News
Labor/Employment
Feb. 28, 2002
'Circuit City' Ruiling Shelves Most Arbitration Clauses
Focus Column - By Johnny Darnell Griggs - In its landmark opinion in Circuit City Stores Inc. v. Adams, 532 U.S. 105 (2001), the U.S. Supreme Court held that mandatory arbitration provisions in employment contracts, except those of transportation workers, may be enforced under the Federal Arbitration Act.
Focus Column
By Johnny Darnell Griggs
In its landmark opinion in Circuit City Stores Inc. v. Adams, 532 U.S. 105 (2001), the U.S. Supreme Court held that mandatory arbitration provisions in employment contracts, except those of transportation workers, may be enforced under the Federal Arbitration Act.
In Circuit City, the Supreme Court interpreted Section 1 of the Federal Arbitration Act, which excludes from its coverage "contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce," to apply only to transportation workers rather than to all employees.
On the heels of the Supreme Court's opinion, and on remand from the high court, the 9th U.S. Circuit Court of Appeals has held unconscionable and unenforceable as a matter of California state law the very same arbitration provision at issue in the Supreme Court's Circuit City opinion, thus invalidating the provision.
In October 1995, Saint Clair Adams applied for a job as salesperson at Circuit City. As part of the application process, and as a prerequisite to employment at Circuit City, Adams signed the "Circuit City Dispute Resolution Agreement." It contained a provision requiring Adams to submit to arbitration any and all claims "arising out of or relating to [his] application or candidacy for employment, employment and/or cessation of employment with Circuit City."
The arbitration provision expressly included all statutory civil rights claims. The agreement also did the following:
• Restricted the amount of damages. It limited back pay to one year, front pay to two years and punitive damages to the greater of front pay and back pay awarded or $5,000.
• Required the employee to split the costs of arbitration, including the arbitrator's fees, the cost of the court reporter and the cost of renting a venue for the arbitration, unless the employee prevailed and the arbitrator ordered Circuit City to bear the costs.
• Did not require Circuit City to submit its claims against the employee to arbitration.
Two years after commencing employment in the Santa Rosa, Calif., Circuit City store, Adams filed an action in California state court asserting causes of action for sexual harassment and retaliation in violation of California's Fair Employment and Housing Act, Government Code Section 12900 et seq., related torts under California law and discrimination based on sexual orientation under Section 1102.1 of the California Labor Code.
Circuit City then filed a petition in the U.S. District Court to enjoin the state court action and compel arbitration under the Federal Arbitration Act. The District Court compelled arbitration of Adams' claims. The 9th Circuit reversed the District Court, ruling that Section 1 of the Federal Arbitration Act excluded the arbitration provision at issue, which was, therefore, unenforceable under the Federal Arbitration Act.
The Supreme Court reversed the 9th Circuit, holding that the exclusion in Section 1 was limited to transportation workers and, therefore, that the arbitration provision was not rendered invalid on that basis. The court remanded the matter to the 9th Circuit for further proceedings consistent with its ruling.
On remand, in Circuit City Stores Inc. v. Adams, 2002 U.S.App.LEXIS 1686 (9th Cir. Feb. 4, 2002), the 9th Circuit considered whether the arbitration agreement was unconscionable as a matter of California state law. As a preface to its ruling, the 9th Circuit observed that "Circuit City has devised an arbitration agreement that functions as a thumb on Circuit City's side of the scale should an employment dispute ever arise between the company and its employees. We conclude that such an arrangement is unconscionable under California law."
With that ominous sign of things to come, the court proceeded to invalidate Circuit City's mandatory arbitration provision. The court determined first that California contract law applied to its analysis. The court observed that Section 2 of the Federal Arbitration Act provides that arbitration agreements "'shall be valid, irrevocable, and enforceable, save upon such grounds that exist at law or in equity for the revocation of any contract.'"
The court concluded that in examining the validity of an agreement to arbitrate, federal courts "'should apply ordinary state-law principles that govern the formation of contracts.'" Finally, the court concluded that, while federal courts may not invalidate arbitration provisions using state-law principles applicable only to arbitration agreements, "'general contract defenses such as fraud, duress, or unconscionability, grounded in state law, may operate to invalidate arbitration agreements.'"
