Ninth Circuit Upholds Portions of California Law Prohibiting the Use of Mandatory Employment Arbitration Agreements

AB 51 was signed by California Governor Newsom in October 2019, and it created Labor Code Section 432.6, which would have prohibited employers from requiring employees, as a condition of employment, continued employment, or the receipt of any employment-related benefit, to waive any right, forum or procedure related to an alleged violation of the California Fair Employment and Housing Act (FEHA) or the California Labor Code. In other words, employers in California could no longer require employees to sign arbitration agreements as a condition of employment. Importantly, AB 51 also created civil and criminal penalties for employers who violated this law, including up to six months imprisonment and a fine of up to $1,000. AB 51 was scheduled to take effect on January 1, 2020.

The District Court’s Injunction Blocking Enforcement of AB 51

On December 9, 2019, a few weeks before the law’s effective date, the U.S. Chamber of Commerce, along with several other business groups, filed suit in U.S. District Court for the Eastern District of California seeking a declaration that AB 51 was preempted by the Federal Arbitration Act (FAA) and a preliminary injunction halting the enforcement of AB 51. (Chamber of Commerce v. Becerra, Case No. 2:19-at-01142.) On January 31, 2020, U.S. District Judge Kimberly Mueller issued the preliminary injunction, concluding that AB 51 was preempted by the FAA both because it placed arbitration agreements on “unequal footing” with other contracts and because AB 51 stood as an obstacle to the purposes and objectives of the FAA.

The Ninth Circuit’s Decision

Over 19 months later, on September 15, 2021, the Ninth Circuit, in a split decision with a strong dissent, reversed the district court’s determination that AB 51 was preempted by the FAA and vacated the court’s preliminary injunction, though it affirmed the district court’s decision to enjoin imposition of civil and criminal penalties on employers pursuant to the FAA.

The appellate court first held that AB 51 was not preempted to the extent that it seeks to regulate “pre-agreement behavior” that occurs prior to executing an arbitration agreement, which was not covered by the FAA. In reaching its decision, the Court relied on the historical context of the FAA, its legislative history, and subsequent Supreme Court jurisprudence in finding that “Congress was focused on the enforcement and validity of consensual written agreements to arbitrate and did not intend to preempt state laws requiring that agreements to arbitrate be voluntary.” Because AB 51 only “mandated [that] employer-employee arbitration agreements be consensual” and because it “does not make invalid or unenforceable any agreement to arbitrate, even if such agreement is consummated in violation of the statute,” the Court held that it did not conflict with the goals of the FAA, which is to ensure the enforcement and validity of consensual arbitration agreements.

However, the Court held that AB 51 was preempted by the FAA to the extent that it imposed civil and criminal penalties on employers who obtained “executed arbitration agreements” governed by the FAA. Unlike regulating “pre-agreement employment behavior,” the Court found that these enforcement mechanisms are preempted by the FAA because they punish employers for entering into arbitration agreements.

The result of the majority’s decision is that California can restrict the use of mandatory employment arbitration agreements, but if an employer and employee nevertheless enter into such a mandatory agreement in direct violation of AB 51, the state cannot impose civil and criminal penalties on the employer.

Circuit Judge Sandra Ikuta authored a powerful dissenting opinion, calling AB 51 a “blatant attack” on arbitration agreements and a “poster child for covertly discriminating against arbitration agreements and enacting a scheme that disproportionately burdens arbitration.” Judge Ikuta further wrote that the majority’s decision conflicts with existing Supreme Court precedent and creates a circuit split in the First and Fourth Circuits, which have held that “too-clever-by-half” workarounds and efforts to block the formation of arbitration agreements are preempted by the FAA. Judge Ikuta also called into question the majority’s logic and corresponding impact:

“In case the effect of this novel holding is not clear, it means that if the employer offers an arbitration agreement to the prospective employee as a condition of employment, and the prospective employee executes the agreement, the employer may not be held civilly or criminally liable. But if the prospective employee refuses to sign, then the FAA does not preempt civil and criminal liability for the employer under AB 51’s provisions.”

The Impact on California Employers

Though this decision may not be the final word on whether AB 51 is preempted, the Ninth Circuit’s decision nonetheless creates uncertainty regarding the use of mandatory employment arbitration agreements. Nevertheless, employers can continue to enter into voluntary arbitration agreements with their employees, permitting employees to decline to sign an arbitration agreement.