March 07, 2023

Ninth Circuit Rules California Employers Can Require Arbitration Agreements

Some good news for California employers. Recently, the U.S. Court of Appeals for the Ninth Circuit ruled that California employers can require employees and applicants to sign arbitration agreements as a condition of employment, reversing its own prior decision which vacated U.S. District Court for the Eastern District of California’s grant of a preliminary injunction against enforcement of Assembly Bill 51 (AB 51).

By way of background, AB 51, which was signed into law in 2019 and codified in California Labor Code § 432.6, was enacted to protect employees from “forced arbitration” by making it a criminal offense for an employer to require an employee or applicant for employment to consent to arbitrate specified claims a condition of employment. After the District Court granted preliminary injunction against enforcement of AB 51 in January 2020, in September 2021, a divided three-judge panel of the Ninth Circuit Court vacated the preliminary injunction, which was the subject of a previous client alert

Fast forward to 2023, another divided three-judge panel of the Ninth Circuit held that the Federal Arbitration Act (FAA) preempted AB 51, which – it explained – discriminates only against the formation of an arbitration agreement but does not make unenforceable an agreement executed in violation of the law. See Chamber of Commerce of The United States of America v. Bonta.

In holding that the FAA preempted AB 51, the Ninth Circuit highlighted, inter alia, previous legislative efforts relating to arbitration that had been struck down as preempted by the FAA, including California Governor Jerry Brown’s own veto of AB 465 in 2015 (a bill similar to AB 51). The court applied the principles of obstacle preemption, beginning with the FAA’s purpose, which – it explained – is to combat the longstanding “hostility towards arbitration” and “give preference (instead of mere equality) to arbitration provisions.” In light of that explicit purpose, the court explained that state rules that burden the formation of arbitration agreements – not just state rules affecting the enforceability of arbitration agreements – stand as an obstacle to the FAA, citing to Doctor’s Assocs., Inc. v. Casarotto, 517 U.S. 683 (1996) and Kindred Nursing Ctrs. Ltd. P’ship v. Clark, 137 S. Ct. 1421, 1428 (2017). AB 51’s penalty-based scheme, the Ninth Circuit went on, “is intended to have a deterrent effect” by inhibiting arbitration agreements before they are formed. The court further explained AB 51 “singles out arbitration provisions as an exception” to generally applicable law, emphasizing that “California law generally allows an employer to enter into a contract with an employee that includes non-negotiable terms as a condition of employment, including requirements related to compensation, see Koehl v. Verio, Inc., 142 Cal. App. 4th 1313, 1331 (2006), and drug usage, see Ross v. RagingWire Telecomms., Inc., 42 Cal. 4th 920, 924 (2008).” The court held that, for these reasons, AB 51 violates the “equal-treatment principle” inherent in the FAA and established by the Supreme Court in Kindred Nursing, which “requires courts to place arbitration agreements on equal footing with all other contracts.” Because AB 51’s penalty-based scheme is the “type of ‘device[]’ or ‘formula’ evincing ‘hostility towards arbitration’ that the FAA was enacted to overcome,” AB 51 is preempted by the FAA, the court concluded.

The court’s holding, it explained, is in line with similar conclusions reached by two of its sister circuits. In Saturn Distrib. Corp. v. Williams, 905 F.2d 719 (4th Cir. 1990), the U.S. Court of Appeals for the Fourth Circuit found that FAA preemption extended to a Virginia law that prohibited automobile manufacturers and dealers from entering into an agreement that contained a non-negotiable arbitration provision. Because the Virginia statute was “clearly intended to avoid potentially adhesive arbitration contracts between automobile manufacturers and dealers,” and the state had not “uniformly barred the formation of nonnegotiable contractual terms or declared all contracts of adhesion to be presumptively unenforceable,” the Fourth Circuit concluded that the law treated arbitration agreements “more harshly than other contracts,” and was thus preempted. Similarly, in Sec. Indus. Ass’n v. Connolly, 883 F.2d 1114 (1st Cir. 1989), the U.S. Court of Appeals for the First Circuit held that the FAA preempted Massachusetts regulations that prohibited securities firms from requiring clients to agree to arbitration “as a nonnegotiable condition precedent to account relationships.” It reasoned that because the regulations “inhibit a party’s willingness to create an arbitration contract,” they stood as an obstacle to the purposes of the FAA.

The court rejected California’s argument that because AB 51 regulates the conduct of employers before an arbitration agreement is formed, rather than affecting the validity or enforceability of the executed arbitration agreement itself, it does not conflict with the FAA. It explained that “[r]ules that impede parties’ ability to form arbitration agreements hinder the broad ‘national policy favoring arbitration’ . . . just as much as those that undermine the enforceability of already-existing arbitration agreements.” The court also rejected California’s argument that AB 51 does not pose an obstacle to the FAA because it is simply a prohibition against “forced arbitration,” reasoning that such an argument “misunderstand[s] basic principles of California contract law, Supreme Court caselaw regarding consent in arbitration cases, and AB 51 itself.” The court emphasized that contracts may be consensual even if they are a product of unequal bargaining power and that “mandatory arbitration provisions in employment contracts of adhesion are not enforceable if the provisions are procedurally and substantially unconscionable, or otherwise unenforceable under generally applicable contract rules.” These are basic principles, the court explained, that AB 51 does nothing to change.

Finally, the court rejected California’s argument that it could sever Section 433 – which makes any violation of Section 432.6 a misdemeanor offense – under the severability clause in Section 432.6(i), and then uphold the balance of AB 51. In so doing, the court explained that AB 51 provides no authority to delete Section 433, because the severability clause in Section 432.6(i) applies only to Section 432.6. In any event, the court could not presume that the California Legislature would want to invalidate a generally applicable provision such as Section 433. The court also held that the dissent’s proposal to sever Section 12953 of the California Government Code, which imposes civil penalties for a violation of Section 432.6 of the California Labor Code, fails for the same reason.

Recommended Next Steps for California Employers

It is possible that the Ninth Circuit may take this matter up further en banc or that the U.S. Supreme Court may grant cert. Otherwise, this matter will return to the District Court for further proceedings. Until there is further clarity on arbitration agreements, employers should consult with counsel to assess the implications of this decision on their arbitration agreements.

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