Ninth Circuit Upholds Portions of California Law Prohibiting Use of Mandatory Arbitration Agreements

In a split 2-1 decision that likely raises more questions than it answers, the Ninth Circuit Court of Appeals cast some doubt upon the ability of employers to implement mandatory arbitration agreements with their employees. In Chamber of Commerce of the United States of America v. Bonta, the Ninth Circuit upheld portions of California Labor Code section 432.6, which prohibits employers from making arbitration agreements a condition of employment and imposes significant criminal and civil sanctions for violations. The Ninth Circuit’s decision holds that arbitration agreements signed by parties remain enforceable (even if they violate section 432.6), while parties who refused to sign an arbitration agreement may still seek a remedy against the employer under the statute. Moreover, the court held that employers may also have some exposure to criminal and civil sanctions in those instances. Admittedly, this is confusing. The upshot is that employers may want to examine their practices regarding implementation of employee arbitration agreements, at least until the Ninth Circuit considers whether to hear the matter en banc or the Supreme Court of the United States weighs in.

Background

In October 2019, the legislature passed and Governor Gavin Newsom signed Assembly Bill (AB) 51, which, among other things, created Labor Code section 432.6. Section 432.6 bans mandatory employment arbitration agreements in California. For the past several decades, the Supreme Court of the United States has vigorously enforced the provisions of the Federal Arbitration Act (FAA), which requires courts to enforce arbitration agreements pursuant to their terms and preempts state laws that interfere with or impede arbitration. Section 432.6 was an effort to work around the Supreme Court’s pro-arbitration jurisprudence. This was not the legislature’s first attack on arbitration: Governor Jerry Brown vetoed two prior attempts to limit mandatory arbitration in California. Governor Newsom endorsed the legislature’s latest effort, AB 51, which was to become effective on January 1, 2020.

Section 432.6 prohibits employers from requiring applicants to sign arbitration agreements “as a condition of employment, continued employment, or the receipt of any employment-related benefit.” The law then added criminal and civil sanctions against any employer that retaliated, discriminated, threatened, or terminated an employee who refused to consent to arbitration.

Two days before AB 51 was to take effect, the United States District Court for the Eastern District of California issued a restraining order prohibiting enforcement of the law. The court then issued a preliminary injunction stopping enforcement, finding the law in violation of the FAA. California appealed.

The Court’s Decision

The Ninth Circuit, in a 2-1 decision, authored by Judge Carlos Lucero, a member of the Tenth Circuit Court of Appeals, sitting by designation, and joined by Judge William Fletcher, terminated the district court’s injunction concerning the validity of section 432.6. But it affirmed the district court’s decision to enjoin imposition of civil and criminal sanctions. Judge Sandra Ikuta dissented.

The Majority Struggles to Find a Way to Save Prohibitions on Mandatory Arbitration

The majority opinion recognized that the FAA requires enforcement of arbitration agreements pursuant to their terms but held that Section 432.6 does not violate the FAA because it merely requires parties to consent to arbitration and bars involuntary arbitration agreements. The court took pains to distinguish the volumes of federal arbitration jurisprudence that would bar a state from imposing conditions on arbitration, asserting that while the FAA preempts states from imposing conditions on the enforcement of arbitration agreements, it does not require states from banning mandatory arbitration. Importantly, and reflecting the narrowness (or weakness) of its holding, the court emphasized that even though it was allowing section 432.6 to take effect, the law “does not create a contract defense that allows for the invalidation or nonenforcement of an agreement to arbitrate.” Because a party that signs an arbitration agreement may not use Section 432.6 to invalidate an agreement, Section 432.6, according to the court, focuses upon “pre-agreement” conduct, which is not subject to the FAA.

