For several years, employers have raised concern over the cost and management disruption caused by employment-related claims and litigation. As a result, many companies have implemented alternative dispute resolution programs, many of which include employment arbitration agreements. In these agreements, the employer and employee agree to resolve any employment-related dispute through a binding arbitration as opposed to a jury trial. The majority view is that the use of an arbitrator to resolve employment-related disputes would be more expeditious, less expensive, private, and from the employer’s perspective, avoid the possible “runaway” jury verdict.

For years, the legislature has supported and promoted the use of arbitration to resolve disputes. In fact, the Federal Arbitration Act was adopted in 1925 and California followed with its first arbitration statute in 1927. Since that time, California courts and its legislature have consistently shown a policy favoring the arbitration process. That policy was expanded and clarified in the most recent revisions to the arbitration statute adopted in 1961.

In early 1991, the United States Supreme Court issued its decision in Gilmer v. Interstate/Johnson Lane Corporation (1991) 50 U.S. 20 and held that a claim brought under the Age Discrimination in Employment Act could be subject to compulsory arbitration pursuant to an arbitration provision in a securities registration form signed by an employee. Since the high court’s ruling in Gilmer, the federal circuit courts have issued several inconsistent decisions concerning the enforceability of various arbitration agreements causing confusion and concern for employers. The primary legal argument used to avoid arbitration is an argument that the agreement is “unconscionable,” a legal term used to invalidate an agreement that is not negotiated by the parties, and, in the eyes of the employee and several courts, unfair.

In 1998, the United States Court of Appeals for the Ninth Circuit (the federal appellate court which governs the state of California) issued its decision inDuffield v. Roberts & Stevenson Company (9th Cir. 1998) 144 F.3d 1182. The court in Duffield ruled that the Civil Rights Act of 1991 prohibits the enforcement of mandatory employment agreements to arbitrate claims under Title VII of the Civil Rights Act of 1964 or equivalent state anti-discrimination statutes like the California Fair Employment and Housing Act (“FEHA”). The Duffield case involved a securities broker who sought to litigate state and federal discrimination claims against her employer after alleged sexual discrimination and harassment. The Civil Rights Act of 1991 states that, “where appropriate and to the extent authorized by law, the use of alternative means of dispute resolution, including . . . arbitration, is encouraged to resolve disputes arising under the acts or provisions of federal law amended by this title.” Despite this language, the court found the congressional intent of the statute to outlaw compulsory arbitration of employees’ civil rights claims. The 9th Circuit was the only federal appellate court to take such a strong stance against arbitration of employment disputes. As a result, most legal scholars concluded that arbitration agreements governing discrimination and related claims were invalid.

Recently, the California Supreme Court addressed this same issue in Armendariz v. Foundation Health Psychcare Services Inc. (August 24, 2000) 00 C.D.O.S. 7127. In Armendariz, two employees filed a complaint for wrongful termination including claims of sexual harassment, discrimination and breach of contract. Both employees filled out employment application forms which contained an arbitration clause, and subsequently executed a separate employment arbitration agreement. In general, the agreement obligated the employee to submit any employment-related claims to binding arbitration pursuant to California’s arbitration statute (the clause did not require the employer to arbitrate claims it initiated). The agreement also limited the remedies available to the employees to the wages they would have earned from the date of discharge until the date of arbitration. The clause specifically excluded the award of any future lost wages, emotional distress, punitive damages, reinstatement rights and/or injunctive relief.

When the employees filed their claim, the employer filed a motion to compel arbitration. The trial court denied the motion finding the arbitration contract to be an invalid “adhesion contract” (one in which the employee had no opportunity to negotiate its terms) and also found several of the provisions in the contract to be “so one-sided as to ‘shock the conscience'” of the court. The trial court placed great emphasis on the fact that only employees who filed claims against the employer were required to arbitrate their claims but not visa-versa. Furthermore, the court was offended by the limitation of damages and the lack of discovery (investigation of facts) permitted under the terms of the arbitration agreement.

The employer appealed the decision and the Court of Appeal reversed. While the Court of Appeal concluded that the contract was one of adhesion and that the damages provision was unconscionable, the Court of Appeal held that the balance of the arbitration agreement should be enforced. The California Supreme Court then granted review. The California Supreme Court ruled that claims brought under California’s FEHA are in fact arbitratable if “the arbitration permits an employee to vindicate his or her statutory rights.” In sum, the court stated that in order for an employment arbitration agreement to be enforceable (particularly with respect to discrimination claims under the FEHA) the arbitration clause must meet certain minimum requirements. These include: (1) no limit on remedies otherwise available; (2) a provision for “adequate discovery”; (3) a requirement that the arbitrator “issue a written arbitration decision that will reveal, however briefly, the essential findings and conclusions on which the award is based”; and (4) a prohibition against any language requiring the employee to bear any type of expense that the employee would not be required to bear if he or she were to bring the action in court (i.e., arbitrator compensation). The court also addressed the unconscionability doctrine and whether the unconscionable provisions could be stricken or limited to avoid an unconscionable result. The court refused to strike the unconscionable provisions and invalidated the entire agreement.

What can be learned from this decision is that the California Supreme Court continues to support binding arbitration of employment disputes whether based in contract or in tort (discrimination, harassment and other injuries not based on a contract). However, in order for the arbitration agreement to be enforceable, the process agreed to must be fair and impartial and not “shock the conscience” of the reviewing court due to its substantial limitations and procedural roadblocks. The agreement must still allow employees the ability to vindicate their rights in a fair and impartial forum.

Employers should review and revise any current or anticipated arbitration clauses in policy manuals, applications or separate agreements to assure compliance with the recent guidance from the California Supreme Court. The agreement must not be one-sided like the Foundation Health agreement. A properly drafted arbitration provision that will pass judicial scrutiny can still provide the benefits of a less expensive, efficient and private dispute resolution mechanism to resolve state law claims. We will have to wait and see whether the U.S. Supreme Court revisits this issue on the federal level. In the interim, employers should consult with their legal counsel to assure that their agreement is enforceable.

James M. Peterson Chairs, and Alexis S. Gutierrez is a member of, the Employment Law and Litigation Group at Higgs, Fletcher & Mack LLP representing management in advice and litigation relating to the employment relationship. Higgs, Fletcher & Mack is a 65 attorney, full-service San Diego firm founded in 1939. Mr. Peterson and Mr. Gutierrez can be reached at (619) 236-1551 or at [email protected].