California Supreme Court Continues Assault on Employment Arbitration Agreements
Despite having its anti-arbitration rulings reversed several times (and counting) by the United States Supreme Court, the California Supreme Court issued another questionable anti-arbitration decision today in Oto, LLC v. Kho, furthering the Golden State’s ongoing agenda to try to disallow these agreements in the employment setting. In today’s ruling, the Court reversed an order compelling arbitration of an employee’s administrative wage claim that had been filed with the Department of Labor Standards Enforcement (“DLSE”). The Court could not hold that such disputes are categorically exempt from arbitration (because the Court already had its hand slapped on this issue by the U.S. Supreme Court a few years ago), so the Court found another way to invalidate the agreement by holding that it was too procedurally unconscionable to be enforced. In layman’s terms, this basically means that the Court found that the manner in which the agreement was presented to the employee (the print was purportedly small and hard to read and the employee was not given sufficient time to review the agreement or ask questions) was unfair and deprived the employee of meaningful choice in signing the agreement.
The California Supreme Court has quite a record of anti-arbitration decisions, most of which have been reversed by the United States Supreme Court. As pertinent here, in 2011, the California Supreme Court held in Sonic v. Calabasas (Sonic I) that employees may not be required to arbitrate administrative wage claims and that they instead must be allowed to resolve such claims through the DLSE’s administrative hearing process (referred to as a “Berman hearing”). The United States Supreme Court subsequently ordered the California Supreme Court to reconsider this ruling in light of U.S. Supreme Court precedent holding that states may not enact laws that discriminate against arbitration as a forum for resolving disputes. The California Supreme Court thereafter issued a new ruling, Sonic II, holding that if an arbitration agreement provides a sufficiently “accessible and affordable forum” for resolving wage disputes, then they are required to be arbitrated. The wishy-washy ruling [purposefully] left the door open to litigants to argue about whether this particular standard is met in any given wage dispute, and for individual judges to rule inconsistently on this issue.
Importantly, although it is crystal clear that states may not adopt rules that discriminate against arbitration (e.g. rules stating that certain types of disputes are exempt from arbitration), the U.S. Supreme Court has held that state courts may refuse to enforce an arbitration agreement under state law contract principles that are generally applicable to any type of contract (not just arbitration agreements). One such contract principle is called “unconscionability.” Under this defense to enforcement, a contract, including an arbitration agreement, will not be enforced if it is determined to be procedurally and substantively unfair. Both procedural and substantive unfairness must be present in order to successfully prevent enforcement of the agreement. The procedural element focuses on the manner in which the agreement was presented to the party challenging it, i.e. was the arbitration provision buried in a multi-page agreement and/or printed in tiny font so as to effectively hide it and/or are there other factors suggesting it was presented in an unfair or oppressive way? The substantive element focuses on the fairness of the actual terms, i.e. are the rules governing the arbitration proceeding fair to both parties or are they unduly one-sided in favor the employer? In 2000, the California Supreme Court issued a decision called Armendariz v. Foundation Health, in which the Court laid out several rules for employment arbitration agreements that must be met in order to pass the substantive fairness test (at least where statutory discrimination claims are at issue). Specifically, the Court held that an employment arbitration agreement must provide for sufficient discovery to fairly adjudicate the dispute, a neutral arbitrator, a written award, and the employee may not be required to bear costs beyond what the employee would incur if the dispute was arbitrated in court. In other words, the employer has to pay for all costs unique to the arbitration (the arbitrator’s hourly rates).
Turning to the facts of the Oto v. Kho case, the plaintiff in this case, Kho, worked as a technician for One Toyota of Oakland (“OTO”). Three years into his employment, the company apparently rolled out an arbitration agreement. The agreement was presented to Kho while he was working. Kho claims he had no real time to review the agreement (it was slightly more than one page long) because the employee who presented it to him waited for him to review and sign it. The agreement was a mandatory condition of employment and required virtually all employment-related disputes be resolved by way of binding arbitration instead of court litigation. Kho signed the agreement. Despite the agreement, Kho later filed a wage claim against Oto with the DLSE. Oto attended a settlement conference and tried to resolve the claim, but the settlement effort was unsuccessful. Per normal DLSE procedure, the DLSE set the claim for a Berman hearing. Prior to the hearing, Oto filed a petition to compel arbitration of the claim in state court. The DLSE refused to delay the hearing pending a ruling by the court on its petition to compel arbitration. Oto refused to participate in the hearing, and, unsurprisingly, the DLSE found in favor of Kho. Oto asked the trial court to vacate the DLSE’s award in favor of Kho. The trial court agreed to vacate the award, holding that the DLSE should not have proceeded with the hearing in Oto’s absence. However, the trial court denied Oto’s petition to compel arbitration, finding that the agreement was both procedurally and substantively unconscionable. On the substantive side, the court held that the arbitration proceeding called for by the agreement did not provide a sufficiently accessible or affordable forum for resolving a wage claim. Oto successfully appealed. The court of appeal ruled that the arbitration agreement was enforceable because, even though it was procedurally unconscionable, it was not substantively unconscionable (i.e. there were no unfair terms). Because both elements must be present to avoid enforceability, the agreement still had to be enforced. Kho successfully petitioned for review by the California Supreme Court, with the Court agreeing to decide the issue of whether arbitration provides an accessible and affordable forum for resolution of the wage dispute.
