California’s Struggle Against the Federal Arbitration Act

The last few decades have seen companies turning to arbitration agreements and class action waivers to curb the continued rise and monumental expenses of both litigation and class actions.  However, with the continuous upheaval in California’s interpretation of arbitration provisions, and the ongoing friction between California and federal courts, companies subject to the jurisdiction of California courts should be strategic in how to get the most out of their arbitration provisions.

California’s versus the Federal Arbitration Act

California Courts have traditionally disfavored class action waivers and broad arbitration agreements, often holding such agreements unconscionable and therefore unenforceable.  In 2005, the California Supreme Court held that a class action and arbitration waiver is unconscionable in a consumer-facing contract of adhesion (i.e., a boilerplate contract where the consumer has no opportunity to negotiate).ⁱ For the next six years, California companies with class action waivers were left completely exposed.

Then, in 2011, the U.S. Supreme Court overruled the California Supreme Court and held that its rule against class-wide arbitration fundamentally interferes with the Federal Arbitration Act (FAA).  It then held that the FAA preempts state law.ⁱⁱ

California courts quickly began to chafe under the U.S. Supreme Court’s rule.  Within a few years of the high Court’s decision, California began finding exceptions.  In 2014, the California Supreme Court held that when an arbitration clause acts as a waiver of California’s Private Attorney General Act (PAGA), the arbitration clause was void.ⁱⁱⁱ

In 2015, the U.S. Supreme Court was forced to remind California that it could not apply its previously overruled decision to hold class action waivers and arbitration clauses enforceable.^iv

Undeterred, in April 2017, the California Supreme Court extended its exception to all California statutes that were “established for a public reason” and included California’s Consumers Legal Remedy Act, California unfair competition laws, and California’s false advertising laws as those that cannot be waived in arbitration.^v Given the issues at stake, it is likely the U.S. Supreme Court will review California’s most recent decision, leaving California companies unsure of the continued viability of their arbitration and class action waiver provisions.

Arbitration Best Practices

Even with a continuously changing arbitration landscape, a pattern of best practices has emerged based on California’s recent decisions. Companies subject to California’s jurisdiction can mitigate the risk of having their arbitration clauses found invalid or unenforceable by following these steps:

1. Avoid unilateral modifications. While having the flexibility to modify a contract is highly attractive, California courts have found that allowing a company to modify or revoke an arbitration agreement without the customer’s affirmative consent may be substantively unconscionable.^vi A best practice would be to make sure that all rights of modification and revocation be bilateral.
2. Avoid reducing the statute of limitations. Although California courts have enforced agreements that limit the time-period for when a claim can be brought, they have also held that an arbitration agreement cannot be made to serve as a vehicle for the waiver of statutory rights.^vii Since most written contracts have a 4-year statute of limitations, contractually reducing that limitation could cause problems for your arbitration provisions.  A best practice would be to leave the statute of limitations alone. 
3. Disclose all arbitration procedures. California courts have found arbitration clauses unenforceable where the contract failed to disclosure all of the rules governing arbitration.  A best practice is to identify a specific arbitration service, such as AAA or JAMS, and then expressly incorporate its rules and procedures.^viii
4. Avoid overly costly arbitration fees for indigent consumers. Aware of the potentially high-cost of arbitration, California courts employ a case-by-case analysis to ensure that indigent or low-income consumers are not improperly excluded from vindicating their rights.^ix Requiring multiple arbitrators or costly arbitration appeal procedures could affect the court’s analysis as to the arbitration’s affordability.  A best practice would be to include a provision allowing for a reduced arbitration cost structure for indigent or low-income consumers. 
5. Create a carve-out for claims for public injunctive relief. Since the U.S. Supreme Court’s 2011 decision, California courts have largely found arbitration provisions unenforceable when they impede a parties’ right to seek public injunctive relief, i.e., relief based on statutes that are intended to benefit the general public, rather than just the parties involved.^x As a best practice, an arbitration agreement should state that public injunctive relief may be sought through arbitration.  Then, in case that is found to be insufficient, add a provision that allows claims to be bifurcated, with individual claims going to arbitration and public claims going to litigation, but requiring the individual claims to be fully resolved before the public claims begin.^xi

During this period of uncertainty, any company subject to the jurisdiction of California courts should consider these best practices when drafting their contracts to prevent problems down the road.