Business Transactions

Arbitration Agreements

September 12, 2018 Update:

On May 21, 2018, the U.S. Supreme Court decision, EPIC SYSTEMS CORPORATION v. JACOB LEWIS (No. 16–285), addressed arbitration agreements, the Federal Arbitration Act (FAA) and the National Labor Relations Act (NLRA).

GORSUCH, J., delivered the opinion of the Court, in which ROBERTS, C. J., and KENNEDY, THOMAS, and ALITO, JJ., joined. GINSBURG, J., filed a dissenting opinion, in which BREYER, SOTOMAYOR, and KAGAN, JJ., joined.

Below are excerpts from Justice Gorsuch’s opinion:

Mr. Morris sued Ernst & Young in federal court. He alleged that the firm had misclassified its junior accountants as professional employees and violated the federal Fair Labor Standards Act (FLSA) and California law by paying them salaries without overtime pay. Although the arbitration agreement provided for individualized proceedings, Mr. Morris sought to litigate the federal claim on behalf of a nation¬wide class under the FLSA’s collective action provision, 29 U. S. C. §216(b). He sought to pursue the state law claim as a class action under Federal Rule of Civil Procedure 23.

Ernst & Young replied with a motion to compel arbitration. The district court granted the request, but the Ninth Circuit reversed this judgment. 834 F. 3d 975 (2016). The Ninth Circuit recognized that the Arbitration Act generally requires courts to enforce arbitration agreements as written. But the court reasoned that the statute’s “saving clause,” see 9 U. S. C. §2, removes this obligation if an arbitration agreement violates some other federal law. And the court concluded that an agreement requiring individualized arbitration proceedings violates the NLRA by barring employees from engaging in the “concerted activit[y],” 29 U. S. C. §157, of pursuing claims as a class or collective action.

Of course, Concepcion has its limits. The Court recognized that parties remain free to alter arbitration procedures to suit their tastes, and in recent years some parties have sometimes chosen to arbitrate on a classwide basis… But Concepcion’s essential insight remains: courts may not allow a contract defense to reshape traditional individualized arbitration by mandating classwide arbitration procedures without the parties’ consent.

Seeking to demonstrate an irreconcilable statutory conflict even in light of these demanding standards, the employees point to Section 7 of the NLRA. That provision guarantees workers

“the right to self-organization, to form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.”
29 U. S. C. §157.

Nothing in our cases indicates that the NLRA guarantees class and collective action procedures, let alone for claims arising under different statutes and despite the express (and entirely unmentioned) teachings of the Arbitration Act.

The policy may be debatable but the law is clear: Congress has instructed that arbitration agreements like those before us must be enforced as written. While Congress is of course always free to amend this judgment, we see nothing suggesting it did so in the NLRA—much less that it manifested a clear intention to displace the Arbitration Act. Because we can easily read Congress’s statutes to work in harmony, that is where our duty lies. The judgments in Epic, No. 16–285, and Ernst & Young, No. 16–300, are reversed, and the cases are remanded for further proceedings consistent with this opinion. The judgment in Murphy Oil, No. 16–307, is affirmed.

Justice Gorsuch’s opinion holds that the saving clause recognizes only defenses that apply to “any” contract. This would include state law defenses covering agreements extracted, say, by an act of fraud or duress or in some other unconscionable way that would render any contract unenforceable.

August 22, 2018 Update

There is a pending criminal case in Manhattan, the United States District Court, Southern District of New York, United States v Michael Cohen, in which Michael Cohen pleaded guilty on August 21, 2018, to criminal charges involving the $130,000 payment to Stormy Daniels. In Mr. Cohen’s guilty plea statement in open court he admitted the payment was made “in coordination with and at the direction of the same candidate” as was the the $150,000 paid to Karen McDougal, which was “in coordination with and at the direction of a candidate for federal office,” and “for the principal purpose of influencing the election.” Mr. Cohen’s attorney, Lanny Davis, identified the candidate as Donald Trump.

April 3, 2018 Update

United States District Judge James Otero issued an order denying plaintiff’s Motion for Expedited Jury Trial and Limited Expedited Discovery for Stormy Daniels v. Donald Trump. The court order also outlined the outstanding issues of the Federal Arbitration Act (FAA) and Federal Rules of Civil Procedure.

