To Sever or Not to Sever? A Key Consideration in Drafting Your Arbitration Agreement

January 7, 2015 – California employment laws – especially those involving so-called “representative” actions and arbitration – create a potential minefield for unwary employers. A decision issued today by the California Court of Appeal (Second Appellate District, Division Four) highlights the need for employers who wish to require their employees to arbitrate disputes, rather than litigating in court, to carefully consider what will happen if a court concludes that a part of their arbitration agreement is unenforceable. Will the court sever the invalid provision and enforce the remainder of the agreement, or will the entire agreement be thrown out? An employer can, to some extent, determine the answer to this question – but which approach is preferable?

In Montano v. The Wet Seal Retail Inc., a former employee filed a class action lawsuit seeking class-wide damages arising out of Wet Seal’s alleged failure to provide its employees with required meal and rest breaks and related violations of California’s labor laws and regulations., as well as penalties under California’s Labor Code Private Attorneys General Act (“PAGA”) for those violations. PAGA enables an employee to bring “representative” claims; that is, an individual plaintiff can recover penalties arising not only out of violations committed against him- or herself, but also penalties based on violations committed against every other current and former employee. Obviously, these representative claims can create massive exposure for employers.

Wet Seal, like many savvy employers, required its employees to sign arbitration agreements. The agreement contained a “non-severability clause” which stated that “[t]he parties also waive their right to join or consolidate claims with others or to make claims with others as a representative or a member of a class or as a private attorney general. The waiver in the preceding sentence is a material or important term of this arbitration agreement. If either party initiates or joins in a lawsuit or arbitration against the other party in violation of this waiver and the waiver is found to be unenforceable for any reason by a court or arbitrator, then this entire arbitration agreement is void and unenforceable by the parties.”

Had Wet Seal required its workers only to waive class and collective actions, but not representative actions, then the case would have been boring, and I would not be writing this post. There’s no doubt that, under current law, the class and collective action waiver would have been enforceable. But Wet Seal went further, attempting to require its employees to waive the right to bring representative PAGA claims – which the California Supreme Court recently decided in Iskanian v. CLS Transportation Los Angeles, LLC cannot be waived.

To vastly oversimplify an important and nuanced opinion: The Iskanian Court held that an employee must be able to bring a representative action somewhere – either in court or arbitration. The Court didn’t decide which forum was appropriate for the claim before it, leaving that issue to be decided by the lower courts. (Note that the federal district courts disagree with the Iskanian rule, holding that the Federal Arbitration Act allows employers to require workers to waive representative PAGA claims – so an agreement that is unenforceable in state court may well be enforceable in federal court! Kids, don’t try this at home.)

In the part of the Wet Seal decision that surprised no one, the Court of Appeal held that, under Iskanian, the PAGA waiver could not be enforced. The more interesting aspect of the Wet Seal opinion is that, because the arbitration agreement contained a non-severability clause, the entire agreement was invalid. So, even though the waiver of class claims would have been enforceable, it – along with all other provisions in the arbitration agreement – was thrown out. Thus, instead of arbitrating only an individual claim, Wet Seal would be forced, by the terms of its own arbitration agreement, to defend in court against claims for class-wide damages and for PAGA penalties arising out of alleged violations against all of its employees.

You may at this point ask why an employer would ever include a non-severability provision. Many agreements with these clauses were drafted during the period when it was unclear whether courts would enforce class waivers in arbitration agreements; some employers decided that, if they were going to face class claims, they would prefer to do so in court rather than face the relative informality and unpredictability of arbitration. Given the high stakes of class-wide claims, many employers preferred to litigate those claims in court, where (among other things), there is much greater availability of appellate review of the outcome.

Even now, when courts readily enforce class waivers – and typically read them into any arbitration agreement that doesn’t expressly allow for class claims – employers seeking greater procedural protections may prefer to have PAGA claims decided by a court. Most importantly, some courts require PAGA plaintiffs to prove that their claims meet all of the formal requirements of a class action; this can be a significant hurdle. (Again, the specific court where a claim is brought will determine which rules apply. California state courts do not require that the class action criteria be met. The federal courts are split, with the Northern District following the state court practice. I warned you that this area is tricky! Fortunately, there are some steps an employer can take to increase the odds that any dispute will be litigated in a favorable forum.)

There may also be reasons why an employer would want to include a severability provision, so that the portions of the arbitration agreement that are not objectionable will be enforced. Wet Seal, for example, could have avoided class-wide claims entirely, thereby significantly reducing its exposure. Additionally, arbitration is more likely to be kept confidential, whereas litigation makes your employee disputes a matter of public record – with all the attendant PR headaches. Note that, without a severability clause, a court is likely to strike down an entire agreement – though the trial courts have broad discretion in deciding whether to do so, making prediction difficult.

Ultimately, the approach that will best protect your business depends on many factors, especially those that will impact whether claims against you can be heard in federal court (such as the size of your company and the location(s) of your operations and employees) and on the importance of (relative) confidentiality. You should enlist a knowledgeable attorney to help you navigate these thorny issues.

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