Next, the court, relying on the California Supreme Court's opinion in Armendariz v. Foundation Health Psychcare Services Inc., 24 Cal.4th 83 (2000), set forth the standard under California law for determining whether a contract is unenforceable based on its unconscionability. According to the court, a contract will be declared unenforceable where it is both procedurally and substantively unconscionable.
An assessment of procedural unconscionability involves the consideration of "the equilibrium of bargaining power between the parties and the extent to which the contract clearly discloses its terms." The consideration of substantive unconscionability entails "whether the terms of the contract are unduly harsh or oppressive."
Having articulated the applicable standard, the court turned its attention next to the question of whether Circuit City's mandatory arbitration provision was procedurally and substantively unconscionable.
Initially, the court considered the issue of procedural unconscionability. The court held that the arbitration provision was procedurally unconscionable because it was a contract of adhesion, i.e, a standard-form contract, drafted by the party having superior bargaining power and proffered to the other party on a take-it-or-leave-it basis.
To support its conclusion in this regard, the court noted that Circuit City, which generally has more bargaining power than its employees, drafted the provision, used it as a standard agreement for all of its employees, made the provision a prerequisite to employment with the company and did not permit employees to negotiate or modify its terms. Accordingly, the court declared the provision procedurally unconscionable.
In analyzing the issue of substantive unconscionability, the court again relied heavily on Armendariz. The court observed that, in Armendariz, the California Supreme Court reversed an order compelling arbitration of a discrimination claim brought under the Fair Employment and Housing Act based on two factors.
First, the provision under review was asymmetrical, in that it required the employee, as a condition of employment, to arbitrate all of the employee's claims relating to the termination of employment but did not require the employer to arbitrate its claims. Because there was no apparent justification for the absence of mutuality, the Armendariz court reasoned that arbitration appeared to be serving "'less as a forum for neutral dispute resolution and more as a means of maximizing employer advantage.'"
Second, the Armendariz provision, which limited the employee to back pay from the date of discharge to the date of the arbitration award, precluded damages that would be available ordinarily under the Fair Employment and Housing Act.
The 9th Circuit found the Circuit City agreement "virtually indistinguishable from the agreement the California Supreme Court found unconscionable in Armendariz." As in Armendariz, the court concluded, the arbitration provision imposed on the employee was a unilateral obligation to arbitrate all claims relating to his or her employment, and it in no way required Circuit City to arbitrate its claims against employees.
Nor, the court observed, did Circuit City proffer any legitimate business justification for the one-sided agreement. Hence, the court concluded that the provision deprived employees of the "modicum of bilaterality" required of contracts under California law and was therefore unconscionable.
In addition, the court found that the unilateral nature of the provision was compounded by the fact that the agreement limited the relief that would be available otherwise under the Fair Employment and Housing Act to employees.
Circuit City's provision limited the aggrieved employee's back pay, front pay and punitive damages and precluded altogether damages for emotional distress. In addition, the provision required the employee to split the costs of arbitration (which, the court believed, in and of itself would invalidate the agreement) and imposed a strict one-year statute of limitations that would deprive employees of the benefit of the continuing-violation doctrine. Thus, the Arbitration Clause deprived Adams of the complete panoply of statutory remedies.
Finally, after opining that its ruling was consistent with federal law and did not contravene the Federal Arbitration Act, the court declined merely to sever offending portions of the contract, choosing instead to invalidate the agreement in its entirety.
Again relying on Armendariz, the court concluded, "In this case, as in Armendariz, the objectionable provisions pervade the entire contract. ... Removing these provisions would go beyond mere excision to rewriting the contract, which is not the proper role of this Court. ... Therefore, we find the entire arbitration agreement unenforceable."
The latest appellate decision in the Circuit City saga demonstrates the extent to which the 9th Circuit will continue to scrutinize the fairness of pre-dispute agreements to arbitrate employment disputes. If the 9th Circuit's ruling withstands Supreme Court scrutiny, or if the high court declines to review the ruling, an employer's resort to the federal courts and the Federal Arbitration Act may be unavailing where, under state law, there are substantive defenses to the arbitration contract such as fraud, duress or unconscionability.
Johnny Darnell Griggs, a partner with Sidley Austin Brown & Wood in Los Angeles, represents employers in employment disputes.
