waive their right to bring a PAGA action serves to disable one of the primary mechanisms for enforcing the Labor Code,” and is against public policy, making it unenforceable, the court wrote. “Such an agreement also violates Civil Code 3513’s injunction that ‘a law established for a public reason cannot be contravened by a private agreement.’ The PAGA was clearly established for a public reason, and agreements requiring the waiver of PAGA rights would harm the state’s interests in enforcing the Labor Code and in receiving the proceeds of civil penalties used to deter violations.”

CLS’s contention that the agreement only prohibited representative claims – not individual PAGA claims – was scorned by the majority. “[W]hether or not an individual claim is permissible under the PAGA, a prohibition of representative claims frustrates PAGA’s objectives,” the court said. “We conclude that where, as here, an employment agreement compels the waiver of representative claims under the PAGA, it is contrary to public policy and unenforceable as a matter of state law.”

Further, a rule against PAGA waivers did not frustrate the FAA’s objectives, the court added. “Simply put, a PAGA claim lies outside the FAA’s coverage because it is not a dispute between an employer and an employee arising out of their contractual relationship,” Justice Liu wrote. “It is a dispute between an employer and the state, which alleges directly or through its agents – either the Labor and Workforce Development Agency or aggrieved employees – that the employer has violated the Labor Code.”

The majority’s conclusion left the parties on uncertain ground. Both pursued all-or-nothing positions and did not consider the possibility that Iskanian’s claims could be bifurcated. “Iskanian must proceed with bilateral arbitration on his individual damages claims, and CLS must answer the representative PAGA claims in some forum,” the court said.

Several questions remain on remand: “(1) Will the parties agree on a single forum for resolving the PAGA claim and the other claims? (2) If not, is it appropriate to bifurcate the claims, with individual claims going to arbitration and the representative PAGA claim to litigation? (3) If such bifurcation occurs, should the arbitration be stayed pursuant to [civil procedure]?”

Two additional opinions were filed in the case. In a concurring opinion, Justice Ming W. Chin (joined by Justice Marvin R. Baxter) agreed with the majority but wrote separately to question the basis upon which the majority concluded that PAGA was exempt from FAA coverage, still agreeing that PAGA was exempt, but for a different reason.

And in a dissent comparing class waivers in employment agreements to “yellow dog contracts” from the 19th century, Justice Kathryn M. Werdegar argued that the FAA should not be interpreted to operate as a “super statute” because the NLRA provides employees with the right to engage in collective action, including the filing of wage and hour class actions.

“[T]he whole point of protecting a right to collective action is to allow employees to do precisely what CLS Transportation’s clause forbids – band together as a group to peaceably assert rights against their employer,” she wrote. “When Congress invalidated yellow dog contracts and protected the right to engage in collective actions, it could not have believed it was conveying rights enforceable only at the grace of employers, who could at their election, erase them by the simple expedient of a compelled waiver inserted in an arbitration agreement.”

Whether the court’s view that PAGA is outside the scope of the FAA will withstand further scrutiny remains to be seen, and is an issue that may find itself next before the United States Supreme Court.

To read the decision in Iskanian v. CLS Transportation, click here.