March 28, 2018 Update

Stormy Daniels v. Donald Trump was removed to the United States District Court, Central District of California.

March 8, 2018 Update

The case Stormy Daniels v. Donald Trump filed in Los Angeles Superior Court on March 6, 2018, which reportedly involves arbitration provisions, makes a request for the court to grant a judgment against the defendant and to declare no agreement was formed or the agreement is void, invalid and unenforceable.

Under California law the challenge to the legality of an agreement is an issue for the trial court to decide rather than the arbitrators. (Sheppard, Mullin, Richter v J-M Manufactuireing Co. 244 Cal.App.4th 590 (2016), 198 Cal. Rptr. 3d 253.) Sheppard above is on appeal at the California Supreme Court on the issue of whether or not the facts of the case warrant a finding of illegality on the part of Plaintiff and Respondent, Sheppard. (368 P.3d 922, 201 Cal.Rptr.3d 254.) The arbitrator in the Sheppard case found in favor of Sheppard. The California Court of Appeals reversed and held that “Determining whether federal or state law governs the Agreement is crucial to whether the court or the arbitrators should have decided if the Agreement was enforceable…Where the parties agree that California law governs the contract, the FAA does not apply…California arbitration law is not preempted by the FAA when the parties have agreed that their arbitration agreement will be governed by California law… Under California law, a challenge to the legality of an entire contract that contains an arbitration provision must be determined by the trial court, not the arbitrator. ‘The power of the arbitrator to determine rights under a contract is dependent upon the existence of a valid contract under which this right might arise, and the question of the validity of the basic contract is essentially a judicial question, which cannot be finally determined by an arbitrator (citations omitted).’ ” The court in Sheppard cited Lindenstadt v. Staff Builder, Inc. (1997) 55 Cal.App. 4th 882, “And if a party challenges the enforceability of a contract after arbitration in a motion to vacate the arbitration award, the court should ‘review’ the evidence de novo to determine whether the arbitration award was based on illegal agreements or transactions.”

February 2, 2017 Update:

On January 13, 2017, the United States Supreme Court granted certiorari for the Ninth Circuit Court of Appeals case below Stephen Morris v. Ernst & Young, LLP (August 22, 2016) 2016 DJDAR 8732. On the same day the Supreme Court granted certiorari for the Fifth Circuit case National Labor Relations Board v. Murphy Oil and the Seventh Circuit case Epic Systems Corporation v. Jacob Lewis. These circuit courts have splits regarding their analysis of the interaction of the Federal Arbitration Act (FAA) and the National Labor Relations Act (NLRA).

September 14, 2016 Update:

In September 2015, the Ninth Circuit Court of Appeals followed the analysis of the California Supreme Court in Iskanian below, and held that the Federal Arbitration Act (FAA) does not preempt the California Private Attorney General Act (PAGA) claims, and PAGA claims are not arbitrable under California state law. Shukri Sakkab v. Luxottica Retail North America, Inc., (2015) 803 F.3d 425.

In August 2016, the Ninth Circuit Court of Appeals held that an arbitration agreement which precluded employees from bringing a concerted legal claim regarding wages, hours and terms and condition of employment was a violation of employee rights under the National Labor Relations Act (NLRA), and therefore, not enforceable. Stephen Morris v. Ernst & Young, LLP (August 22, 2016) 2016 DJDAR 8732. The arbitration agreement required the employee to pursue legal claims against the employer exclusively through arbitration and only as individuals and in separate proceedings. NLRA state “Employees shall have the right to self-organization, to form, join or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection”. 29 U.S.C. § 157. The Court held these are substantive rights, and the FAA does not allow for arbitration to invalidate these rights. FAA states “ A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy therafter arising out of such contract or transaction… shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2. The arbitration agreement sought to defeat the substantive right to pursue concerted work-related legal claims.

The Ninth Circuit joined the Seventh Circuit rule for considering the interaction of the NLRA and the FAA: “…when an arbitration contract professes to waive a substantive federal right, the saving clause of the FAA prevents the enforcement of the waiver.”

