Right to Modify Employee Handbook Voids Arbitration Clause

An employer who includes an arbitration agreement in an employee handbook cannot enforce the arbitration clause where the employer maintains the right to modify the handbook. A federal court of appeals held that the arbitration agreement in an employee handbook was illusory because the employer retained the unilateral right to amend the agreement without notice to employees. ABA Litigation Section leaders advise that an enforceable agreement to arbitrate should not include a unilateral right to amend the agreement.

Modification Language in Employee Handbook Undercuts Arbitration Clause

In Coady v. Nationwide Motor Sales Corp., former Nationwide employees sued the company and its owners in a wage dispute. Nationwide moved to compel arbitration and to dismiss or stay the employees’ suit. To support its motion, Nationwide submitted its Employee Handbook, which included a section called “Agreement to Submit All Employment Disputes to Arbitration.” The section required arbitration of employment claims, provided the rules and procedures to govern such claims, and contained an “Acknowledgement Receipt of the Employee Handbook” to be signed by each employee and a manager.

The former employees opposed Nationwide’s motion to compel arbitration, arguing that the arbitration agreement was invalid because Nationwide retained its right to “change, abolish or modify existing policies, procedures or benefits applicable to employees as it may deem necessary with or without notice.” Nationwide responded that the modification clause does not apply to the arbitration agreement because the clause is not within the “four corners” of the arbitration agreement at issue. Additionally, Nationwide argued that the modification clause only applied to “policies, procedures or benefits,” not agreements.

The U.S. District Court for the District of Maryland held that the arbitration agreement was “illusory” because of the modification clause and denied Nationwide’s motion. Nationwide appealed. The U.S. Court of Appeals for the Fourth Circuit affirmed the district court’s denial of Nationwide’s motion to compel arbitration.

Opinion Clarifies Bounds of Employment Contracts

Using Maryland law as its guide, the court of appeals first determined that the acknowledgement receipt was a part of the arbitration agreement. To decide the “plain meaning” of a contract, Maryland courts “‘construe the contract as a whole’ and decline to ‘read each clause or provision separately.’” The court of appeals explained that the fifth paragraph of the arbitration agreement incorporated the acknowledgement receipt, which stated that an “employee’s signature on the ‘Employee Handbook and Operating Procedures’ Acknowledgement Receipt . . . confirm[ed] that [he] ha[d] read and underst[ood] each of the four sections set forth in this Agreement.”

The court of appeals then determined that the modification clause of the acknowledgement receipt invalidated the arbitration agreement as illusory. According to Maryland law, “a promise to arbitrate is illusory—and thus cannot constitute the consideration necessary to support a binding contract—if the employer reserves the right ‘to alter, amend, modify, or revoke the Arbitration Policy . . . at any time with or without notice.’” The court of appeals explained that the modification clause reserved Nationwide’s ability to “change, abolish or modify” existing policies, procedures, and benefits without notice. According to the appellate court, the modification clause in the acknowledgement receipt applied to the arbitration agreement because the sections of the handbook, including the arbitration agreement, were specifically listed in the receipt immediately above the paragraph containing the modification clause.

Beware of Unilateral Rights to Amend

Litigation Section leaders agree with the outcome of the Coady decision and advise practitioners to become familiar with the case law regarding employment contracts in their jurisdiction. “The outcome of this case concluding that the arbitration provision was illusory is not surprising because you have an arbitration provision in an employee handbook that can be altered at any moment,” states Rebecca Sha, New Orleans, LA, cochair of the Section’s Diversity, Equity & Inclusion Committee. “The decision is extremely narrow and based on a contractual analysis. In Coady, the court determined that the employer’s reservation of the right to unilaterally amend the arbitration agreement made it illusory,” observes David Seserman, Denver, CO, cochair of the Section’s Solo & Small Firm Committee.

Some Section leaders predict additional court rulings and legislation in this area. “In some jurisdictions, employment arbitration provisions are highly disfavored. There is not only judicial erosion of the use of employment arbitration provisions but also legislative erosion of the use of these provisions in some jurisdictions,” opines Sha. “I predict there will be state level and federal legislation, along with additional judicial opinions, as we figure out the bounds of employment arbitration provisions,” she adds.

“Courts do not like strong arm arbitration provisions forced on employees who have little to no opportunity to negotiate the terms,” advises Seserman. There are several steps practitioners can take in this area. “Practitioners should review the law of their jurisdiction to determine whether employee handbooks are considered employment agreements,” Sha counsels. Additionally, practitioners “can avoid this issue by not providing the arbitration agreement in a handbook and instead use individual employment contracts that incorporate an arbitration provision,” advises Sha.