Introduction

After some fits and starts, on February 15, as a result of a rehearing, the Ninth Circuit upheld a lower federal district court decision finding that the Federal Arbitration Act ("FAA") preempts AB 51—the California Legislature's latest attempt to end mandatory arbitration in the employment setting. The Court found that, by imposing criminal sanctions on an employer who sought to compel an arbitration agreement, the bill ran afoul of U.S. Supreme Court precedent, which holds that the FAA preempts a state law that discriminates against arbitration.

The Court held that AB 51's penalty-based scheme was aimed at punishing employers, and therefore, inhibiting arbitration agreements before they are formed, and therefore, violated the FAA's "equal-treatment principle" inherent in the FAA. It found that AB 51's penalty provision evidenced hostility towards arbitration that the FAA was specifically enacted to overcome. The Court further agreed that the district court appropriately enjoined AB 51's enforcement when it issued a preliminary injunction.

Thus, for now, subject to other conditions, employers are free to require arbitration agreements with their employees that cover any and all claims—including those that arise under the FEHA and the Labor Code.

Background

In 2019, the California legislature passed and Governor Newsom signed AB 51—a bill that sought to end mandatory arbitration in the employment relationship by making it a criminal offense to require an existing employee or an applicant for employment to agree to arbitrate specified claims as a condition of employment. Specifically, AB 51 sought to deter employers from mandating that applicants or employees "waive any right, forum, or procedure" with regard to any claims an employee might bring under the Department of Fair Employment and Housing Act or California's Labor Code by providing that the employer's conduct was a criminal offense.¹

Notably, AB 51 did not invalidate arbitration agreements that an employer might enter into with its employees; it simply imposed criminal liability on the employer's conduct. ("Any person violating this article is guilty of a misdemeanor." See Labor Code section 433).²

Shortly after its passage, the United States Chamber of Commerce and other business groups sued in the United States District Court for the Eastern District of California arguing that the FAA preempted AB 51. The district court granted a temporary restraining order against the enforcement of AB 51 and then issued a preliminary injunction, finding the FAA preempted AB 51.

Brief Summary of the Bonta Decision

The decision is an interesting read: the Ninth Circuit first took great pains to explain how much California is opposed to arbitration agreements and then went to great lengths to point out that the California Legislature was purposely trying to avoid FAA preemption in the manner in which it crafted AB 51.

"Legislative reports made clear why AB 51 provided that criminal conduct—entering into an arbitration agreement with an employee—does not affect the enforceability of the resultant agreement to arbitrate. The California Senate Judiciary Committee report on AB 51 asserted that AB 51 "successfully navigates around" Supreme Court precedent and avoids preemption by applying only to the condition in which an arbitration agreement is made, as opposed to banning arbitration itself."

The Court then looked to determine if AB 51 discriminates against arbitration agreements, either expressly or by disfavoring agreements in some manner. The Court noted that "The burden imposed on the formation of arbitration agreements is severe. AB 51 deters an employer from including non-negotiable arbitration requirements in employment contracts by imposing civil and criminal sanctions on any employer who does so... The threat of criminal and civil liabilities is intended to have a deterrent effect ... and so it is clear that the penalties imposed by AB 51 inhibit an employer's willingness to create an arbitration contract with employees."

The Court did not agree with any of the State's arguments, surprisingly even the argument that, absent the protection provided in AB 51, "employees could be forced to sign arbitration agreements that are illegal, or an employer could retaliate against even a long-term employee who refused to sign." The Court responded that a contract may be consensual, as that term is used in contract law, "even if one party accepts unfavorable terms due to some degree of unequal bargaining power."

What Does This Mean for Employers? Does the Bonta Case Now Mean All Arbitration Agreements are Valid?

No. The Bonta ruling simply holds that the FAA pre-empts AB 51 due to the penalties that AB 51 placed on employers for mandating arbitration agreements. While arbitration agreements are enforceable (including, presumably, class and representative action waivers contained in those agreements), California case law still requires that any arbitration agreement not be either procedurally or substantively unconscionable. The Ninth Court specifically noted that caveat: "Of course, mandatory arbitration provisions in employment contracts of adhesion are not enforceable if the provisions are procedurally and substantively unconscionable, or otherwise unenforceable under generally applicable contract rules. See OTO, L.L.C. v. Kho, 8 Cal. 5th 111, 125–26 (2019)." In other words, arbitration agreements must still meet the "Armendariz requirements" to be enforceable.

How Does This Impact Employers?

Requiring employees to arbitrate employment claims is a business decision. Of late, some employers have given up on arbitration agreements altogether believing that it allows serial harassers to remain undetected by hiding in a relatively private forum. If an employer believes arbitrating employment claims is a good business model, the Bonta decision certainly provides further support for that decision as it confirms that an employer may impose an arbitration agreement upon hire or with existing employees. That said, employers should consult with their counsel to review any current arbitration agreements or before proceeding with an arbitration program to assure they are legal, including providing a severability clause as a fail-safe provision. For this reason, employers should also consider creating a stand-alone arbitration agreement, rather than coupling arbitration into a larger agreement.

Conclusion

While this area is one that has continued to evolve over the last few years, of late, the window of opportunity has opened a bit more. California employers have had two major wins in the area of mandatory arbitration agreements. Last year, in Viking River Cruises, Inc. v. Moriana, 20-1573 (June 2022), the U.S. Supreme Court ruled that an employer could require an employee to arbitrate a claim under California's Private Attorneys General Act (PAGA). This week, with the Bonta decision, California's effort to penalize employers for requiring to arbitrate employment claims is in the rearview mirror.

To be sure, though, we can expect that the Legislature will be looking for some other creative "solution" to the FAA's preemption obstacle as the State's arguments to the Court demonstrate that it remains determined to ban arbitration in the employment setting.

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¹ The specific language – added as Labor Code section 432.6 states: (a) A person shall not, as a condition of employment, continued employment, or the receipt of any employment-related benefit, require any applicant for employment or any employee to waive any right, forum, or procedure for a violation of any provision of the California Fair Employment and Housing Act (Part 2.8 (commencing with Section 12900) of Division 3 of Title 2 of the Government Code) or this code, including the right to file and pursue a civil action or a complaint with, or otherwise notify, any state agency, other public prosecutor, law enforcement agency, or any court or other governmental entity of any alleged violation.

²  That distinction prompted the unique question before the Ninth Circuit: "This appeal raises the question whether the FAA preempts a state rule that discriminates against the formation of an arbitration agreement, even if that agreement is ultimately enforceable."