September 9, 2014 Update:

In April 2011, The United States Supreme Court held that California law which the Ninth Circuit Court used to hold AT&T Mobility arbitration agreement unconscionable and unenforecable was preempted by the Federal Arbitration Act (FAA) 9 U.S.C. § 2. AT&T Mobility v. Concepcion (2011) 563 U.S.__[131 S.Ct. 1740] (Concepcion). The 5-4 majority opinion in Concepcion written by Justice Scalia stated that “The FAA was enacted in 1925 in response to widespread judicial hostility to arbitration agreements.” After quoting parts of 9 U.S.C. § 2, the Court stated “We have described this provision as reflecting both a ‘liberal federal policy favoring arbitration’…and the ‘fundamental principle that arbitration is a matter of contract’…In line with these principles, courts must place arbitration agreements on an equal footing with other contracts.” The AT&T Mobility arbitration agreement did not allow class action claims. The Ninth Circuit Court had held California law defined by the California Supreme Court in Discovery Bank v. Superior Court, 36 Cal. 4th 148, 113 P.3d 1100 (2005) required a ruling that the arbitration agreement was unconscionable because of the prohibition of class action procedures and California law was not preempted by FAA. The Concepcions purchased AT&T services advertised as including a free phone when in fact they were charged $30.22 sales tax based on the retail value of the phone.

California courts continue to revisit the Concepcion decision. On June 23, 2014, the California Supreme Court held in Iskanian v. CLS Transportation Los Angeles (2014 DJDAR 8037) (Iskanian) that Concepcion invalided Gentry v. Superior Court (2007) 42 Cal 4th 443 (Gentry). The Court in Gentry held that class action waivers in some arbitration agreements in employment contracts may be unenforceable in some circumstances. Iskanian sought to bring a class action claim for his employer’s alleged failure to compensate for overtime and meal and rest periods. The California Supreme court in Iskanian stated “…the FAA does not prevent states through legislative or judicial rules from addressing the problems of affordability and accessibility of arbitration. But Concepcion held that the FAA does prevent states from mandating or promoting procedures incompatible with arbitration.” The California Supreme Court also decided in Iskanian that the class action employee waiver on wage claims was not an unfair labor practice in violation of the National Labor Relations Act (NLRA) enacted in 1935 and reenacted in 1947. Therefore, NLRA did not represent a contrary mandate to FAA’s liberal federal policy favoring arbitration as outlined in Concepcion. The Court found that NLRA does impose some limits on the enforceability of arbitration agreements. The arbitration agreement can not violate Section 8(a) (1) and (4) of the NLRA by containing language that would lead employees to reasonably believe they are prohibited from filing unfair labor practice charges with the National Labor Relations Board (Board). The Court noted the arbitration agreement in Iskanian permitted a broad range of collective activity to vindicate wage claims.

However, the California Supreme Court in Iskanian held that the arbitration agreement which compelled waiver of representative claims was against public policy and violated the Private Attorney General Act of 2004 (PAGA) (Lab Code § 2968 et seq.) and the FAA does not preempt California law prohibiting such waiver. PAGA claims are not arbitrable under California state law. The Court discussed in great length a states police powers and that those powers are not superseded by federal law unless that was the clear and manifested purpose of Congress. “There is no question that enactment and enforcement of laws concerning wages, hours, and other terms of employment is within the state’s historic police power… Moreover, how a state government chooses to structure its own law enforcement authority lies at the heart of state sovereignty…In sum, the FAA aims to promote arbitration of claims belonging to the private parties to an arbitration agreement. It does not aim to promote arbitration of claims belonging to a government agency, and that is not less true when such a claim is brought by a statutorily designated proxy for the agency as when the claim is brought by the agency itself.”

Federal district courts in California continue to analyze Concepcion. Also, the Ninth Circuit has revisited California law after Concepcion. In Chavarria v. Ralphs Grocery Company 733 F.3d 916 (2013), the Court held that Ralphs’s arbitration policy was unconscionable under California law, and the state law was not preempted by FAA. Under California law a contract is invalid if it is procedurally and substantively unconscionable. The Court took into consideration the fact the arbitration agreement was imposed upon the employee. “Where the employee is facing an employer with overwhelming bargaining power who drafted the contract and presented it …on a take-it-or-leave-it basis, the clause is procedurally unconscionable.” Also to be considered is when the employee receives the terms of the arbitration agreement, and if the employee can reasonably understand the agreement from the document given. Factors affecting the issue of substantively unconscionable include whether or not the arbitration agreement severely limits the authority of the arbitrator to allocate arbitration cost in the award.