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California Supreme Court Places Further Restrictions on Employment Arbitration

By: Veronica M. Gray
09/14/07

The California Supreme Court recently held that waivers of class action proceedings in employee arbitration agreements may be against public policy. Such waivers are unenforceable where (1) a class action is an effective way to adjudicate relatively small claims of numerous employees and (2) the waiver extends to unwaivable statutory rights and interferes with the employee's ability to vindicate such rights. The Court also said that providing employees with a 30-day window to opt out of an agreement to arbitrate employment disputes does not necessarily insulate the agreement from being unenforceable as being against public policy or legally "unconscionable." The case is Gentry v. Superior Court (Circuit City Stores, Inc.), No. S141502, filed August 30, 2007.

Robert Gentry went to work for Circuit City Stores in 1995. As part of his orientation packet he received there was a description of Circuit City’s dispute resolution procedures, which included the option of arbitration for disputes arising between employees and Circuit City. Also included was a form for opting out of the arbitration alternative. Mr. Gentry did not sign and return the opt out form within 30 days, as required, so he was deemed by Circuit City to have consented to arbitration of disputes.

Mr. Gentry was classified as an exempt employee and was not paid for working overtime. At some point he concluded that he and other similarly situated employees were misclassified, and he filed a class action lawsuit on behalf of himself and a class of similar employees seeking prospective and retroactive overtime compensation.

Circuit City moved to dismiss the lawsuit and have Mr. Gentry’s claim decided by an arbitrator. Circuit City also pointed out that the arbitration agreement to which Mr. Gentry was deemed to have consented barred class action arbitration of employee claims. Mr. Gentry argued, however, that the class action waiver provision, and other provisions of the arbitration agreement which heavily favored Circuit City, were against public policy and made the agreement unconscionable and therefore unenforceable. Circuit City responded that Mr. Gentry could not raise those issues because he freely consented to arbitration by failing to timely exercise his right to have opted out of arbitration. The lower courts agreed with Circuit City and ordered Mr. Gentry’s individual claim to arbitration. Mr. Gentry appealed, and ultimately the case found its way to the California Supreme Court.

The Supreme Court reversed the lower courts. In order to reach this result the Court had to decide two issues: 1) whether under the circumstances the class action waiver in the arbitration agreement was enforceable and 2) whether the opt out provision insulated the agreement from being attacked as unconscionable. In both cases the Court ruled in favor of Mr. Gentry and against Circuit City.

In regard to the class action waiver, the Court said that the issue was whether, under the circumstances, Mr. Gentry’s class action waiver was against public policy. The Court said that California law favors the use of class actions to resolve relatively small claims of similarly situated claimants. The Court further emphasized that denying the availability of a class action remedy could have the effect of interfering with private enforcement of important statutory rights (such as the right to overtime pay), because few if any employees having such claims would be willing or able to bring them on an individual basis. The Court held that claims for overtime compensation are the type of claims that might not be pursued by individuals, because each employee’s claim is relatively small compared to the costs of litigation and because many employee fear retaliation for bringing such claims. Accordingly, the Court concluded that, if the trial court finds that Mr. Gentry’s case qualifies for certification as a class action and that class arbitration is likely to be a significantly more effective practical means of vindicating the rights of affected employees, the class action waiver in Circuit City’s arbitration agreement was against public policy and unenforceable.

The Court also observed that the lower courts never ruled on Mr. Gentry’s contention that other features of the arbitration agreement (such as a short statute of limitations for bringing claims and a limit on punitive damages) made the entire agreement unenforceable. The reason the lower courts did not rule on that issue was because they considered the existence of the opt out provision, which Mr. Gentry did not sign, eliminated the issue of unconscionability. In California, in order for a contract to be unconscionable it must be both procedurally and substantively unconscionable. Procedural unconscionability ordinary means the contract was a contract of adhesion in which one of the parties had no bargaining power and had to take the contract as is or not at all. By offering Mr. Gentry the opportunity to opt out, the lower courts held that Circuit City had eliminated the procedural unconscionability element, since his agreement to arbitrate was in fact voluntary.

