California Supreme Court Says Severing Unconscionable Terms From Arbitration Agreements Is a Question of Fairness

Quick Hits

• The Supreme Court of California held that courts may only sever unconscionable terms from arbitration agreements and enforce the rest of the agreement when the terms are collateral, severance will cure any unconscionability, and equally important, only when the court concludes severance is in the interests of justice.
• The court noted that the enforceability of the remainder of the agreement does not turn on whether there were a certain number of unconscionable provisions.
• The ruling could provide trial courts with grounds to refuse to enforce arbitration agreements if they find even one unconscionable provision that the court believes renders the agreement unfair to the employee.
• The ruling further empowers trial courts to decline to enforce arbitration agreements that contain problematic provisions on the grounds that the trial court believes that enforcement would be counter to the “interests of justice.”

In a unanimous ruling, the California supreme court ruled that courts in the state should consider whether severing unconscionable provisions of an arbitration agreement will cure the unconscionability and whether severance is in the “interests of justice.” The number of unconscionable terms within a particular arbitration agreement is not determinative to the trial court’s decision, the court ruled.

The California supreme court remanded a California Second District Court of Appeal ruling that had declined to enforce an employment arbitration after finding four provisions of the agreement were unconscionable.

The case involved claims under California’s Fair Employment and Housing Act (FEHA) and a wrongful discharge claim filed by an employee who was discharged after less than a year on the job. The employer moved to compel arbitration and to recover attorneys’ fees for its motion based upon the parties’ arbitration agreement.

While the California high court agreed with the appellate court’s findings on three of the four provisions found to be unconscionable, the court sent the case back for reconsideration on whether those provisions should be severed and the remainder of the agreement enforced, or whether the entire agreement was unenforceable.

The state high court explained that courts may sever unconscionable provisions and enforce the remainder of the contract only when the severed portions are collateral to the main purpose of the agreement, the unconscionable terms can be cured by severance (as opposed to augmentation or reformation), and “enforcing the balance of the contract would be in the interests of justice.”

Severability

The employer argued that all the alleged unconscionable provisions could be severed because they are collateral to the main purpose of the arbitration agreement. The employer also pointed to a severability provision in the agreement that provided that if any provisions are found to be “illegal, invalid, or unenforceable” by a court, then the rest of the agreement should be unaffected and enforced.

Further, the employer argued that the Court of Appeal had effectively applied a bright-line rule whereby severance is prohibited if an agreement contains more than one unconscionable provision.

While noting that some California appellate courts have “treated the severance question as more of a quantitative inquiry than a qualitative one,” the California supreme court rejected this approach. It stated that “no bright line rule requires a court to refuse enforcement if a contract has more than one unconscionable term.” (Emphasis in original.) Additionally, “a court is not required to sever or restrict an unconscionable term if an agreement has only a single such term.” (Emphasis in original.)

Instead, the California supreme court explained that courts should look at whether the agreement’s overall unconscionability can be cured by severing the unconscionable terms without rewriting or reforming the agreement. However, critically, the court stated that “[e]ven if a contract can be cured, the court should also ask whether the unconscionability should be cured through severance or restriction because the interests of justice would be furthered by such actions,” the court stated. (Emphasis in original). The court then added:

“This part of the inquiry focuses on whether mere severance of the unconscionable terms would function to condone an illegal scheme and whether the defects in the agreement indicate that the stronger party engaged in a systematic effort to impose arbitration on the weaker party not simply as an alternative to litigation, but to secure a forum that works to the stronger party’s advantage.”

The California supreme court further found that its approach does not violate the Federal Arbitration Act (FAA) because it treats the unconscionability of arbitration agreements the same way it would treat the issue with other contracts.

Key Takeaways

The California supreme court’s decision takes a skeptical view of employment arbitration agreements, suggesting that employers implement them by using their superior bargaining power to take advantage of employees. As a result, trial courts in the state may rely on the ruling to refuse to sever unconscionable provisions if they find, essentially, that including such a provision (even if there is only one) is unfair to employees. Presumably, such a decision, which rests upon vague and potentially malleable notions of the “interests of justice” will be difficult to attack on appeal.

California employers may want to review their arbitration agreements to avoid problematic and potentially overreaching provisions. They may also want to examine severability clauses in their arbitration agreements.

Ogletree Deakins will continue to monitor developments and will provide updates on the Arbitration and Alternative Dispute Resolution and California blogs.

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