Recently, California’s legislature and judiciary have attempted to prohibit or significantly limit arbitration clauses in employment agreements on a number of occasions.  In response, Federal courts, including the U.S. Supreme Court, have rebuked these attempts dating back to 1987 on the basis that they were preempted by the Federal Arbitration Act (“FAA”).

With this backdrop in mind, in 2019, California enacted Assembly Bill 51 (“AB 51”) in another attempt to attack arbitration clauses in employment agreements. Rather than attack the enforceability of arbitration agreements per se, AB 51 instead attacked the formation of arbitration agreements.

Specifically, AB 51 prohibited employers from imposing contractual provisions requiring the mandatory arbitration of Fair Employment and Housing or California Labor Code claims as a condition of employment, continued employment, or receiving an employment benefit. Employers who violated these prohibitions would be subject to both criminal and civil penalties.

However, in an attempt to avoid FAA preemption, AB 51 provided that agreements that were formed in violation of AB 51 would still be enforceable under FAA. As a result, AB 51 created the curious result where an employer could be subject to criminal penalties for mandating arbitration even though the agreement itself was ultimately enforceable.

In response, a number of trade and commerce groups challenged AB 51’s constitutionality in Chamber of Commerce, et al. v. Bonta, et al. On Feb. 15, a divided panel of the United States Court of Appeals for the Ninth Circuit held that AB 51 was preempted by the FAA. The State of California’s key argument was that AB 51 did not violate the FAA because it only addressed the formation of arbitration agreements and did not attack the ultimate enforceability of such agreements. While the 9^th Circuit acknowledged that AB 51 did not attack the ultimate enforceability of arbitration agreements per se, the majority held that AB 51’s attack on the formation of arbitration agreements nevertheless violated the FAA.  Relying on prior Supreme Court precedent, the 9^th Circuit held that “state rules that burden the formation of arbitration agreements stand as an obstacle to the FAA” and that no current precedent “suggests that a state rule targeting only the formation of arbitration agreement falls outside of the FAA’s preemptive scope.” In short, the 9^th Circuit held that AB 51 was preempted because it discourages the formation of arbitration agreements.

The 9^th Circuit decision is unlikely to be the final chapter in this saga. It is very possible that the 9^th Circuit will choose to review the issue en banc (i.e., a review by eleven randomly selected 9^th Circuit judges) and may reach a different conclusion. In either event, it is also possible that the Supreme Court will ultimately rule on AB 51’s validity.  Also, the California legislature may try to craft a different statute in a further attempt to sidestep the FAA.

In terms of what this decision means for employers and next steps:

• California law does not currently prohibit mandatory arbitration in the employment context.
• Arbitration agreements in California remain subject to challenge-based procedural and/or substantive unconscionability.
• Employers should review their arbitration agreements on at least an annual basis to account for new legislation or court decisions.