Wage Claims After OTO v. Kho: Are Arbitration Agreements Enforceable?
The California Supreme Court recently addressed—again—the enforceability of an arbitration agreement of an employee who sought to recover allegedly unpaid wages through California’s administrative process.
Ken Kho worked as a service technician at an automobile dealership known as OTO. Three years into Kho’s employment, a low-level HR employee approached Kho at his workstation and presented him with several documents to sign immediately. Kho had no opportunity to read the documents, and the HR employee did not explain their contents or provide copies for Kho to retain. Instead, Kho was required to sign on the spot.
Kho had signed a two-page arbitration agreement containing an acknowledgment of at-will employment. The arbitration promise appeared in a dense, single-spaced, page-long paragraph printed in an extremely small font. It provided that, subject to limited exceptions, almost all employment-related claims by either party must be submitted to binding arbitration before a retired judge. The arbitration allowed full discovery, pleadings, rules of evidence, and motion practice in accordance with California’s rules of civil litigation. The clause did not address allocation of arbitration costs explicitly but stated that statutory code and case law would control.
After Kho was discharged, Kho filed a complaint for unpaid wages with the Labor Commissioner. Upon Kho’s request, the Labor Commissioner set a date to conduct a “Berman hearing,” an administrative procedure to recover unpaid wages.
OTO appealed, seeking de novo review in the Superior Court. The Labor Commissioner represented Kho on appeal. The trial court vacated the Labor Commissioner’s award because it was improperly held in OTO’s absence. However, the trial court also held that the arbitration agreement at issue was both procedurally and substantively unconscionable. The court of appeal reversed, holding that while the agreement contained an “‘extraordinarily high’ degree of procedural unconscionability,” the agreement was not substantively unconscionable. Therefore, OTO could enforce the arbitration agreement and bypass the Berman hearing process.
The California Supreme Court granted review.
General Unconscionability Principles
California unconscionability law is well developed. An arbitration agreement is unenforceable only where both substantive and procedural unconscionability exist; it is not enough that one may exist without the other.
Whether an agreement is procedurally unconscionable depends on whether there is “‘oppression’ arising from an inequality of bargaining power,” or “‘surprise’ arising from buried terms in a complex printed form.”
Substantive unconscionability concerns “the fairness of an agreement’s actual terms and . . . assessments of whether they are overly harsh” or “so one-sided as to shock the conscience.”
The OTO Court Held the Agreement Was Unconscionable
The California Supreme Court found OTO’s arbitration agreement to be both procedurally and substantively unconscionable and therefore unenforceable.
With respect to procedural unconscionability, the Court found that the agreement created oppression and surprise. The Court viewed the agreement as procedurally unconscionable in part because Kho was forced to sign it to retain a job he had held for three years. Moreover, the agreement was “presented to Kho in his workspace,” with “[n]either its contents nor its significance . . . explained,” by a “low-level employee” which “creat[ed] the impression that no request for an explanation was expected and any such request would be unavailing.”
The Court also found the element of surprise in how the arbitration provisions were conveyed. The text was “visually impenetrable” as a page-long paragraph in small font with complex sentences “filled with statutory references and legal jargon.”
Given the “exceptionally strong” degree of procedural unconscionability present, the Court noted that “even a relatively low degree of substantive unconscionability may suffice to render the agreement unenforceable.”
While acknowledging that, in general, the waiver of Berman process is not per se unconscionable, the Court held that, here, OTO’s agreement was substantively unconscionable, given the “unusually coercive setting in which this bargain was entered” and considering the “terms of what Kho gave up and what he received in return.”
