In a recent decision, the California Supreme Court held that courts cannot refuse to enforce arbitration agreements simply by finding that three or more provisions are unconscionable. Rather, courts must use a three-prong test to assess whether to remove or limit unconscionable terms and enforce the remainder of the agreement. Ramirez v. Charter Communications, Inc. is a reminder to employers to ensure that their employment arbitration agreements are fair and balanced, and the decision clarifies the standard to determine whether courts can sever unconscionable (i.e., one-sided and/or illegal) terms.  

Background

The employee in Ramirez signed an arbitration agreement at the outset of her employment. After she was terminated, the employee filed a lawsuit in court rather than in arbitration. The employer filed a motion to compel the case to arbitration. The trial and appellate court concluded that because there were multiple unconscionable provisions in the employment arbitration agreement, that the employer’s motion should be denied. 

In particular, the employee challenged four provisions of the arbitration agreement:  

1. First, that the claims subject to arbitration were primarily claims brought by employees (e.g., unlawful termination, discrimination, harassment, wage and hour disputes, etc.); while claims typically brought by employers were explicitly excluded from arbitration (e.g., theft, embezzlement, non-compete agreements, unauthorized disclosure of trade secrets or confidential information, intellectual property right claims, etc.). 
2. Second, that claims subject to a pre-filing administrative agency filing were required to be filed in arbitration within the time period for to submit the claim to the administrative agency; effectively shortening the time to bring a claim for discrimination, harassment, and/or retaliation under the Fair Employment and Housing Act (FEHA). 
3. Third, that the discovery permitted under the agreement (4 depositions, 20 interrogatories, and 15 document requests) was too limited. 
4. Fourth, that if a lawsuit is filed in court rather than arbitration and the matter was compelled to arbitration, that the party resisting arbitration is required to pay the other party’s attorneys fees and costs incurred in compelling arbitration.

The CA Supreme Court affirmed the lower court’s findings that the following provisions were unconscionable: (1) the scope of claims included and excluded from arbitration; (2) the shortening of time to submit claims; and (3) the fee-shifting provisions. On the issue of limited discovery, the CA Supreme Court held that the discovery provision was not unconscionable because arbitration agreements can limit discovery to less than what is permitted in court, and language in the discovery provision allowing the arbitrator to “decide all discovery disputes” included the ability to allow more discovery.  

Despite affirming that the arbitration agreement contained unconscionable terms, the CA Supreme Court’s holding infers that the existence of unconscionable terms does not render the agreement per se unconscionable. 

The Three-Prong Test

On the issue of whether the agreement should be enforced, the CA Supreme Court explained that there is no bright line rule regarding the number of unconscionable terms in a contract that mandates that a court refuse enforcement of the contract. Instead, it set forth the following three-prong test.

A court may liberally sever any unconscionable provision of a contract and enforce the rest when:

1. The unconscionable provision(s) are collateral to the main purpose of the contract;
2. It is possible to cure the unconscionability by removing or limiting the provision; and 
3. Enforcing the remainder of the contract would be in the interests of justice.

Under the first prong, the court considers whether the main purpose of the contract is tainted by an unlawful purpose (e.g., creating a system that disfavors/disadvantages an employee’s claims and that favors/advantages an employer’s claims). If not, the unconscionable provision(s) are collateral.  

Under the second prong, the court considers whether striking or limiting existing terms removes the unconscionability and whether the agreement contains a severance clause indicating the parties’ intent to have the court do so. However, if terms must be added to the contract to remove the unconscionability, the court should not enforce the contract.  

Under the third prong, the court considers whether (1) severance of unconscionable terms condones an illegal scheme (e.g., whether severance creates an incentive for employers to draft one-sided agreements in the hopes that employees won’t challenge them, and if they do, that the court would fix the problems for them) and (2) if the agreement indicates a systematic effort to impose arbitration on an employee as an inferior forum that works to the employer’s advantage. If the answer is yes to either question, then in the interests of justice, the court should not enforce the agreement. 

The case has been remanded for further consideration in light of the three-prong test laid out in the CA Supreme Court’s decision.

Lessons Learned

Here are the key takeaways from the Ramirez v. Charter Communications, Inc. decision.

1. If an employer’s arbitration agreement is generally fair and balanced between the parties, the fact that more than one or two provisions are challenged will not necessarily invalidate the agreement.
2. The assessment of whether a provision is unconscionable is based on the circumstances when the arbitration agreement was entered into, not on subsequent developments.
3. It is important to ensure that arbitration agreements that provide for limited discovery to also authorize the arbitrator to allow for additional discovery that is necessary to the adequate arbitration of claims.