Iskanian: Gentry Overturned; PAGA Claims Survive, Not Preempted by FAA

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In a closely-watched case, the California Supreme Court reversed a decision of the Court of Appeal that had held that Defendant CLS Transportation’s mandatory arbitration agreement, which contained a class action waiver and a waiver of the right to bring a representative action, was enforceable in all respects. Iskanian v. CLS Transportation LLC, No. S204032 (June 23, 2014) (Mr. Iskanian is represented by Capstone Law APC) (slip opinion available here). By a 6-1 majority, the Court concluded that its prior decision holding class action waivers unenforceable under certain circumstances, Gentry v. Superior Court, 42 Cal.4th 443 (2007), is preempted by the Federal Arbitration Act (FAA) in light of recent United States Supreme Court precedent. But the Court also unanimously held that a waiver of the right to bring a representative action under the Private Attorneys General Act of 2004 (PAGA) is unenforceable, though the Justices’ analyses diverged in their reasoning. Justice Liu wrote the majority opinion, which was joined by Chief Justice Cantil-Sakauye and Justices Corrigan and Kennard. Justice Chin authored a separate concurrence which was joined by Justice Baxter, and Justice Werdegar partially dissented in a blistering attack on the use of class action waivers as a modern day version of the notorious “yellow dog” contracts of the early 20th century.

The majority began by analyzing the lower court’s enforcement of the class action waiver in CLS’s arbitration agreement, which in turn required it to revisit its earlier Gentry decision. Gentry had held that a trial court may invalidate a class action waiver in an arbitration agreement if individual arbitration was significantly less effective in enforcing unwaivable statutory rights than class arbitration based on consideration of four factors. In 2011, the U.S. Supreme Court issued AT&T Mobility LLC v. Concepcion, 563 U.S. 321 (2011), which invalidated the Discover Bank rule, an earlier California state law rule that had limited the enforceability of class action waivers in adhesive consumer contracts, as being preempted by the FAA. The Iskanian Court acknowledged that the Gentry rule against class waivers was narrower than the Discover Bank rule, but nonetheless held that it is preempted by the FAA. Slip op. at 7. The Court also rejected an argument made by Iskanian’s counsel at oral argument that a modified Gentry test might not be preempted if it applied only where a class action waiver amounted to a de facto waiver of rights and the at-issue arbitration agreement failed to provide a suitable alternative means for vindicating those rights. This argument, based on the Court’s analysis in Sonic-Calabasas II, was rejected because the constellation of Berman protections (the subject of Sonic-Calabasas II) includes things such as one way fee-shifting and mandatory undertaking that do not frustrate “fundamental attributes of arbitration” as articulated by Concepcion, while Gentry is focused only on a procedure that “frustrates fundamental attributes of arbitration.” Slip op. at 10.

The Court also rejected Iskanian’s argument that the class action waiver was invalid under federal labor law, specifically the National Labor Relations Act (NLRA), which protects workers’ rights to engage in “concerted activity” for “mutual aid or protection,” and the Norris-LaGuardia Act, which prohibits “yellow-dog” contracts. The Court declined to follow the NLRB’s decision in D.R. Horton Inc. & Cuda, 357 NLRB No. 184 (2012), which had held that class action waivers and other contractual prohibitions on aggregate litigation in employment contracts (including arbitration agreements) are invalid, and instead followed the Fifth Circuit Court of Appeals in D.R. Horton Inc. v. NLRB, 737 F.3d 344 (5th Cir. 2013), holding that the NLRA was overridden by the earlier statute, the FAA, and did not fall within the savings clause of the FAA (i.e. poses an obstacle to arbitration). The Court also agreed with the Fifth Circuit that there is no inherent conflict between the FAA and the later-enacted NLRA (or Norris-LaGuardia Act) because the federal class action rule did not yet exist when the NLRA became law, and that the NLRA does not embody a “contrary congressional command” overriding the FAA’s mandate. Slip op. at 20-21.

Although the Court ruled that the class action waiver was enforceable, it reached the opposite conclusion regarding CLS’s contractual waiver of PAGA claims. The Court first analyzed whether PAGA claims may be waived under California law. The Court found that PAGA claims, which allow an “aggrieved employee” (an employee who has suffered an enumerated violation of the Labor Code) to recover civil penalties on behalf of the state and all other aggrieved employees, cannot be waived under California law. In its analysis, the Court noted that PAGA is a type of qui tam action, in which the named aggrieved employee recovers twenty-five percent of all the penalties (to be distributed among the other aggrieved employees in some fashion) and seventy-five percent goes to the State. Slip op. at 33. The Court further recognized that PAGA claims are inherently representative, because, at its core, the PAGA-named aggrieved employee “represents” the State’s law enforcement interest. Id. at 36. The Court concluded that, because it would cripple the State’s ability to enforce its labor laws by allowing PAGA claims to be waived by private contract, “[i]t is against public policy for an employment agreement to deprive employees of this option altogether, before any dispute arises” and thus PAGA waivers are unenforceable under state law. Id. at 35-36.

