High Court Tackles Threshold Question of Arbitrability of Employment Contract

On June 21, with Justice Antonin Scalia writing for a 5-4 majority, the U.S. Supreme Court issued an important decision for employers that are utilizing or are considering utilizing employment arbitration agreements. The Court ruled on the issue of the enforceability of an arbitration agreement (included as part of an employment contract), which stated that the arbitrator must determine the enforceability of the contract. According to the Court, because the employee in this case challenged the enforceability of his employment contract as a whole, rather than specifically challenging the provision contained in the agreement granting the arbitrator the authority to determine enforceability (the “delegation” provision), the question of enforceability of the agreement to arbitrate must be decided by an arbitrator, not a court. Rent-A-Center, West, Inc. v. Jackson, No. 09–497, U.S. Supreme Court (June 21, 2010).

Factual Background

Antonio Jackson was employed by Rent-A-Center, West, Inc. At the time of hiring, he signed an agreement, entitled “Mutual Agreement to Arbitrate Claims,” as a condition of his employment. In a section entitled “Claims Covered By The Agreement,” the agreement required that all “past, present or future” disputes arising out of Jackson’s employment with Rent-A-Center be submitted to arbitration. Another section, “Arbitration Procedures,” included a provision that stated that, “The Arbitrator, and not any federal, state, or local court or agency, shall have exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Agreement including, but not limited to, any claim that all or any part of this Agreement is void or voidable.”

In February 2007, Jackson filed a discrimination suit against Rent-A-Center in federal district court in Nevada. Rent-A-Center subsequently filed a motion under the Federal Arbitration Act (FAA) to force Jackson to resolve his claims though arbitration. Jackson argued that the arbitration agreement is “unenforceable in that it is unconscionable.” Rent-A-Center countered that because Jackson had agreed that the arbitrator would have exclusive authority to resolve disputes about the enforceability of the agreement, the issue of unconscionability was for an arbitrator, not the court, to decide.

The trial judge granted Rent-A-Center’s request and compelled arbitration. The Ninth Circuit Court of Appeals reversed, holding that the court must decide whether the agreement is enforceable. The case ultimately reached the U.S. Supreme Court.

Legal Analysis

Justice Scalia identified the “controversy” in the case to be whether the agreement is unconscionable. Thus, the question before the Court was whether the provision in the Arbitration Procedures section of the contract, which delegates resolution of the conscionability issue to the arbitrator, is valid under the FAA. The validity of such so-called delegation provisions – agreements to arbitrate threshold issues concerning an arbitration agreement – are governed under section 2 of the FAA, which provides that a written provision in a contract to settle by arbitration a controversy arising out of that contract “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”

The Court next identified two types of validity challenges under section 2 of the FAA. The first specifically challenges the validity of the agreement to arbitrate. The second challenges the contract as a whole. Based on an earlier line of cases, the Court noted that only the first type of challenge is relevant to a court’s determination of whether the arbitration agreement at issue is enforceable. Finding that an arbitration agreement is severable from the remainder of a contract, the Court ruled that a challenge “to the contract as a whole, does not prevent a court from enforcing a specific agreement to arbitrate.” If, however, a party challenges the validity “of the precise agreement to arbitrate” under section 2, the federal court must consider the challenge before ordering compliance with that agreement.

As a result, “in an employment contract,” the Court reasoned, “many elements of alleged unconscionability applicable to the entire contract (outrageously low wages, for example) would not affect the agreement to arbitrate alone.” Even where that is not the case, for example, where the alleged fraud that induced the whole contract equally induced the arbitration agreement that was part of that contract, the Court held “we nonetheless require the basis of challenge to be directed specifically to the agreement to arbitrate before the court will intervene.” Thus, unless Jackson specifically challenged the delegation provision contained in the Arbitration Procedures section of his contract, the Court ruled that it must treat it as valid and enforce it, “leaving any challenge to the validity of the Agreement as a whole for the arbitrator.”

The Court found, however, that Jackson had challenged only the validity of the contract as a whole and not the delegation provision. None of Jackson’s substantive unconscionability challenges – for example, that the agreement’s coverage was one-sided in that it required arbitration of claims an employee was likely to bring but not claims Rent-A-Center was likely to bring – was specific to the delegation provision. On the contrary, the Court found that Jackson argued that the “entire agreement” favors Rent-A-Center and that the agreement’s limitations on discovery further his “contention that the arbitration agreement as a whole is substantively unconscionable.”

The Court also noted that the fact that the underlying contract was itself an arbitration agreement was not salient: “Application of the severability rule does not depend on the substance of the remainder of the contract.”

The Court acknowledged that in his brief to the Supreme Court, Jackson did argue that the delegation provision is unconscionable. However, the Court did not consider the challenge because Jackson brought it too late. Thus, because Jackson did not make any arguments specific to the delegation provision, the Court reversed the Ninth Circuit’s decision.

According to Ron DeMoss, General Counsel at Rent-A-Center, who argued this case before the Supreme Court, “It helped our case that we had a very fair and reasonable arbitration agreement. In fact, Justice Ginsburg remarked that our employment arbitration agreement was more favorable than most.”

Justice John Paul Stevens, writing for the dissent, took issue with the majority’s claims about the underlying contract: “Its breezy assertion that the subject matter of the contract at issue – in this case, an arbitration agreement and nothing more – ‘makes no difference,’ … is simply wrong.” If Jackson’s unconscionability claim was correct, “it would contravene the existence of clear and unmistakable assent to arbitrate the very question petitioner now seeks to arbitrate.” Thus, according to the dissent, it was necessary for the Court to resolve the merits of Jackson’s unconscionability claim in order to decide whether the parties have a valid arbitration agreement under the FAA.

Practical Impact

According to Jill Garcia, a shareholder in Ogletree Deakins’ Las Vegas office, “Rent-A-Center is an excellent decision for employers nationwide, and particularly in the Ninth Circuit. The ability to contract, whether with consumers, employees, franchisees or otherwise, is a cornerstone in day-to-day business operations. Employers would be wise to revisit their existing agreements, and if they determine they do not have a provision which specifically delegates the question of enforceability to the arbitrator, insert one immediately.”

However, Jeffrey Winchester, also a shareholder in Ogletree Deakins’ Las Vegas office, warns employers, “Based on this ruling, delegation clauses are likely to come under attack by plaintiffs seeking to avoid arbitration of claims. Employers may want to consider taking steps to highlight the delegation clause, such as printing the clause in bold, using large font, and including language whereby the employee acknowledges that, by signing the agreement, he or she is waiving the right to have a court determine the enforceability of the agreement, as well as waiving the right to have his or her statutory claims heard in court.”

Michael Fox, a shareholder in Ogletree Deakins’ Austin office, believes this battle may not be over yet. “I can almost guarantee that there will be an outcry by Senator Patrick Leahy (D-VT) and others that the Supreme Court has dealt yet another vicious and erroneous blow to employee rights and that the only recourse is swift and sure Congressional action. The problem for employers is that the swift and sure Congressional action if it should come, is unlikely to merely undo Rent-A-Center. It is much more likely to be the enactment of the Arbitration Fairness Act, which notwithstanding what you may hear, will be the end of arbitration as a means of dispute resolution in the employment setting except for collective bargaining agreements.

“I am not sure what term one uses to describe something that is far worse than a mere pyrrhic victory, but if as a result of today’s decision is the passage of the Arbitration Fairness Act, then the employer community will certainly need one.”