California Gets Creative: How AB 51’s Future May Shape State Regulation of Arbitration

By: Scarlett Horn; Junior Staffer

The United States (“U.S.”) Supreme Court has used cases such as Concepcion and Lamps Plus to establish its preference for enforcing arbitration clauses, including those that waive the right to class actions in consumer and employment contracts. Despite the pro-arbitration trend, California has remained undeterred in its resolve to avoid the enforcement of arbitration agreements. This anti-enforcement outlook has survived in California regardless of numerous judgment reversals by the U.S. Supreme Court. California’s most recent attempt to sidestep the barbed-wire protection of the Federal Arbitration Act (“FAA”), and its general encouragement of arbitration agreements, comes from California’s state legislature in the form of Assembly Bill No. 51 (“AB 51”). However, AB 51, which prohibits the use of arbitration clauses as a condition of employment, remains in a tumultuous state. The law’s future may make or break state control of the formation of arbitration clauses in employment contracts, offering a creative loophole to the expansive protections of the FAA by targeting “pre-agreement behavior” and waivers rather than regulating arbitration agreements explicitly.

California’s state legislature passed AB 51 in 2019, with the law set to take effect on January 1, 2020, through the California Labor Code and Government Code. AB 51 prohibits any employer from using an arbitration clause (waiver of right, forum, or procedure) as a condition to employment and prohibits using threats, retaliation, or discrimination towards employees who refuse to consent to such a waiver. The ultimate purpose of AB 51 is to ensure that any release of rights, such as those waived in arbitration agreements, is voluntary and free of coercion. Unsurprisingly, various business groups challenged AB 51 in the United States District Court for the Eastern District of California for its alleged preemption by the FAA. In 2021, the United States Court of Appeals for the Ninth Circuit partially upheld the District court’s ruling on the legality of AB 51 in Bonta and held that the pre-agreement condition of voluntariness does not violate the FAA; however, the civil and criminal sanctions for those who violate AB 51 were preempted by the FAA- taking away the enforcement mechanisms of the law. In August of 2022, the Ninth Circuit withdrew its prior opinion and granted a panel rehearing, leaving AB 51 in a limbo state.

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Section 2 of the FAA allows for an arbitration clause to be invalidated only by applicable contract defenses. In other words, section 2 puts arbitration clauses on equal footing with other contracts. Section 2, or “the savings clause,” allows state laws to invalidate an arbitration agreement only when that state law is intended for the use of contracts generally. In Concepcion, the U.S. Supreme Court held that, as per section 2, the FAA preempts any state law discriminating on its face against arbitration. Such decisions form the basis of opposition against AB 51 and its implied restriction of arbitration agreements. California typically applies the contractual affirmative defense of unconscionability to avoid enforcement of arbitration clauses; however, this approach has hit a dead end after repeated reversals by the Supreme Court.

Before AB 51, California courts relied mainly on common law to avoid enforcing arbitration clauses in employment contracts. Typically, the courts employed the affirmative defense of unconscionability to prevent enforcement. In 2000, the Supreme Court of California held in Armendariz that a mandatory arbitration clause in an employment contract was unconscionable because of its non-mutual nature and the employees’ inability to negotiate. In 2005, the Supreme Court of California held in Discovery that a waiver of class action arbitration was unconscionable, which was later interpreted in Cohen to set forth the three-prong test of such unconscionability. The California District Court applied this test in Concepcion. However, when Concepcion went on appeal, the U.S. Supreme Court abrogated Discovery, once again blocking California courts from attempting to interfere with arbitration clauses.

AB 51 is unique in that it is a legislative attempt, rather than a common law attempt, to restrict the reach of the FAA. It is clear from judicial history that California courts are concerned with the lack of equal bargaining power that exists in many transactions where arbitration clauses are common, such as employment contracts. Though the Ninth Circuit has withdrawn its initial decision on the validity of AB 51 in Bonta, the legislature has shown that it is not afraid to get involved in arbitration’s complex and nuanced world. As arbitration becomes more mainstream, lawmakers may have an interest in shedding light on the genuine disadvantages that certain transactional contexts pose for parties of lesser bargaining power. What is most creative about AB 51, evidenced by the Ninth Circuit’s initial upholding of the legislation, is that it aims to control employers’ behavior before applicants/employees sign the agreement to ensure that applicants/employees agree to arbitration clauses on an entirely voluntary basis.

What is most creative about AB 51, evidenced by the Ninth Circuit’s initial upholding of the legislation, is that it aims to control employers’ behavior before applicants/employees sign the agreement to ensure that applicants/employees agree to arbitration clauses on an entirely voluntary basis.

– Scarlett Horn

There is a convincing argument that AB 51’s attempt at restricting employer behavior interferes with the formation of arbitration agreements, which the FAA intends to protect. However, the Ninth Circuit may again rule that AB 51’s general focus on the waiver of rights, rather than arbitration specifically, remove it from the FAA’s scope. But since the panel already withdrew such a ruling once, there is little likelihood that it will be inclined to reissue the same ruling. Besides, the FAA preempted the sanctions tied to AB 51, meaning that even if the Ninth Circuit were to reinstate their previous decision, without the ability to punish, there would be little to no enforceability of AB 51.

In conclusion, AB 51’s destiny is uncertain until the Ninth Circuit rules on whether the FAA preempts the regulation of employer behavior before the formation of an arbitration agreement. If the Ninth Circuit once again upholds AB 51, the U.S. Supreme Court will likely rule on its preemption. However, even if AB 51’s existence is short-lived, it shows the new ways state legislatures are willing to involve themselves in the rapidly expanding field of arbitration.

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