Article

Courts Wrestle With Compulsory Arbitration Of Employment Claims In Wake Of U.S. Supreme Court Decision In Circuit City v. Adams

by Robert J. Hagerty, Esq.

In its March 2001 decision, Circuit City v. Adams,[1] the United States Supreme Court reversed the Ninth Circuit Court of Appeals and held that agreements to arbitrate disputes arising out of employment are governed by the Federal Arbitration Act (except with respect to transportation workers). The Supreme Court then remanded the case to the Court of Appeals to determine whether the arbitration agreement was enforceable. In February 2002, the Court of Appeals ruled that it was not.[2] In so doing, the Court of Appeals applied California contract law to the arbitration agreement. This approach is required by the Federal Arbitration Act, which provides that arbitration agreements are valid, irrevocable and enforceable, except that they may not be enforced upon any legal or equitable grounds for revoking a contract. These grounds are normally determined by the law of the State in which the contract to arbitrate arose.

Under California law, a contract is not enforceable if it is both procedurally and substantively unconscionable. Procedural unfairness is examined in light of the equality of bargaining power, or lack of the same, between the parties, along with the clarity and simplicity of the language of the contract. Substantive fairness is measured by the undue harshness or oppressiveness of the contract’s terms. If a contract is found to be unconscionable, the reviewing court has a discretionary choice: it may sever the unfair provisions and enforce the balance of the contract, or it may refuse to enforce the entire contract. The severance of unfair provisions either requires the presence of a severance provision in the agreement, or a Court’s willingness to sever based upon the public policy favoring arbitration. This latter tool is not uniformly embraced by the Courts.

The Ninth Circuit determined that the Circuit City arbitration agreement was unenforceable because it was both procedurally and substantively unconscionable. The appeals court found that the agreement was procedurally unconscionable because it:

• was a contract of adhesion, which is defined as a standard form contract prepared by the party with the superior bargaining power (the employer) and offered to the other party (the employee) on a "take it or leave it" basis.
  
• was a prerequisite to employment and was non-negotiable.
  The Court ruled the arbitration agreement substantively unconscionable because it:
• required employees to arbitrate claims while it did not require Circuit City to do so.
  
• did not allow the full recovery of damages available under the employment statutes in question. Instead, it limited recovery to injunctive relief, up to one year of back pay and up to two years of front pay, compensatory damages and punitive damages equal to $5,000 or the combined award of front and back pay, whichever was greater.
  
• imposed a strict one year statute of limitations on claims.
  
• required the employees to pay one half of the arbitrator's fees.
  

The Court exercised its discretion and declined to enforce the arbitration agreement at all, rather than severing the illegal provisions, finding that the central purpose of the contract was fatally tainted with illegality and therefore unenforceable.

In the year between the Supreme Court’s decision and the Ninth Circuit Court of Appeals’ decision on the remand, the published opinions of the California United States District Court went in both directions. Thus, in October 2001, in two cases involving Circuit City, the Court for the Northern District concluded that the Supreme Court’s Circuit City decision did not overrule a prior Ninth Circuit case, Duffield v. Robertson Stephens & Co.,[3] which prohibits the arbitration of Title VII discrimination claims and related state law claims, and arbitration was denied.[4] However, just one month earlier, in another employment case, a different judge sitting in the same District ruled that Circuit City did overrule Duffield and ordered arbitration.[5]

With respect to judicial treatment of the terms of Circuit City’s arbitration agreement itself, the company fared better in the Eighth Circuit than it did in the Ninth. In Gannon v. Circuit City Stores, Inc.,[6] the Court of Appeals, applying Missouri contract law, determined that it would sever the provision limiting punitive damages from the agreement rather than wholly invalidate it. Although the company still had punitive damage exposure, that decision lay with an arbitrator rather than a jury. In contrast, in Perez v. Globe Airport Security Services, Inc.,[7] the Eleventh Circuit invalidated an arbitration agreement which required the parties to share arbitration costs equally, because this provision directly contravened the statutory right of a prevailing plaintiff to collect her attorneys’ fees and costs, and it lacked a severance clause.

Circuit City is not the only employer obtaining varied results from the courts examining what are presumably identical arbitration agreements. Ryan’s Family Steakhouses, Inc. required its prospective employees to enter into an agreement with a company called Employment Dispute Services, Inc. (EDS) to have EDS provide an arbitration forum for all employment-related disputes between Ryan's and its employees. The document stated explicitly that it was a contract with EDS, not with Ryan's, although it added that Ryan's was a third-party beneficiary of the contract. Ryan’s had a separate, similar agreement with EDS providing for arbitration services.

This elaborate contractual structure was apparently employed to avoid claims by employees that they had a contract of employment with Ryan’s. The arrangement was struck down as unenforceable by the Seventh Circuit Court of Appeals, applying Indiana contract law.[8] The court concluded that the promise of service by EDS to the employee was illusory, because, among other things, the contract allowed EDS to unilaterally change the terms at any time. In contrast, the Louisiana State Court of Appeals, applying Louisiana law, determined that this identical arrangement was enforceable.[9]

Another pitfall to be avoided is obtaining the employee’s signature only on a document which incorporates the arbitration agreement by reference. This was found to be insufficient to bind the employee to arbitration by the District Court of New Jersey in Parker v. Hahnemann Univ. Hosp., 2001 U.S. Dist. N.J. LEXIS 10661. In that case, the employment letter agreement signed by the employee made reference to and incorporated the employer’s "Fair Treatment Process" which was set forth in the employee handbook. Indeed, plaintiff acknowledged receipt of the handbook. Nonetheless, the District Court declined to compel arbitration because the employment letter made no reference to arbitration. A similar result was reached in the New Jersey State appellate court in Grasser v. United Healthcare Corp.,[10] even though the acknowledgment form explicitly referenced arbitration. The failure to notify the employee that he was waiving statutory rights was fatal to the agreement.

CONCLUSION

The examples of judicial treatment of employment arbitration agreements discussed above illustrate that these agreements are subject to attack on many fronts. Employees making claims, and their attorneys, have a strong incentive to avoid arbitration and have a jury hear their cases. Multi-state employers must be careful to tailor their arbitration agreements to each state’s law governing contracts, state discrimination laws, and, in some states, special rules relating to employment arbitration agreements. In light of the high stakes involved, employers should approach creation of arbitration agreements with the assumption that they will be challenged in court in the future, and are therefore well advised to seek the advice of local counsel well versed in the local law governing arbitration agreements.