Employment Arbitration Agreements - Enforceable? Desirable?

Aaron Morris, Esq.

A relatively new trend has emerged, whereby employers are attempting to limit the expense and exposure of wrongful termination actions by requiring that all employees sign arbitration agreements. I am frequently asked by employers whether they should adopt such an approach. Before turning to that question, let's dispel some of the myths about arbitration.

Arbitration is not Mediation

I find that when many people use the term arbitration, they are really thinking of a procedure more akin to mediation. For example, in those case where an arbitration clause is in place, the client is often surprised when I begin talking in terms of gathering evidence and witnesses and preparing for the arbitration. Without having actually thought it through, they somehow thought that the arbitration agreement would avoid all of the traditional methods of proof. When I dig deeper, I find that they envisioned a meeting between the parties, where the arbitrator would listen to both sides, and then either issue a King Solomon-like proclamation, or persuade the parties to enter into a mutually acceptable settlement agreement.

Arbitration is best thought of as a trial proceeding in a different forum. The rules of that forum are defined by the parties and/or the arbitration agreement. For instance, if the agreement provides that the arbitration will be conducted by the American Arbitration Association, then the rules of that organization will apply. Issues such as whether the parties are free to bring motions, take depositions, and conduct written discovery are all determined by the rules agreed to. Arbitration can be every bit as involved as traditional litigation, which leads to the next point:

Arbitration is not Always a Cheaper Alternative to Litigation

In most cases, arbitration can be a less expensive alternative to litigation, but that is by no means always the case. Often, an arbitration clause can add a new level of complication and expense to a case. In the employment context, for example, an employee will often argue that the arbitration agreement is unenforceable or does not apply to the causes of action being pursued. When that occurs, the parties will find themselves in court fighting over that issue. Or what if one of the parties simply refuses to cooperate in the process? Then you must either petition the court to compel arbitration, ignore the arbitration provision and go to court (only to have the other side then invoke the arbitration provision), or proceed with the arbitration without the other party, and run the risk that the court may later disagree with your assessment that the arbitration provision was enforceable. Other times the situation will arise where there are necessary parties to the action that are not parties to the arbitration agreement. You then end up with a situation where one or more parties to the arbitration agreement insist on proceeding under that agreement, while the non-parties refuse to stipulate to do so. This can result in the worst of all worlds - the time and expense of litigating the action in both forums.

Even if things go as planned, arbitration can be very expensive. In a court trial, the parties must pay their attorneys, and perhaps some incidental expenses such as court reporter fees. In an arbitration, the parties must also pay the arbitrator and the arbitration service. A five day arbitration will easily exceed $24,000, and that is just for the time spent at arbitration - it does not include any of the preparation time. And that figure is based on a single arbitrator. Often, in an effort to avoid a groundless decision that might be rendered by a single arbitrator, arbitration agreements provide for a panel of three arbitrators. Obviously, such an agreement carries with it a much higher cost for the arbitration.

Conceptually, arbitration should be more expensive than litigation because it adds the expense of the arbitration service and the arbitrator(s). The only reason that arbitration is usually cheaper than litigation is because of the options it eliminates. For example, if the rules provide for only limited discovery and do not permit motions, then those costs are eliminated. You must decide, however, if you want to have an employment dispute decided without all of the tools available.

Giving Up the Protections of the Court is Not Always Desirable

Judges and arbitrators are all capable of rendering completely baseless decisions. So, the first question is, who is more likely to render what you consider to be the proper decision? And if you decide to place your confidence in an arbitrator or arbitrators, are you willing to live with the fact that there will be no mechanism for appeal (depending on the agreement and your jurisdiction)?

Some war stories will illustrate how scary it can be to give up your right of appeal. In a case I recently handled, the parties were ordered by the court to non-binding arbitration. We represented an investment advisor who, along with his partner, had handled an investment for the partner's daughter. When the investment did not do as well as hoped (although the investors did not lose any money), the daughter sued our client for negligent misrepresentation, ignoring the fact that her own father had recommended the investment, and that our client had invested far more than she had. The plaintiff's case was ridiculous, and she ultimately dismissed the case to avoid a suit for malicious prosecution. But before the dismissal, at the court-ordered non-binding arbitration, the result was far different.