By Johnny Darnell Griggs
In its landmark opinion in Circuit City Stores Inc. v. Adams, 532 U.S. 105 (2001), the U.S. Supreme Court held that mandatory arbitration provisions in employment contracts, except those of transportation workers, may be enforced under the Federal Arbitration Act.
In Circuit City, the Supreme Court interpreted Section 1 of the Federal Arbitration Act, which excludes from its coverage "contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce," to apply only to transportation workers rather than to all employees.
On the heels of the Supreme Court's opinion, and on remand from the high court, the 9th U.S. Circuit Court of Appeals has held unconscionable and unenforceable as a matter of California state law the very same arbitration provision at issue in the Supreme Court's Circuit City opinion, thus invalidating the provision.
In October 1995, Saint Clair Adams applied for a job as salesperson at Circuit City. As part of the application process, and as a prerequisite to employment at Circuit City, Adams signed the "Circuit City Dispute Resolution Agreement." It contained a provision requiring Adams to submit to arbitration any and all claims "arising out of or relating to [his] application or candidacy for employment, employment and/or cessation of employment with Circuit City."
The arbitration provision expressly included all statutory civil rights claims. The agreement also did the following:
• Restricted the amount of damages. It limited back pay to one year, front pay to two years and punitive damages to the greater of front pay and back pay awarded or $5,000.
• Required the employee to split the costs of arbitration, including the arbitrator's fees, the cost of the court reporter and the cost of renting a venue for the arbitration, unless the employee prevailed and the arbitrator ordered Circuit City to bear the costs.
• Did not require Circuit City to submit its claims against the employee to arbitration.
Two years after commencing employment in the Santa Rosa, Calif., Circuit City store, Adams filed an action in California state court asserting causes of action for sexual harassment and retaliation in violation of California's Fair Employment and Housing Act, Government Code Section 12900 et seq., related torts under California law and discrimination based on sexual orientation under Section 1102.1 of the California Labor Code.
Circuit City then filed a petition in the U.S. District Court to enjoin the state court action and compel arbitration under the Federal Arbitration Act. The District Court compelled arbitration of Adams' claims. The 9th Circuit reversed the District Court, ruling that Section 1 of the Federal Arbitration Act excluded the arbitration provision at issue, which was, therefore, unenforceable under the Federal Arbitration Act.
The Supreme Court reversed the 9th Circuit, holding that the exclusion in Section 1 was limited to transportation workers and, therefore, that the arbitration provision was not rendered invalid on that basis. The court remanded the matter to the 9th Circuit for further proceedings consistent with its ruling.
On remand, in Circuit City Stores Inc. v. Adams, 2002 U.S.App.LEXIS 1686 (9th Cir. Feb. 4, 2002), the 9th Circuit considered whether the arbitration agreement was unconscionable as a matter of California state law. As a preface to its ruling, the 9th Circuit observed that "Circuit City has devised an arbitration agreement that functions as a thumb on Circuit City's side of the scale should an employment dispute ever arise between the company and its employees. We conclude that such an arrangement is unconscionable under California law."
With that ominous sign of things to come, the court proceeded to invalidate Circuit City's mandatory arbitration provision. The court determined first that California contract law applied to its analysis. The court observed that Section 2 of the Federal Arbitration Act provides that arbitration agreements "'shall be valid, irrevocable, and enforceable, save upon such grounds that exist at law or in equity for the revocation of any contract.'"
The court concluded that in examining the validity of an agreement to arbitrate, federal courts "'should apply ordinary state-law principles that govern the formation of contracts.'" Finally, the court concluded that, while federal courts may not invalidate arbitration provisions using state-law principles applicable only to arbitration agreements, "'general contract defenses such as fraud, duress, or unconscionability, grounded in state law, may operate to invalidate arbitration agreements.'"
Next, the court, relying on the California Supreme Court's opinion in Armendariz v. Foundation Health Psychcare Services Inc., 24 Cal.4th 83 (2000), set forth the standard under California law for determining whether a contract is unenforceable based on its unconscionability. According to the court, a contract will be declared unenforceable where it is both procedurally and substantively unconscionable.
An assessment of procedural unconscionability involves the consideration of "the equilibrium of bargaining power between the parties and the extent to which the contract clearly discloses its terms." The consideration of substantive unconscionability entails "whether the terms of the contract are unduly harsh or oppressive."
