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October 24, 2012 Articles

When Amendable Arbitration Clauses Are Illusory

By Brian E. Cohen

According to the Federal Arbitration Act of 1925 (FAA), 9 U.S.C. §1 et seq., "arbitration is a matter of contract." As a result, agreements to arbitrate disputes are contracts that require consideration—a bargained-for benefit or detriment. An illusory promise, "a promise merely in form, but in actuality not promising anything, . . . cannot serve as consideration . . . it would impose no obligation since the promisor always has it within his power to keep his promise and yet escape performance." 3 Williston on Contracts § 7:7 (4th ed.). In Peleg v. Neiman Marcus Group, Inc., a California court, analyzing Texas Law and the FAA, held that an arbitration clause in an employment agreement was illusory because the employer retained the ability to amend the clause to cover claims that had already accrued. 204 Cal. App. 4th 1425, 140 Cal. Rptr. 3d 38 (Cal. Ct. App. 2012).

An Illusory Arbitration Agreement
The employment contract between the employer and its at-will employees contained a modification provision that permitted the employer to amend, modify, or revoke the arbitration contract with 30 days' written notice. Peleg, 1432. Such changes applied to any claims that had not yet been filed with the American Arbitration Association. An employee brought a claim for violations of the Fair Employment and Housing Act, and the employer moved to compel arbitration. Peleg, 1433. The Superior Court of California granted the employer's petition to arbitrate the claim and subsequently confirmed the award in the employer's favor. Applying Texas law as the agreement dictated, the California Court of Appeals reversed, holding that the unilateral modification provision rendered the arbitration agreement illusory. The court reasoned that a provision that permitted the employer to amend the agreement in anticipation of a particular claim would make it more likely the employer would prevail in the ultimate dispute. Although the agreement contained a 30-day notice provision, the court noted that a valid agreement would need to exempt all accrued or known claims from contractual changes. Peleg, 1467. The court viewed the 30-day notice period as trivial—too short to provide employees with enough time to file a claim, particularly given the significantly longer statute of limitations periods for such claims. Peleg, 1453.

In reaching its decision, the Peleg court relied heavily on In re Halliburton Co., 80 S.W.3d 566 (Tex. 2002). Peleg, 1448. In Halliburton, the Supreme Court of Texas evaluated whether a similarly amendable arbitration agreement between an employer and its employees was illusory. Although the arbitration permitted amendments by the employer, unlike in Peleg, such amendments did not apply to disputes about which the employer had actual notice at the time of the amendment. Halliburton, 569–70. Such modification provisions, the court held, were not illusory if they did not apply to claims the employer knew about. The agreement did not permit the employer to avoid its promise to arbitrate disputes; it merely gave him the right to suspend or revoke his arbitration agreement as to future, unknown claims.

Because the agreement in Peleg provided that it was governed by the FAA, in addition to Texas law, the court analyzed whether the agreement would be illusory under FAA decisions as well. Peleg, 1461–63. The court noted that federal courts have found agreements with a unilateral right to amend to be illusory regardless of whether the employer had actually exercised its right to amend—the mere ability to amend is what matters. Courts interpreting the FAA have similarly found that an employer's right to amend must be restricted so that it does not apply to any claims that have accrued or about which the employer has knowledge.

Texas Declines to Follow Peleg
As the Peleg court noted, decisions from the Texas Court of Appeals are inconsistent with Halliburton and its progeny. And in fact, in Nabors Drilling USA, LP v. Pena, No. 04-11-00910-CV, 2012 WL 3731690 (Tex. App., Aug. 29, 2012), decided four months after Peleg, the Texas Court of Appeals held that an amendment clause similar to the one in Peleg was not illusory. The court noted that Peleg, a California case, was not controlling.

The court in Nabors declined to draw a distinction between the amendment provision before it and the one the Halliburton court had found acceptable. The clause at issue in Halliburton prohibited contract amendments from applying to any claim about which the employer had notice. The clause at issue in Nabors, similar to the clause in Peleg, prohibited contract amendments from applying to any claim for which a proceeding had been initiated. To the Peleg court, the critical distinction between these clauses was whether contractual amendments could apply to claims that were already known to the employer at the time of the amendment even though they were not yet filed. The ability of the employer in Peleg and Nabors to retroactively apply an amendment to a claim about which it had notice was sufficient for the Peleg court to find the contract illusory. The Nabors court rejected this distinction.

It is too early to know the long-term impact of Peleg and Nabors. Neither case has been cited for their holdings related to potentially illusory arbitration clauses.

Keywords: litigation, alternative dispute resolution, arbitration, illusory, Federal Arbitration Act, Peleg, Nabors