After the arbitration had concluded and the parties were leaving, the arbitrator asked the plaintiff if our client had ever given her a printed disclosure statement regarding any commissions he would receive from the investment. She answered that while she knew that her father and our client were both receiving commissions, and that she knew the amount (her father had rebated his commission to her), she did not recall if she had ever received a formal written statement. I protested this "in the hall" testimony, and said that if the arbitrator was going to consider this (seemingly innocuous) statement by the plaintiff, he would have to afford me the opportunity to elicit testimony from my client on this point. The arbitrator answered that no testimony from my client would be needed, since there was clearly not any problem with the disclosure.

I was flabbergasted when the arbitrator's decision arrived a few days later. He had properly found that there had not been any misrepresentations made to the plaintiff, but based on his own research on disclosure laws - an issue that was not raised in the complaint or had ever been advanced by the plaintiff - he awarded damages based on the alleged failure of our client to give the plaintiff a written statement. Not only was that not a reasonable basis for an award, given that the plaintiff herself had testified that she was fully informed of the commission amounts, if the arbitrator had permitted our client to testify on this point, he would have learned that the plaintiff had been provided with a written statement.

This was all just a pointless exercise in any event since the arbitration was non-binding, but imagine if it had been binding, with no avenue for appeal. This is just one example, but at my firm we have experienced several arbitration decisions that were nearly as arbitrary and had no resemblance to the ultimate determination in the case.

In one of my favorite examples, in a case not involving my firm, an attorney advised his client in the strongest possible terms not to pursue a very risky business venture. When the client insisted, the attorney reluctantly agreed to help him with the legal aspects of the venture, but in the fee agreement, which contained an arbitration provision, the attorney had the client sign and acknowledge in 20 different places that he was proceeding with the venture against the specific advice of his attorney. When the venture failed, the client sued the attorney, claiming that he had not adequately disclosed the risky nature of the venture. The arbitrator agreed, stating that the 20 disclaimers in the fee agreement only served to illustrate that the attorney knew this was a risky venture, and "should not have permitted the client to go forward." The attorney was ordered to reimburse the client for the money lost in the venture, as well as to pay emotional distress damages. Had there been no arbitration clause in the agreement, the attorney could have appealed this foolish decision, but as it was he was bound by it.

Are Employment Agreements that Require Arbitration Enforceable?

If you still feel the benefits of arbitration outweigh the negative aspects, the next issue is whether an arbitration agreement can be drafted that will be enforceable. There are two forces at work that are competing to establish the law in that area. The courts and lawmakers have long favored arbitration clauses as a means to keep civil disputes off the court dockets, and employment agreements have not been an exception. On the other hand, government agencies such as the EEOC, and the plaintiff's bar, have argued that in the employment context, arbitration clauses are seldom the product of an arm's-length agreement, and therefore amount to contracts of adhesion. (Indeed, the plaintiff's bar has supported legislation in California (AB574) that would make it a violation of the Fair Employment and Housing Act to require an employee to consent to arbitration.)

This latter position has found an ear in the courts. In Stirlen v. Supercuts, Inc., the arbitration agreement used by the company was found to be unenforceable because it not only prevented the employees from seeking damages that would normally be recoverable for wrongful termination, such as punitive damages and attorney fees, it permitted the company to sue its employees in court if it suspected them of unfair competition or disclosing confidential information. Normally, parties can agree to whatever they want, so long as it is not illegal, and on that level, there was nothing improper about the one-sided nature of the Supercuts employment agreement. But in the employment context, where the employer and employee have always been assumed to be at disparate bargaining positions, the court found this agreement to be unenforceable because it could not be viewed as having been arrived at through mutual assent.

Thus, when drafting an arbitration agreement, an employer and its counsel must be ever mindful of whether the agreement is fair and even-handed, and whether it can be reasonably argued that the employee voluntarily and knowingly agreed to the arbitration agreement.

