Federal Arbitration Act Preempts Argument that Arbitrator has Financial Self-Interest in Deciding Unconsionability

After a recent case found that parties, whose arbitration agreement contained a delegation clause, had to let the arbitrator rather than the court decide whether the delegation clause was unconscionable. In the case of Malone v. Super. Ct., 226 Cal. App. 4^th 1551 (2014), the California Court of Appeal held that a delegation clause was not unconscionable under California Law. The Court further found that the Federal Arbitration Act preempted a finding that the delegation was substantively unconscionable.

This case arose from a dispute between Plaintiff-Petitioner Keeya Malone and her former employer Defendant California Bank & Trust (“CB&T”). The employee handbook that governed Malone’s employment contained an arbitration clause. The arbitration clause provided for mandatory arbitration of any employment-related disputes between Malone and CB&T. The arbitration agreement was governed by the Federal Arbitration Act (“FAA”) and gave the arbitrator “exclusive authority to resolve any dispute relating to the interpretation, applicability, or enforceability of this binding agreement.” This is called the “delegation clause,” and it simply means that any disputes related to the meaning of the agreement would be resolved through arbitration.

After Malone ended her employment with CB&T, she brought claims against her former employer for various violations of the Labor Code and unfair business practices. Malone also sought to certify a class action. In response, CB&T sought to compel arbitration citing the arbitration agreement in the employee handbook. Malone opposed the motion to compel arbitration, arguing that the arbitration agreement was unconscionable and unenforceable. Malone specifically argued that the delegation clause, which empowered the arbiter to decide the enforceability of the agreement, was itself unconscionable. The trial court disagreed with Malone, and issued a ruling enforcing the delegation clause and compelling arbitration. The trial court’s sole basis for ruling was that the delegation clause was not unconscionable. Malone then filed an interlocutory review and filed a petition for a writ of mandate.

The issue on appeal was whether or not the delegation clause was unenforceable. Malone had argued that the delegation clause was unenforceable for three reasons: (1) it was not bilateral, (2) it was outside the reasonable expectation of the parties, and (3) the FAA preempts it. The court rejected each of these arguments in turn.

First, as to whether the agreement was bilateral, the court held that, because the clause applied to all issues of interpretation and not just arbitrability, the delegation clause was not one sided. Second, even though it was a contract of adhesion, the arbitration agreement was not outside the reasonable expectation of the parties.

Third, as to FAA preemption, the court found that the FAA preempts it from ruling that the delegation clause was unconscionable. Malone had relied on California precedent to argue that the FAA was unconscionable. But CB&T argued that the FAA preempted that precedent. The FAA is a federal statute and generally favors arbitration. Section 2 of the FAA is a savings clause, which permits a party to invalidate an arbitration agreement due to generally applicable defenses such as fraud, duress, or unconscionability. Section 2 is supposed to protect consumers against unfair pressure to agree to arbitration contracts. At the same time, the FAA preempts state statutes or state common law that were intended to keep actions in court where parties had agreed to arbitrate. Taken together, this means that a state law could invalidate an arbitration agreement under Section 2 of the FAA only if that state law governs an issue concerning the validity of contracts in general, and so long as the state law’s sole purpose is not to invalidate arbitration agreements. In general, the FAA will preempt state rules that stand as an obstacle to the purposes of the FAA. Despite this strong rule favoring arbitration, the California Supreme Court had considered arbitration agreements in Sonic-Calabasas A, Inc. v. Moreno, 57 Cal. 4^th 1109 (2013) and found that unconscionability is still a defense to arbitration agreements. But, under the Sonic Court’s rule, the FAA places the following limits on any rules that would invalidate arbitration agreements on the basis of unconscionability. First, “such rules must not facially discriminate against arbitration and must be enforced evenhandedly.” Second, “such rules, even when facially nondiscriminatory, must not disfavor arbitration as applied by imposing procedural requirements that interfere[] with fundamental attributes of arbitration. . . . “

Here, the court found that the FAA ultimately preempted the three California cases that Malone had relied on, because the cases, in assuming that arbitrators act in their own financial interests rather than the interests of justice, disfavor arbitration, thereby violating the second Sonic rule.

For this reason, the court found that the arbitration agreement’s delegation clause was not unconscionable. The court thus denied Malone’s writ of mandate and granted CB&T costs.

After this case, parties to an arbitration agreement may not argue that a delegation clause is per se unconscionable. It is much more likely that courts will uphold delegation agreements, which can make it more difficult for employees wishing to maintain an action in court to do so. If you have any employment-related dispute, contact the employment attorneys at Nassiri Law Group, practicing in Orange County, Riverside, and Los Angeles. Call (949) 375-4734.