The court’s analysis is problematic in that it relies upon a restricted reading of the Supreme Court’s prior arbitration decisions, including its ruling in Kindred Nursing Centers Ltd. Partnership v. Clark, 137 S.Ct. 1421 (2017), in which the Court rightfully held the FAA preempts state laws that impede the formation of arbitration agreements. To avoid this, the majority states that FAA protection is limited solely to enforcement of agreements and not does not address pre-enforcement conduct and that the California law “applies only in the absence of an agreement to arbitrate.” In other words, Section 432.6 may not be used by a signatory to an arbitration agreement as a way to escape the agreement.

Does the Majority Circumscribe Criminal and Civil Penalties?

While the court did not invalidate section 432.6, it did enjoin Labor Code section 433 and Government Code section 12953, which impose criminal and civil sanctions against employers that violate section 432.6, at least as to “the extent that they apply to executed arbitration agreements” covered by the FAA. (Emphasis added.) This raises the issue as to whether these sections apply in situations when an employee refuses to sign an agreement. The majority opinion is unclear on this issue. Thus, employers that try to condition employment upon the execution of an arbitration agreement may want to examine their particular situation to determine if they have additional risk because of the Ninth Circuit’s decision.

In sum, the court upheld section 432.6’s prohibition on mandatory arbitration agreements but only as applied to parties that do not actually sign them. The court’s decision does not provide a mechanism for vitiating executed arbitration agreements. The court’s decision also reduces, but does not eliminate, the risk of criminal and civil penalties, and leaves open the chance that employers that condition employment upon the execution of an arbitration agreement may still face penalties.

Judge Ikuta Issues Powerful Dissent

Judge Ikuta dissented. Noting that California’s anti-arbitration legislation was “like a classic clown bop bag,” wherein California keeps trying to pass laws that violate the FAA only to have them struck down, Judge Ikuta stated that the Court’s ruling was inconsistent with the Supreme Court’s decision in Kindred Nursing and decisions from the First and Fourth Circuit Courts of Appeals. The dissent argued that the FAA prohibits states both from enacting laws that burden the formation of arbitration agreements, as well as arbitration enforcement. Thus, because section 432.6 discourages or prohibits mandatory arbitration agreements, it improperly burdens the formation of an arbitration agreement, all in violation of Kindred and the FAA. As the dissent notes, “AB 51 is the poster child for covertly discriminating against arbitration agreements and enacting a scheme that disproportionately burdens arbitration.”

The dissent also noted that the majority’s decision creates the strange situation in which an employer may not condition employment upon the employee’s acceptance of an arbitration provision, but if the employer does, and the employee signs the arbitration agreement, the arbitration agreement remains enforceable, and section 432.6 does not apply. On the other hand, “if the prospective employee refuses to sign, then the FAA does not preempt civil and criminal liability for the employer under AB 51’s provisions.” (Emphasis added.) Thus, the majority’s decision means “that an employer’s attempt to enter into an arbitration agreement with employees is unlawful, but a completed attempt is lawful.” (Emphasis added.)

By citing Supreme Court precedent, and alleging a circuit split, Judge Ikuta was apparently laying the groundwork for en banc review or review by the Supreme Court. In the just completed 2020-2021 Supreme Court term, Judge Ikuta either led or was part of a group of Ninth Circuit dissenters in cases that the high court ultimately reversed.

Key Takeaways for Employers

The court’s decision creates some uncertainty regarding the use of arbitration agreements in the employment context in California. On the one hand, employers likely can continue to implement voluntary arbitration agreements with their employees, permitting employees to decline to participate without any penalty. On the other hand, the decision indicates that Labor Code section 432.6 still applies to situations in which employers are seeking to condition employment upon the agreement to arbitration but then only if employees refuse to sign the agreement. In those cases, it is unclear whether civil and criminal penalties would apply. We do know that Section 432.6 will not apply to agreements signed by both parties.

In view of the uncertainty created by this decision, employers may want to consider pausing on imposing arbitration on a mandatory basis upon their employees, at least until the court decides whether to reconsider the decision en banc, or the Supreme Court of the United States weighs in.