The Supreme Court, however, looked behind the mere fact that Mr. Gentry had failed to timely sign the opt out form. The Court decided that there were a number of circumstances surrounding the opt out provision that made it less voluntary than it appeared. The Court noted that the description of arbitration in the orientation packet was one-sided in pointing out the virtues of arbitration, but omitted to mention the disadvantages of arbitration to employees. The Court also felt that the overall tenor of the orientation material relative to arbitration was that Circuit City definitely wanted employees to agree to the arbitration process and that new employees might feel that failure to do so would be held against them in terms of advancement within the company. The Court thus held that Mr. Gentry’s failure to sign the opt out form was not a fully informed and voluntary decision. Circuit City’s opt out provision did not per se eliminate procedural unconscionability, and the Court sent the case back to the trial court to decide whether the entire arbitration agreement was substantively unconscionable and unenforceable.

This decision requires employers who include class action waivers in arbitration agreements with employees and/or who provide employees an opportunity to opt out of arbitration to revisit those practices. Unfortunately, the Court did not provide any bright line between an enforceable and an unenforceable waiver of class actions. That issue must still be resolved on a case-by-case analysis of the nature of the employee’s claim and the class the employee wishes to represent. Thus, for example, the types of claim involved in the Gentry case – failure to pay overtime – probably would generally not be subject to class action waiver. On the other hand, a sexual harassment claim, which is highly individualistic, probably would survive a challenge to the class action waiver. As a practical matter, however, class action waivers are aimed at the small but typically similar claims which can aggregate into a large class action award; whereas such a waiver will not have much meaning when an employee has a large individualized claim. One therefore needs to question the continuing efficacy of class action waivers given the uncertainty about their enforceability.

First, with respect to class action waivers, such provisions will often trigger subsidiary litigation over their enforceability, thus defeating one of the perceived benefits of arbitration, namely that it is less costly than court litigation. The Gentry decision also opens the door to class action arbitration, which Supreme Court said is valid in California. Employers must ask whether that is a desired result. The one area where arbitration is not less expensive than judicial litigation is in the fees of the arbitrator. A class action arbitration is likely to be a prolonged affair in which there will be many days of arbitration proceedings, and under California law the employer must bear the full cost of the arbitrator’s fees. Furthermore, arbitration decisions are not appealable, which may be a downside from the employer’s perspective where the class award may hinge on a disputed legal issue. Finally, there will be categories of cases that in any event will not qualify as class actions and where a waiver adds nothing helpful for the employer. Hence, in the only area where the waiver would really do any good for an employer, i.e., in situations where many employees have similar and relatively small claims, the waiver would most likely be unenforceable.

Second, employers should review their arbitration opt out procedures to make sure they actually are and also appear to be fair and voluntary. This will require at minimum that the materials provided to employees contain a balanced description of arbitration as applied in the particular employment context. For example, if the arbitration agreement contains features designed to eliminate some advantages employees could obtain in a judicial proceeding, that would have to be disclosed. But this is a double-edged sword, because the more one-sided the agreement, the less likely are employees going to agree to arbitration, if they know all the facts. In addition, the employer must somehow overcome the perception that opting out of arbitration will be held against the employee. At minimum the descriptive materials must avoid indicating the employer’s preference. Another procedure might be to have all employees return the opt out forms, whether signed or unsigned, in sealed envelopes, to be opened only in the event of a dispute arising that requires adjudication.

The California Supreme Court and the California Courts of Appeal have been very tough on employment arbitration agreements (as well as such agreements in consumer transactions). That means that employers must walk a tightrope to design an arbitration program that will survive challenge in the California courts. This raises a question as to how much benefit employers gain by arbitrating employment disputes. The bottom line that still applies is that arbitration avoids jury trials of employment disputes. If that is enough incentive to continue with an employment arbitration program, then employers need to make sure their program legally satisfies the demands of the California courts. Nossaman is fully prepared to advise its clients on how to do that.

John T. Hansen, Of Counsel at Nossaman, specializes in employment law, bankruptcy, corporate reorganization and complex business litigation. He can be reached at (415) 438-7245 or jhansen@nossaman.com.

Veronica M. Gray is Chair of Nossaman’s Employment Practice Group and represents employers in all areas of employment law including, but not limited to, wrongful termination, discrimination and harassment, wage and hour, unfair competition & trade secrets and drafting of policies and procedures, and nondisclosure agreements. She can be reached at (949) 477-7663 or vgray@nossaman.com.

     
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