Showing that the employee "knowingly" entered into the agreement has split into two different interpretations by the courts. This is really just an issue of informed consent, and the courts have split on whether words are sufficient to inform someone of any rights they are waiving, or if they must be given and understand actual examples of that they are waiving. With this split, it is far better to err on the side of too much disclosure. Employees should sign a separate arbitration agreement (language in a handbook will almost certainly be found insufficient) that enumerates and specifies each of the federal and state provisions they will be waiving right to trial under.

In the case of union agreements, all the disclosure in the world may not save an arbitration clause. An individual union member enjoys the benefits of the collective bargaining agreement, but it certainly cannot be argued that he or she made an individual waiver of the right to trial. Further, having been forced into arbitration, it cannot be said that even that procedure will be conducted in the best interests of the worker. As the court held in Buckley v. Gallo Sales Co. (N.D. Cal. 1996) 949 F. Supp. 737, "when a union represents an individual in arbitration proceedings, it has to consider the interests of all of its members, which may be in conflict with the individual."

Finally, the agreement should merely be an alternative means to resolve the dispute, not an attempt to limit the exposure of the employer. It is very tempting to insert a provision that the arbitrator may not award punitive damages, or that the damages may not exceed one year's wages, but these provisions are contrary to the law. They will be red flags that the employer was not just trying to find a more equitable and efficient way to resolve the dispute, but rather was trying to strip the employee of certain rights.

Conclusion

Should employers utilize arbitration agreements? In my opinion, no. But that is based in part on the billing practices of my own firm. For our clients, the cost of litigating a matter is not so much higher than the cost of arbitrating it so as to warrant giving up all of the benefits of a court. (See profile.) If you are using a traditional law firm with its concomitant billing practices, you will need to do your own cost analysis.

Further, we have found that with a strategic defense strategy, many cases can be disposed of early in the action by way of a motion for summary judgment. With an arbitration agreement, every dispute must follow the course of the complete arbitration. With court cases, there are several "escape methods" that would be forfeited with arbitration.

Finally, we have witnessed too many arbitrary decisions by arbitrators. Despite all of the uncertainty of a jury, I would prefer to rely on the good, common sense of twelve jurors as opposed to the singular decisions of sometimes officious arbitrators. Jurors will sometimes come out of left field on a factual issue, but you can be fairly confident that the matter will be decided primarily on the facts. Conversely, as illustrated by the example of the investor, arbitrators sometimes assume the role of a third advocate, and will add legal issues that neither side was concerned with, and decide the case on that basis. This is exacerbated by the fact that arbitration services group their arbitrators according to their prior experience. For example, the panel of arbitrators offered in an employment case will be primarily attorneys and judges that have a level of expertise in that area of the law.

For all of these reasons, except in those cases where the employer is located in a jurisdiction where it would likely be faced with an ultra-liberal jury, I recommend against arbitration clauses in employment agreements. There is, however, one hybrid arrangement that might be worth considering. Some companies use employment agreements that mandate that any employment disputes must first be submitted to arbitration before a three arbitrator panel, and that either party may reject the findings of the arbitrators within 30 days. Although this approach has never been challenged in the courts, it appears that it would withstand scrutiny. It should not be deemed to be an improper waiver of the employee's right to trial since the employee is not waiving that right. He or she is always free to go to court, so long as the matter is arbitrated first. This is no different than every collective bargaining agreement that sets forth a process that must be exhausted before an employee can resort to the courts.

True, the company could be made to arbitrate a matter only to then be dragged into court, but the effective result has been that, faced with the up-front costs of the arbitration, the employees and their attorneys have been discouraged from pursuing frivolous suits. There are, unfortunately, a large number of attorneys that will file a complaint on almost any theory, with the hope that they can then extract some sort of "nuisance-value" settlement. Faced with having to finance and complete an arbitration before having access to the courts, many of these attorneys will suddenly have an epiphany as to the merits of the case.

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Aaron Morris is a Partner with the law firm of Morris & Stone, LLP, located in Santa Ana, Orange County, California. He can be reached at (714) 954-0700, or by email.  The practice areas of Morris & Stone include employment law (wrongful termination, sexual harassment, wage/overtime claims), business litigation (breach of contract, trade secret, partnership dissolution, unfair business practices, etc.), real estate and construction disputes, first amendment law, Internet law, discrimination claims, defamation suits, and legal malpractice.