Today’s decision by the California Supreme Court is interesting in that the Court essentially changed the issue that it had agreed to decide, seemingly in order to reach the result it wanted to reach. The Court noted that it had originally agreed to decide the issue of whether the arbitration forum was sufficiently affordable and accessible to require an employee to forego administrative remedies and instead arbitrate a wage dispute. However, the Court then stated that it need not answer that question “definitively” because the agreement at issue in the case purportedly was so procedurally unconscionable that it could not be enforced.
With respect to its finding of procedural unconscionability, the Court reasoned that the agreement was unfairly presented to Kho in a “misleading” and “coercive” manner. The Court noted that the agreement was presented to him by a low-level employee who stood by and waited for Kho to sign the agreement. In the Court’s view, Kho was thereby deprived of a meaningful opportunity to review the agreement or ask questions about it, much less negotiate it. [Notably, there was no evidence that Kho asked for more time or asked any questions, and in any event, Kho was required to sign the agreement as a condition of continued employment.] The Court also noted that Kho was a piece-rate worker and that, implicitly, if he took time to review the agreement, this would have lowered his production rate and, therefore, his compensation. The Court went on to note that Kho’s primary language was Chinese and the agreement was presented only in English. The Court then walked this concern back a bit, noting that there was no evidence that Kho lacked English proficiency (regardless of whether his primary language was Chinese). Finally, the Court went into bizarre detail about the technical aspects of the agreement itself, suggesting that the arbitration agreement was somehow buried in a larger agreement. This is refuted by the actual record though because the agreement covered only two topics – the at-will nature of the employment relationship and the agreement to arbitrate disputes. The agreement to arbitrate was in the title of the agreement and took up the vast majority of the one and one-quarter page agreement. How this can be considered a hidden arbitration agreement is mind-boggling frankly. The Court also criticized that the font used (8.5) was small and supposedly hard to read. Finally, the Court criticized the agreement’s use of legal language, including its reference to claims arising under specifically identified statutes as being covered by the agreement to arbitrate. According to the Court, no layperson would understand what these references mean in order to meaningfully consent. [This too is ridiculous, given that a prudent employer must reference employment-related statutes in its agreement in order to avoid claims that the agreement is vague and arguably does not cover a given dispute.] With all of these factors, the Court found that the agreement had such a shocking degree of procedural unfairness that if the substantive terms were even marginally questionable, the agreement would be unenforceable.
Turning to the issue of substantive unconscionability, the Court held that this issue was a “close call” and did not actually rule one way or the other as to whether the agreement was substantively unconscionable. The Court noted that some aspects of the agreement could support a finding that the arbitral forum was not sufficiently accessible and affordable to be a fair substitute for a Berman hearing before the DLSE. The Court seemed most concerned with the fact that the arbitration agreement basically imported most aspects of California court procedure, providing that the arbitrator be a retired superior court judge and that the parties would have to comply with court discovery rules and the California Evidence Code, and that the parties could bring all motions that would be available in court. Because of this, the Court suggested that it would be difficult for an individual plaintiff to navigate the arbitration process without an attorney. By contrast, the DLSE’s administrative hearing procedure is designed so that a layperson can effectively use it without needing representation. While noting these concerns, the Court did not really decide the issue of substantive fairness one way or the other. In an unhelpfully wishy-washy portion of the decision that will only serve to fuel continued individualized litigation and adjudication in this area, the Court explained that the circumstances may provide a sufficiently affordable and accessible forum for sophisticated employees and/or for employees who can afford to hire counsel, but not for unsophisticated employees or those who cannot afford an attorney. [Since when has there been a shortage of plaintiffs’ attorneys in California who are ready and willing to represent employees on a contingency fee basis, particularly on claims that provide for automatic recovery of attorneys’ fees if the plaintiff wins?] Ultimately, the Court held that it need not definitively decide that issue because on the specific facts of the case before it, there was so much oppression and surprise that Kho effectively was coerced into agreeing to an unfair bargain and, as a result, the agreement was too one-sided and unconscionable to be enforced.
Today’s decision is not a big surprise, given the California Supreme Court’s long-standing and open distaste for arbitration agreements. However, it remains a disappointing decision and one that unfortunately will only serve to fuel further individualized litigation over the enforceability of arbitration agreements where DLSE wage claims are involved. Bright line rules would be a nice change for California employers, but on this issue, the only way the Court could have issued a bright line rule and still achieved the result of disallowing arbitration would have been to rule that arbitration is not an accessible and affordable forum for employees to resolve their wage claims. That hypothetical ruling almost certainly would have invited and resulted in yet another reversal by the United States Supreme Court. By instead issuing a more narrow ruling finding the specific agreement was unconscionable on the unique facts in the case, the Court’s ruling is more likely to evade U.S. Supreme Court review. Employers should note, however, that in an unrelated case (Winston & Strawn LLP v. Ramos), the U.S. Supreme Court currently is being asked to review whether the California Supreme Court’s Armendariz decision (setting forth the rules governing unconscionability of employment arbitration agreements) is still good law. The nation’s high court has not yet decided whether or not it will grant review in that case, but stay tuned.
Action Steps for Employers
Today’s decision does not change the standards for employment arbitration agreements in California. It just presents another example of circumstances a court can cite to in order to find the agreement unconscionable and refuse to enforce it. Employers should consider whether they need to make changes in the way they present arbitration agreements to their employees, and whether the terms of those agreements are fair and understandable. Finally, the arbitration provision should be obvious and not hidden or buried.