By: Daniel A. Corren and John L. Wollman, Cypress LLP

Chamber of Commerce v. Bonta – 62 F.4th 473, filed Feb. 15, 2023

Key Takeaway: California has yet to crack the code to protect employees from mandatory arbitration with their employers. The Ninth Circuit determined that the FAA preempts California’s Assembly Bill 51 (AB 51)[1] even though AB 51 does not affect the enforceability of an agreement to arbitrate. AB 51 violates the obstacle preemption test because it creates a criminal disincentive for employers to enter into arbitration agreements with employees, when the objective of the FAA is to give preference to the existence and enforcement of agreements to arbitrate.

It is likely this decision will be subject to en banc review and appealed to the United States Supreme Court, so stay tuned. In the meantime, Cypress has extensive experience analyzing and litigating employment agreements involving arbitration provisions and can help employers navigate this ever-changing area of law.

Holding: AB 51 violates the FAA and is unenforceable.

Facts:

• Following DirectTV, Inc. v. Imburgia 577 U.S. 47 (2015) and Kindred Nursing Ctrs. Ltd. P’ship v. Clark 137 S. Ct. 142 (2017), California passed AB 51 to protect employees from mandatory arbitration provisions in employment contracts.
• In an effort to avoid FAA preemption, AB 51 only criminalizes the employer’s act of mandating an arbitration agreement without affecting the enforceability of the resulting agreement to arbitrate.
• California reasoned that creating a criminal disincentive would effectively dissuade employers from imposing arbitration without running afoul of the FAA.
• Industry groups filed a lawsuit seeking declaratory relief on the basis that the FAA preempted AB 51 and sought a preliminary injunction against its enforcement.
• The trial court determined the industry group was likely to succeed on the merits and granted the preliminary injunction. California appealed.

Issue: Does the FAA preempt AB 51?

Yes. The Ninth Circuit applied “obstacle preemption,” which justifies preemption when a challenged state law “creates an unacceptable obstacle to the accomplishment and execution of the full purposes and objectives of Congress.”

The intent of the FAA is to promote a national policy favoring arbitration and give preference to the enforcement of arbitration provisions. Obstacle preemption applies to state laws or precedent that single out arbitration agreements and prevent their enforcement, a doctrine described as the “equal-treatment principle.” It requires arbitration agreements to be analyzed in the same way as all other contracts. Only defenses that would apply to the enforcement of any other contract are valid and defenses unique to arbitration are preempted.

State law can violate the equal-treatment principle on its face by singling out arbitration agreements. It also can “covertly” violate the principle if it is designed to target agreements that contain the defining features of arbitration agreements without naming them.

United States Supreme Court precedent makes clear that preemption applies equally to state laws that prevent enforcement of arbitration agreements as to laws that interfere with their formation. If preemption did not apply to the latter, then states could easily avoid the FAA by simply making it illegal to enter into agreements to arbitrate.

Turning that lens to AB 51, the Ninth Circuit said: “[t]he burden imposed on the formation of arbitration agreements is severe” because AB 51 imposes civil and criminal sanctions on any employer who includes non-negotiable arbitration requirements in employment contracts. (Emphasis added.) The express intent of the law was to create a deterrent effect and these provisions only apply to arbitration provisions, not other non-negotiable terms in employment contracts. It held that “AB 51’s penalty-based scheme to inhibit arbitration agreements before they are formed violates the ‘equal-treatment principle’ inherent in the FAA.” It affirmed the district court’s decision.

[1] AB 51 was passed in 2019 and codified as Labor Code § 432.6 (“Section 432.6”) and Government Code § 12953 (“Section 12953”).