California Invalidates Wage Arbitration Agreement, Inviting U.S. Supreme Court Review

Seyfarth Synopsis: The California Supreme Court invalidated an employment arbitration agreement on August 29, 2019. At issue in OTO, LLC v. Kho was an agreement to arbitrate employment claims, including wage claims. Under the agreement, Kho had to arbitrate wage claims instead of having them decided in court or in an administrative “Berman hearing” conducted by the California Labor Commissioner. A Court of Appeal upheld the agreement, even though it was “disturbed” by how it was drafted and presented. But the California Supreme Court struck down the agreement, insisting that an agreement waiving a Berman hearing must be particularly fair, given the “full panoply” of benefits employees would enjoy in a Berman hearing. Dissenting, Justice Chin criticized the majority’s decision as violating the Federal Arbitration Act, and reflecting the Court’s ongoing animus against agreements to arbitrate employment disputes.

Background

Agreements to arbitrate wage claims in California have a turbulent history, dating back to at least 1987, when the U.S. Supreme Court held that the Federal Arbitration Act preempted Labor Code section 229—which purports to invalidate any “private agreement to arbitrate” wage disputes. During the ensuing years the U.S. Supreme Court repeatedly reversed California rules that presented obstacles to the enforcement of arbitration agreements covered by the FAA.

One such occasion presented itself in 2011, when the California Supreme Court, in Sonic Calabasas A, Inc. v. Moreno (Sonic I), held that any arbitration agreement waiving a Berman hearing was unconscionable. Sonic I was overturned by the U.S. Supreme Court, which held that the FAA preempted any categorical bar on arbitrating wage claims. The California Supreme Court revisited the issue in 2013 (Sonic II), to hold that agreements to arbitrate wage disputes are enforceable so long as they provide “an accessible and affordable process for resolving those disputes.” For more details on these decisions, see here and here.

Against this legal backdrop, mechanic Ken Kho signed an arbitration agreement to resolve employment disputes with his car dealership employer. A year later, he filed a wage claim to initiate a Berman hearing with the Department of Labor Standards Enforcement, commonly known as the Labor Commissioner. The employer filed a petition in state court to compel Kho to arbitrate his wage claim.

The trial court denied the petition because the arbitration agreement was “highly” unfair as it deprived Kho of advantages he would enjoy in a Berman hearing, including the right to free advice and assistance by the Labor Commissioner. But the Court of Appeal reversed, finding that, under Sonic II, the arbitration agreement allowed Kho to have his wage claim heard in an accessible, affordable forum that mirrored normal civil litigation, even though the form of the agreement and the way it was presented to Kho were “extraordinarily” unfair.

Supreme Court’s Decision in OTO, LLC v. Kho

The Supreme Court reversed the Court of Appeal, finding the arbitration agreement unenforceable. Key to the decision was the “unusually coercive setting” in which Kho signed the agreement. He was presented with it three years into his employment with OTO and he had to sign it to keep his job. The terms of the 1 1/4 page agreement appeared in one block paragraph, in seven-point font. The agreement included long, complex statutory references and dense legal jargon. One sentence alone ran twelve lines. And rather than state that arbitration costs would be paid by the employer, the agreement stated that costs would be controlled by the Code of Civil Procedure and “controlling case law,” requiring someone with legal knowledge to understand it. The Supreme Court concluded that the agreement’s “visually impenetrable” text aimed to “thwart, rather than promote, understanding.”

The arbitration agreement was delivered to Kho at his desk by a “low-level employee” who lacked both the knowledge to explain it and the authority to negotiate it. The employee waited in front of Kho as he read it, creating the expectation that Kho had to sign immediately. Had Kho spent any time reviewing the agreement, his pay would have been reduced because he was paid by piece rate (Kho signed it after four minutes). Kho had no chance to review the agreement outside of work or in his native language. Finally, Kho was not given a copy of the agreement he signed.

These extraordinary facts drove the Supreme Court’s decision. Sonic II held that if the terms and circumstances in which an arbitration agreement are particularly unfair, or are “procedurally unconscionable,” then it would only take a “relatively low degree” of unfairness in the terms of the agreement to make it unenforceable.

The Supreme Court in Kho found several parts of the arbitration agreement to be unfair or substantively unconscionable, particularly when contrasted with the “simplified,” “efficient,” “affordable” Berman hearing. The agreement did not explain how to initiate arbitration. Rather, Kho would have to submit a pleading to start an arbitration, serve and respond to discovery, comply with state rules of evidence, and make his case before a retired judge who, unlike a Berman hearing officer, would have no duty to assist him. The complexity was such, Kho claims, that Kho would have to hire an attorney to pursue his claim in arbitration. Overall, Kho saw the arbitration agreement as a bad bargain to waive the advantages of a quick, simple, and affordable Berman hearing in exchange for a more time-consuming, complex, and costly arbitration.

Justice Chin’s 55-page dissent challenges at every turn the majority’s view of the procedural and substantive fairness of the arbitration agreement. The dissent argues that the majority reversed the burden on an employee to prove unfairness on its head by instead requiring the employer to explain the arbitration agreement to the employee. Justice Chin makes the case that the Supreme Court misinterpreted the facts, misapplied Sonic II, and again violated the FAA by ultimately relying on a subjective view that arbitration is not an adequate forum.

Action Items for California Employers

Kho, like Sonic I before it, may end up before the U.S. Supreme Court. Justice Chin’s dissent persuasively illustrates how, once again, California has disfavored arbitration in a way that the FAA forbids. But U.S. Supreme Court intervention is always a long shot at best. In the meanwhile, employers should give special attention to the structure and terms of their arbitration agreements—particularly with respect to wage claims—and the manner in which they are presented. While the burden of proof as to procedural and substantive fairness of arbitration agreements properly falls on the employee (not the employer), the Supreme Court’s decision will be read by some to reverse the burden. With that thought in mind, employers should find ways to draft, design, and present arbitration agreements that emphasize accessibility, promote understanding, and eliminate surprise.