May 6, 2020

California Appellate Court Issues Guidance on Enforcing Arbitration Agreements

While much of the world came to a halt in response to the coronavirus pandemic, the California Courts of Appeal were busy issuing important decisions on the enforceability of arbitration clauses. As the economy starts to reopen, businesses can use this guidance to protect themselves from costly and public litigation later. 

Most companies know that arbitration clauses are one of the best tools to keep claims out of court. Less known is that a seemingly ironclad arbitration agreement can be invalidated if the terms are deemed “unconscionable”—i.e., unfair.  Many businesses would also be surprised to know that California’s Arbitration Act—which applies to agreements not involving interstate commerce, such as a California employer’s agreements with its in-state employees—gives the court discretion not to compel arbitration if there is related litigation that includes parties not subject to the agreement to arbitrate. The Federal Arbitration Act has no such exception.  

California’s Courts of Appeal recently issued guidance on both points. In one case, the court held that an arbitration agreement can choose the FAA for enforcement issues (like motions to compel arbitration) while applying the CAA to procedural issues (e.g., selecting an arbitrator). This means drafters can pick and choose between the FAA and CAA for enforcement and procedural issues, depending on their goals. In three other decisions the courts provided additional guidance on which terms can be deemed “unconscionable” – and potentially invalidate the entire arbitration agreement.   

FAA or CAA? Drafter Can Pick and Choose Which Act Applies to Enforcement and Procedural Questions

In Victrola 89, LLC v. Jaman Properties 8 LLC, the court considered whether the FAA or CAA applied to an agreement governed by “California law,” but whose enforcement was “governed by the [FAA].”  The answer was critical to the defendant, a seller of real estate.  If the FAA applied, the court was required to compel arbitration against the plaintiff/buyer.  But under the CAA, the court had discretion not to compel arbitration because the lawsuit named other parties that were not required to arbitrate.  The trial court applied the CAA, forcing the seller to litigate in court.     

The appellate court rejected that ruling.  It held that the agreement could (and did) make the FAA applicable to enforcement issues, while procedural matters were governed by the CAA.  The key term was that enforcement was “governed by the [FAA].”  Because moving to compel involved enforcing the agreement, the FAA applied and the trial court had to compel arbitration of the buyer’s claim.  

Caution – Arbitration Clauses Invalidated as “Unconscionable” 

In three other recent decisions– Lange v. Monster Energy Company; Dougherty v. Roseville Heritage Partners; and Dennison v. Rosland Capital LLC—the courts refused to enforce arbitration clauses that included some combination of the following terms:  

  • a punitive damages waiver on common law claims;
  • a clause lowering the standard to obtain a preliminary injunction; 
  • a pre-dispute jury trial waiver;
  • selecting an arbitration provider that restricted discovery to arbitrator-approved depositions and document demands, and prohibited interrogatories or requests for admissions;
  • a one-sided attorney fee clause in the company’s favor;
  • a limitation on the company’s liability for “consequential, incidental, indirect, punitive or special damages;” and 
  • shortening the time for a consumer to file suit to one year.  

One of these terms on its own probably wouldn’t lead the court to invalidate an entire arbitration agreement. But a combination of these terms together with procedural unfairness, like unequal bargaining power between an employee and his or her employer, could lead to enforcement issues. If your company’s form includes the above terms, the agreement and the circumstances under which it is signed should be reviewed by an experienced professional to minimize enforceability issues later.      

The Bottom Line

Victrola shows that drafters can (and should) pick and choose between the FAA and CAA for enforcement and procedural issues, depending on their objectives. Lange, Dougherty, and Dennison highlight that entire agreements to arbitrate can be invalidated if the terms are so one-sided that they could be considered unfair.            

Pre-dispute arbitration provisions are crucial business tools. There are numerous factors to consider when crafting the provision that is best for you. Contact your Payne & Fears attorney to discuss how you can tailor your arbitration provisions to achieve your goals

 Disclaimer: Laws, regulations, and guidance on matters related to COVID-19 change rapidly. Please contact your Payne & Fears attorney for current guidance.