Implied Covenant of Good Faith and Fair Dealing Saves California Employer’s Arbitration Agreement

Serpa v. California Surety Investigations, Inc., No. B237363 (April 19, 2013): In a recent decision, a California Court of Appeal held that an arbitration agreement contained in an employee handbook was not invalid solely on the basis that the employer reserved the right to change the handbook at its discretion. The court held that the employer’s ability to change the terms of the agreement was limited by the covenant of good faith and fair dealing implied in every contract.

Valerie Serpa was employed as a bail bond investigator by California Surety Investigations (CSI). On the first day of her employment, she signed an arbitration agreement that required employees to arbitrate all employment disputes. The agreement also incorporated, by reference, the company’s arbitration policy (which was included in the employee handbook). On June 24, 2011, Serpa filed a lawsuit against CSI alleging sexual harassment, employment discrimination, wrongful termination, and other related claims.

The trial judge denied the CSI’s motion to compel arbitration, finding that the arbitration agreement was one-sided and only compelled the employee to arbitrate claims. The trial judge rejected the company’s argument that the employee handbook, which was incorporated by reference, required both employees and CSI to arbitrate disputes. The trial judge “recognized [that] the agreement’s incorporation of the arbitration policy in the employee handbook salvages the agreement by establishing an unmistakable mutual obligation on the part of CSI and Serpa to arbitrate ‘any dispute’ arising out of her employment.” However, the trial judge rejected CSI’s arbitration agreement because the employee handbook could be changed at its sole discretion.

The Court of Appeal reversed the decision and held that the right to change the terms of the employee handbook was limited by the covenant of good faith and fair dealing implied in every contract. The court relied on Guz v. Bechtel National in stating, “The implied covenant of good faith prevents one contracting party from ‘unfairly frustrating the other party’s right to receive the benefits of the agreement actually made.’”

The Court of Appeal also found that the attorney fee provision in the arbitration agreement, which required each party to pay their own attorneys’ fees, was unenforceable. However, the court also determined that the unenforceable provision did not void the underlying agreement to arbitrate, as the trial judge should have exercised her discretion and severed the “collateral” provision.

According to Michael Nader, a shareholder in Ogletree Deakins’ San Francisco office: “This case supports the strong public policy in federal and California law that favors arbitration, and provides authority for employers to enforce arbitration agreements with similar defects, including unenforceable provisions that are collateral to the underlying agreement to arbitrate. However, this case also underscores the importance for employers to continually review their arbitration agreements and policies to ensure that they expressly state all of the requisite provisions for a valid arbitration agreement that applies to all types of employment-related claims.”