Good News for Employers: The Federal Arbitration Act Preempts the Prohibition of Mandatory Arbitration Contracts
Published: February 22, 2023
On February 15, 2023, the Ninth Circuit Court of Appeals decided Chamber of Commerce v. Bonta and found that the Federal Arbitration Act (FAA) preempts California’s Assembly Bill 51 (AB 51).
The FAA embodies a national policy favoring arbitration. Over the years, the U.S. Supreme Court has struck down a number of California laws and judge-made rules relating to arbitration as preempted by the FAA.
The California legislature has engaged in a prolonged effort to craft legislation that would prevent employers from requiring employees to enter into arbitration agreements as a condition of employment, while trying to avoid conflict with the FAA. In December 2018, the California legislature introduced AB 51 to protect employees from “forced arbitration.” Governor Newson signed the bill into law, which was enacted with an effective date of January 1, 2020. Oddly, AB 51 criminalized contract formation, prohibiting employers from requiring employees or an applicant for employment to enter into an agreement to arbitrate certain claims as a condition of employment. At the same time, for employees who did enter into arbitration agreements, those agreements were still enforceable under AB 51. This approach was taken to avoid conflict with Supreme Court precedent holding that a state rule discriminating against arbitration is preempted by the FAA by applying only to the condition in which an arbitration agreement is made, as opposed to banning arbitration itself.
On December 9, 2019, a collection of trade associations and business groups (“Chamber of Commerce”) filed a complaint for declaratory and injunctive relief against various California officials seeking a declaration that AB 51 was preempted by the FAA and requesting a permanent injunction prohibiting California officials from enforcing AB 51. The district court granted the motion for a preliminary injunction, ruling that the Chamber of Commerce was likely to succeed on the merits of its preemption claim.
The Ninth Circuit in Chamber of Commerce v. Bonta affirmed the district court’s decision.
The Court explained the various ways a federal statute may preempt state law, one being conflict preemption, which can occur where it is “impossible for a private party to comply with both state and federal requirements,” or where, under the circumstances of a particular case, the challenged state law “creates an unacceptable ‘obstacle to the accomplishment and execution of the full purposes and objectives of Congress.’” (Chamber of Commerce of the United States v. Bonta (9th Cir. Feb. 15, 2023, No. 20-15291) 2023 U.S. App. LEXIS 3586, at *15.)
Here, the state law did create an unacceptable obstacle to the purposes and objectives of Congress. The Supreme Court has made it evident that the FAA was designed to promote arbitration. Additionally, the Court has established an “equal-treatment principle,” requiring courts to place arbitration agreements on equal footing with all other contracts, which allows courts to invalidate an arbitration agreement based on generally applicable contract defenses but not on legal rules that apply only to arbitration agreements or that derive their meaning from the fact that an agreement to arbitrate is at issue. (Chamber of Commerce of the United States v. Bonta, supra, 2023 U.S. App. LEXIS 3586, at *18.)
The Ninth Circuit panel explained that the Court has made clear in past decisions that the FAA’s preemptive scope extends to state laws, like AB 51, that discriminate against the formation of arbitration agreements and pose an obstacle to the FAA. Further, the panel explained that the 4th Circuit in Saturn Distrib. Corp. v. Williams (4th Cir. 1990) 905 F.2d 719, and the 1st Circuit in Securities Industry Asso. v. Connolly (1st Cir. 1989) 883 F.2d 1114, reached similar conclusions that the FAA preempts a state rule discriminating against arbitration by discouraging or prohibiting the formation of arbitration agreements.
As such, the Court found that AB 51 discriminates against arbitration agreements and singles out arbitration provisions as an exception to generally applicable law. This is because California law generally allows an employer to enter into a contract with an employee that includes non-negotiable terms as a condition of employment, but under AB 51, an employer cannot enter into a contract with non-negotiable terms essential to an arbitration agreement. AB 51’s penalty-based scheme inhibiting arbitration agreements before they are formed violates the “equal-treatment principle” inherent in the FAA and demonstrates the type of hostility towards arbitration the FAA was enacted to overcome.
Given the Ninth Circuit’s ruling that the FAA preempts California’s AB 51, California employers may continue using mandatory arbitration agreements for existing employees and new hires. However, please keep in mind, employers still need to ensure that their mandatory arbitration agreements are drafted correctly to comply with other legal requirements and restrictions.
If you have any questions, please do not hesitate to contact your Weintraub Tobin employment attorney.