Does FAA Preemption Extend to Contract Formation?
On appeal, the U.S. Court of Appeals for the Ninth Circuit reversed in part the district court’s conclusion that the FAA preempted §432.6, vacated the preliminary injunction, and remanded for further proceedings. First, the appellate court concluded that because §432.6 governs “pre-agreement employer behavior” rather than arbitration agreements, the FAA neither applied to nor preempted the statute. It explained that the “saving clause” in FAA §2 “permits agreements to arbitrate to be invalidated by generally applicable contract defenses, such as fraud, duress, or unconscionability, but not by defenses that apply only to arbitration.” Thus, the FAA preempts those defenses that only invalidate arbitration agreements, but not other types of agreements.
Because §432.6 states that it is not intended to invalidate agreements subject to the FAA, the appellate court reasoned that a “pre-agreement condition” did not affect the validity or enforceability of arbitration agreements. To hold otherwise would impermissibly expand FAA preemption to scenarios where there was no agreement to arbitrate.
However, the Ninth Circuit held that the FAA preempted the criminal and civil penalties of §432.6. It stated that the enforcement mechanisms, which included imprisonment for entering into an arbitration agreement, directly contradicted §2 of the FAA because “[a]n arbitration agreement cannot simultaneously be ‘valid’ under federal law and grounds for a criminal conviction under state law.”
By contrast, the dissent would have affirmed the district court’s order, observing that §432.6 “criminalizes offering employees an agreement to arbitrate, even though the arbitration provision itself is lawful and enforceable once the agreement is executed.” It noted that the majority’s ruling conflicted with U.S. Supreme Court’s guidance in Kindred Nursing Centers Ltd. Partnership v. Clark. which “confirmed the rule that the FAA invalidates state laws that impede the formation of arbitration agreements.” The dissent pointed out that Kindred Nursing had expressly rejected arguments that attempted to distinguish between contract formation and contract enforcement in holding that the FAA preempted a state law that “specially impeded the ability of attorneys-in-fact to enter into arbitration agreements.” It also observed that the majority’s decision created a split with the First and Fourth Circuits.
The plaintiffs subsequently petitioned the Ninth Circuit for an en banc rehearing. The Ninth Circuit has ordered the petition to be deferred until the Supreme Court decides Viking River Cruises, Inc. v. Moriana.
Decision Leaves Unanswered Questions in Its Wake
Litigation Section leaders are not persuaded that the FAA applies only to existing arbitration agreements and not the circumstances giving rise to them. “State laws may be preempted by the FAA if they undermine certain aspects of arbitration, such as interfering with the formation of arbitration agreements,” states Jerry M. Cutler, New York, NY, cochair of the Section’s Employment & Labor Relations Committee. “In determining whether an arbitration agreement is enforceable under the FAA, the courts often look at the circumstances and conditions under which the agreement was entered into—in order to address contract adhesion and procedural and substantive unconscionability,” explains William E. Weinberger, Los Angeles, CA, cochair of the Section’s Corporate Counsel Committee. “In that sense, the FAA does apply to circumstances or conditions giving rise to them,” he adds.
Section leaders also question invalidating the sanctions but not the prohibition. “It is challenging to comprehend the rationale for not preempting a statutory provision prohibiting arbitration agreements, while at the same time preempting the mechanism by which the statutory prohibition is enforced,” observes Cutler. “In this case, the law prohibits entering into the agreement in the first place, but if the employer insists on it anyway and the employee enters into the agreement to get the job, then the FAA would apply to that agreement and the employee would have a hard time seeking a remedy against the employer for requiring that,” agrees Weinberger.
The decision raises other issues. “If an employer refuses to hire an employee for refusing to enter an arbitration agreement and the employee sues under §432.6 for retaliation, the question arises as to how the FAA will deal with that, and I do not think this case decides that issue,” Weinberger notes. “If the Supreme Court were to hold that the mechanism as provided by §432.6 is not preempted by the FAA, employers would need to make some hard choices,” says Weinberger.
Recommendations for Navigating the Uncertainty
For now, Cutler suggests that California employers “propose, but not require, arbitration as a condition of employment.” Additionally, employers should “(1) make sure that any arbitration agreement with employees contains ample language indicating that the agreement was voluntarily entered into, and (2) avoid making decisions not to hire on the basis of employees refusing to enter into an arbitration agreement,” advises Weinberger.