Having articulated the applicable standard, the court turned its attention next to the question of whether Circuit City's mandatory arbitration provision was procedurally and substantively unconscionable.
Initially, the court considered the issue of procedural unconscionability. The court held that the arbitration provision was procedurally unconscionable because it was a contract of adhesion, i.e, a standard-form contract, drafted by the party having superior bargaining power and proffered to the other party on a take-it-or-leave-it basis.
To support its conclusion in this regard, the court noted that Circuit City, which generally has more bargaining power than its employees, drafted the provision, used it as a standard agreement for all of its employees, made the provision a prerequisite to employment with the company and did not permit employees to negotiate or modify its terms. Accordingly, the court declared the provision procedurally unconscionable.
In analyzing the issue of substantive unconscionability, the court again relied heavily on Armendariz. The court observed that, in Armendariz, the California Supreme Court reversed an order compelling arbitration of a discrimination claim brought under the Fair Employment and Housing Act based on two factors.
First, the provision under review was asymmetrical, in that it required the employee, as a condition of employment, to arbitrate all of the employee's claims relating to the termination of employment but did not require the employer to arbitrate its claims. Because there was no apparent justification for the absence of mutuality, the Armendariz court reasoned that arbitration appeared to be serving "'less as a forum for neutral dispute resolution and more as a means of maximizing employer advantage.'"
Second, the Armendariz provision, which limited the employee to back pay from the date of discharge to the date of the arbitration award, precluded damages that would be available ordinarily under the Fair Employment and Housing Act.
The 9th Circuit found the Circuit City agreement "virtually indistinguishable from the agreement the California Supreme Court found unconscionable in Armendariz." As in Armendariz, the court concluded, the arbitration provision imposed on the employee was a unilateral obligation to arbitrate all claims relating to his or her employment, and it in no way required Circuit City to arbitrate its claims against employees.
Nor, the court observed, did Circuit City proffer any legitimate business justification for the one-sided agreement. Hence, the court concluded that the provision deprived employees of the "modicum of bilaterality" required of contracts under California law and was therefore unconscionable.
In addition, the court found that the unilateral nature of the provision was compounded by the fact that the agreement limited the relief that would be available otherwise under the Fair Employment and Housing Act to employees.
Circuit City's provision limited the aggrieved employee's back pay, front pay and punitive damages and precluded altogether damages for emotional distress. In addition, the provision required the employee to split the costs of arbitration (which, the court believed, in and of itself would invalidate the agreement) and imposed a strict one-year statute of limitations that would deprive employees of the benefit of the continuing-violation doctrine. Thus, the Arbitration Clause deprived Adams of the complete panoply of statutory remedies.
Finally, after opining that its ruling was consistent with federal law and did not contravene the Federal Arbitration Act, the court declined merely to sever offending portions of the contract, choosing instead to invalidate the agreement in its entirety.
Again relying on Armendariz, the court concluded, "In this case, as in Armendariz, the objectionable provisions pervade the entire contract. ... Removing these provisions would go beyond mere excision to rewriting the contract, which is not the proper role of this Court. ... Therefore, we find the entire arbitration agreement unenforceable."
The latest appellate decision in the Circuit City saga demonstrates the extent to which the 9th Circuit will continue to scrutinize the fairness of pre-dispute agreements to arbitrate employment disputes. If the 9th Circuit's ruling withstands Supreme Court scrutiny, or if the high court declines to review the ruling, an employer's resort to the federal courts and the Federal Arbitration Act may be unavailing where, under state law, there are substantive defenses to the arbitration contract such as fraud, duress or unconscionability.
Johnny Darnell Griggs, a partner with Sidley Austin Brown & Wood in Los Angeles, represents employers in employment disputes.
For the Record Due to an editing error, a headline for a Focus Column published in the Los Angeles Daily Journal on February 28, 2002, by Johnny Darnell Griggs, ("'Circuit City' Ruling Shelves Most Arbitration Clauses"), misrepresented the impact of that case. The 9th Circuit found Circuit City clause unenforcable under existing state law due to unconscionablity. There is no indication that courts will hold "most" arbitrtion clauses unenforcable under this ruling. The Daily Journal regrets the error.
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