Several factors led the Court to find substantive unconscionability. First, the agreement provided no explanation of how Kho would initiate arbitration or locate an arbitrator, or even that commercial providers of arbitration services existed. Second, the arbitration agreement required proceedings to follow a civil litigation framework, including formal pleadings, discovery demands, dispositive motions, and technical rules of evidence, which Berman hearings do not follow. Navigating such complexity could deter claimants from bringing wage claims at all. Third, the complexity of the litigation-like arbitral process contemplated by the agreement effectively would require the average claimant to hire counsel. The Court concluded that OTO’s arbitral framework, considered in the context of the identified procedural shortcomings, was not sufficiently accessible or affordable for wage claimants. Kho “surrendered the full panoply of Berman procedures and assistance” of the Labor Commissioner, and “[w]hat he got in return was access to a formal and highly structured arbitration process that closely resembled civil litigation if he could figure out how to avail himself of its benefits and avoid its pitfalls.”
The Court declared that its analysis was consistent with federal law, because it said that its holding “rests on generally applicable unconscionability principles.”
In a lengthy dissenting opinion, Justice Ming Chin rejected the unconscionability analysis and conclusions of the six-justice majority, citing both state-law principles and Federal Arbitration Act preemption.
The majority opinion may not be the last word. Justice Chin’s dissenting opinion demonstrated that the FAA preempts state-law anti-arbitration rules, and the U.S. Supreme Court may again have to intervene to remind the California courts of the FAA’s primacy. The U.S. Supreme Court in Buckeye Check Cashing, Inc. v. Cardegna
In fact, Justice Ginsburg’s opinion for the Court in Preston v. Ferrer
Ferrer and Preston had an arbitration agreement. Ferrer contended that the dispute could not be arbitrated at all because of the Talent Agencies Act, or in the alternative that any arbitration had to await the Labor Commissioner’s exercise of its primary jurisdiction. The Supreme Court rejected Ferrer’s claim, citing the FAA’s provision that arbitration contracts are valid, irrevocable, and enforceable, “save upon such grounds as exist at law or in equity for the revocation of any contract.”
Ferrer’s position—which insisted on the exhaustion of the Talent Agencies Act’s administrative remedy—could not be squared with congressional policy, the Court declared. “Requiring initial reference of the parties’ dispute to the Labor Commissioner would, at the least, hinder speedy resolution of the controversy.”
Why should a Labor Commissioner Berman hearing differ, for FAA preemption purposes, from a Labor Commissioner Talent Agencies Act fees hearing? The OTO majority offered no answer, and the U.S. Supreme Court may well have to supply it.
Practical Take-Aways in the Interim
While the California Court’s FAA reasoning is dubious, U.S. Supreme Court intervention cannot be counted upon. Fortunately, nothing in OTO should trouble careful California employers. Most wage claims are relatively small (Kho’s was an aberration), and the cost-free Berman hearing to adjudicate them may not be materially inferior to—and indeed for many employers may be preferable to—an arbitration that the employer must pay for.
Employers, however, will want to review their arbitration agreements to ensure that OTO cannot be cited as a ground to invalidate an arbitration agreement entirely, for other kinds of claims. There is no single prescribed drafting solution to cater to OTO, but employers might consider provisions like these for their arbitration agreements:
“Nothing in this Agreement prevents Employee from filing or recovering pursuant to a complaint, charge, or other communication with any federal, state or local governmental or law enforcement agency.”
“Nothing in this Agreement requires arbitration of claims that as a matter of law (after application of FAA preemption principles) cannot be made subject to a predispute arbitration agreement.”
For cases arising under arbitration agreements without language of this kind, employers should consider:
Waiving arbitrability for wage claims subject to Berman hearings.
Insisting that courts sever any supposedly offending provision(s) of the arbitration agreement, so as not to (as one case put it) “throw the [arbitration] baby out with the bath water.”
Employers also will want to review the procedural steps used to present and obtain arbitration agreements. The OTO majority clearly was bothered by what it called the “oppressive circumstances present here.”
The appearance of the agreement (e.g., font size).
The understandability of the arbitration language.
The length of time employees have to review the agreement.
The employee’s opportunity to ask questions.
The employee’s opportunity to consult counsel.
The availability to the employee of a copy of the executed agreement.
OTO may well be another in a line of California cases that the U.S. Supreme Court ultimately resolves. But in the meantime, OTO provides employers with a reminder to assess the status of their arbitration agreements, and the procedures used to obtain them.