What are the California rules regarding mandatory arbitration agreements, and how do they differ from federal law?

The Federal Arbitration Act (FAA) not only governs arbitration contracts nationwide but also favors arbitration and pre-empts state laws that discriminate against it. The California Arbitration Act (CAA) regulates private arbitration in the state, and a 2000 California Supreme Court decision, Armendariz v. Foundation Health, set the standards for assessing employment arbitration agreements.

Under the Armendariz standards, an arbitration agreement will not be enforced in California if it is both “procedurally unconscionable” and “substantively unconscionable.” Any arbitration agreement required as a condition of employment (i.e., any mandatory arbitration agreement) is automatically considered procedurally unconscionable. Thus, to be enforceable in California, the substantive provisions of the agreement must not be unfair to the employee (i.e., substantively unconscionable). To provide a few of the most common examples, such agreements must not be one-sided (i.e., the employer must also be required to arbitrate disputes), must not limit any substantive rights that an employee would have had in litigation if the dispute were decided there, and must not impose any added costs or fees on an employee that would not have applied in litigation.

In an April 2017 decision, McGill v. Citibank, the California Supreme Court said a provision in an arbitration agreement isn't enforceable if it waives the right to seek public injunctive relief in any forum. Public injunctive relief is meant to prohibit activities that "threaten future injury to the general public” and allows a plaintiff to ask the court to prevent a defendant from engaging in allegedly unlawful practice in the future. For example, a court could order an employer to cease unfair pay practices or wage-and-hour violations in the future.

California Assembly Bill 51, passed in 2019, would have legislatively made mandatory arbitration unlawful; but the law was immediately challenged, put on hold, and in early 2024, permanently barred from taking effect regarding arbitration agreements governed by the FAA. However, the FAA does not cover “contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce”, which means AB 51 could still apply to those contracts. Additionally, it appears that the scope of the FAA exemption will be litigated by the U.S. Supreme Court in February 2024 (Bissonnette v. LePage Bakeries Park St. LLC), so the exemption may be interpreted more broadly than it has been historically.

Because the law in this area is subject to numerous specific details and frequent refinement by courts, it is important for organizations to regularly take appropriate steps to ensure the continuing enforceability and legal validity of any mandatory arbitration agreements. One recommendation to stay compliant is to include a severability clause that states if one portion of the agreement is found to be unenforceable or illegal, it can be severed, and the other provisions would remain in full force and effect.

Additionally, the enforcement of class-action arbitration requirements under federal law is continually being challenged between the National Labor Relations Board (NLRB) and the courts. Employers are encouraged to seek legal counsel prior to including mandatory arbitration of group/class actions in employment agreements.