In what is likely the critical portion of the Iskanian opinion, the Court also held that the state law rule prohibiting waiver of PAGA claims is not preempted by the FAA. The Court noted that both the FAA’s text and legislative history demonstrate that it applies to private disputes between parties “in a contractual relationship.” Slip op. at 37. The Court found that a PAGA action is not a private dispute, insofar as it involves a dispute between an employer and the state Labor and Workforce Development Agency, the latter of which is the real party in interest. Id. The Court further reviewed the U.S. Supreme Court case law and found that all but one case, EEOC v. Waffle House, Inc., 534 U.S. 279 (2002), involved private disputes between parties in a contractual relationship and were thus inapposite. The Court held that Waffle House, which held that an arbitration agreement between an employee and his employer did not prevent the EEOC from suing the employer on behalf of the employee, controlled the instant case. Slip op. at 39. The Court thus concluded that “[n]othing in the text or legislative history of the FAA nor in the Supreme Court’s construction . . . suggests that the FAA was intended to limit the ability of the states to enhance their public enforcement capacities by enlisting willing employees in qui tam actions.” Id. at 40-41. Importantly, the Court also observed that an unbroken line of U.S. Supreme Court decisions have held that courts should not assume that the historic police powers of the states are preempted “unless that was the clear and manifest purpose of Congress,” that PAGA is clearly within California’s historic police powers and lies at the “heart of state sovereignty,” and that the FAA embodies no such “clear and manifest purpose.” Id. at 42. The Court therefore held that California’s rule prohibiting waiver of PAGA claims is not preempted by the FAA.

Finally, the majority opinion clarified that the rule announced by the Court is not that PAGA claims are inarbitrable, but rather that they cannot be waived entirely. Slip op. at 47 (stating that “CLS must answer the representative PAGA claims in some forum.”). The Court also identified several issues to be decided on remand, including: (i) whether the parties may agree to resolve the PAGA and other claims in the same forum; (ii) if not, whether the claims can be bifurcated and proceed in different forums; and (iii) if bifurcated, which claims should proceed first. Id.

Justices Chin and Baxter concurred with all aspects of the majority’s decision, including that the PAGA waiver in CLS’s agreement is unenforceable, but disagreed with the majority’s reasoning on that latter point. Specifically, whereas the majority found the FAA to be wholly inapplicable to PAGA claims due to their “public” nature, Justice Chin wrote that he would have predicated that holding on the U.S. Supreme Court’s decision in American Express Co. v. Italian Colors Restaurant, 133 S.Ct. 2304 (2013), insofar as Italian Colors reiterated that an arbitration agreement may not “forbid the assertion of certain statutory rights.” Slip op., Chin concurring op. at 5. Because “[r]equiring an arbitration provision to preserve some forum for bringing PAGA actions does not exceed [the FAA’s] limit,” the California rule prohibiting a complete waiver of an employee’s PAGA claims is not preempted by the FAA. Id. at 8.

Finally, Justice Werdegar concurred as to the unenforceability of CLS’s PAGA waiver, but dissented as to the enforcement of the class action waiver. In a strongly-worded defense of the federal labor laws, Justice Werdegar excoriated the majority for ignoring Congress’s declaration 80 years ago that employees have a right to engage in collective action and that contracts purporting to strip those rights are illegal. Because the right to collective litigation has been held to be protected “collective action,” employees’ right to proceed with a class action is therefore protected by the NLRA. Moreover, Justice Werdegar noted that class action waivers in employment contracts “are the descendants of last century’s yellow dog contracts,” referring to the much-maligned agreements that were outlawed in 1932 by the Norris-LaGuardia Act. Justice Werdegar also found no conflict between the FAA and the NLRA, because a rule prohibiting class action waivers would apply equally to arbitration agreements and other contracts, thus falling within the FAA’s savings clause. Slip op., Werdegar dissenting op. at 9. Moreover, she reasoned, if there were a conflict between the FAA and the later-enacted NLRA or Norris-LaGuardia Act, the Norris-LaGuardia Act would prevail, as it expressly repeals other contrary statutes. Id. Justice Werdegar concluded by observing that the majority opinion “rests on the notion that the FAA should be interpreted to operate as a super-statute, limiting the application of both past and future enactments in every particular,” but that the text and legislative history of the Norris-LaGuardia and NLRA “show no such deference” to the FAA. Id. at 13-14. She concluded, “The right of collective action they codify need not yield.” Id. at 14.

While some defense attorneys predictably have hailed the Iskanian decision as a victory for employers, a more accurate assessment would be that it was a mixed bag. Although the California Supreme Court could have adopted the NLRB’s reasoning in D.R. Horton to void the class action waiver before it, that also would have increased the likelihood of review by the U.S. Supreme Court. Further, by announcing that PAGA cannot be waived by arbitration agreements in California, the Court also preserved a powerful form of aggregate litigation for California employees. Indeed, the fact that all seven justices agreed that PAGA waivers are not only illegal under California law, but also that the rule is not preempted by the FAA is a powerful, unified statement, especially in light of recent arbitration-friendly decisions by the U.S. Supreme Court. CLS has indicated some possible interest in filing a petition for certiorari to the U.S. Supreme Court, the deadline for which is September 22, 2014.