California Supreme Court Clarifies Severability in Arbitration Agreements

California Supreme Court building

The California Supreme Court issued its opinion in Ramirez v. Charter Communications, affirming in part that the arbitration agreement contained some substantive unconscionability but remanding the case to determine whether the agreement could be salvaged by severing the unconscionable provisions. In doing so, the California Supreme Court clarified its view on the enforceability of several common arbitration provisions—including those limiting discovery in arbitration—and the standard courts should apply when deciding severability.

The Case

The plaintiff was hired by Charter Communications in July 2019 and signed an arbitration agreement as a condition of her employment. After her termination in May 2020, the plaintiff sued Charter Communications for discrimination, harassment, and retaliation under the Fair Employment and Housing Act (FEHA).

Both the trial court and the court of appeal found the arbitration agreement to be procedurally and substantively unconscionable and ruled that these unconscionable elements could not be severed from the agreement. With respect to substantive unconscionability, the lower courts identified four provisions that, in their view, were unconscionable:

The lack of mutuality in the covered and excluded claims provisions.
A shortened limitation period for filing claims.
The limited number of depositions.
The potential for the employer to recover attorney fees if it prevails on a motion to compel arbitration.

The California Supreme Court granted review, with a particular eye toward resolving a split in the court of appeal regarding the enforceability of an arbitration provision awarding attorney fees to an employer that prevails on a motion to compel arbitration and ultimately held that three of the four provisions identified by the lower courts gave rise to substantive unconscionability:

Mutuality: The California Supreme Court agreed that the lack of mutuality in the covered and excluded claims gave rise to substantive unconscionability. The agreement excluded from its coverage claims most likely to be brought by the employer including claims related to intellectual property rights, noncompete agreements, theft, and disclosure of trade secrets. Meanwhile, the only excluded claims that an employee might bring were already not arbitrable as a matter of law, such as claims for workers’ compensation and unemployment insurance benefits.
Shortened statute of limitations: The California Supreme Court also agreed that the effective shortening of the statute of limitations for filing FEHA claims from three years to one year gave rise to substantive unconscionability. The court reiterated that while arbitration agreements may shorten the statute of limitations for filing claims, such must be reasonable.
Attorney fee shifting: The California Supreme Court also agreed that a provision allowing the employer to recover attorney fees for prevailing on a motion to compel arbitration gave rise to substantive unconscionability. The court reasoned that such a provision imposed a potential expense on the employee that the employee would not have otherwise faced since employers ordinarily cannot recover attorney fees in a FEHA action unless there is a finding that the action was frivolous, unreasonable, or groundless.
Discovery limitations: The California Supreme Court disagreed, however, with the conclusion that the agreement’s limitation on depositions gave rise to substantive unconscionability. The court reiterated that arbitration agreements may include limitations on discovery so long as the employee is afforded discovery adequate to vindicate statutory rights. Rejecting the employee’s assertion that she would need at least seven depositions to prosecute her FEHA claims yet the agreement only afforded her four, the court stressed that unconscionability is determined at the time the agreement is entered, not in hindsight after claims are asserted. Moreover, four depositions were not unreasonable in light of the fact that the agreement could be construed as allowing the arbitrator to grant additional depositions if needed.

Having concluded that three of the four identified provisions were substantively unconscionable, the California Supreme Court remanded the matter for the lower court to determine if severance of the unconscionable provisions would be appropriate.

In doing so, the court re-highlighted three principles that should guide a court’s severability analysis. First, the test for severability is qualitative, not quantitative: the key question is whether “the central purpose of the contract is tainted with illegality,” not whether one, two, three, or more provisions give rise to unconscionability. Second, while an arbitration agreement can be cured by severing or limiting a provision, it cannot be cured through reformation, augmentation, or a rewriting of the agreement. Third, a court must consider whether severing the offending provisions and enforcing the balance of the agreement furthers the interests of justice.

Takeaway

California arbitration case law continues to evolve at a torrential pace. Employers should carefully monitor developments in this area and routinely have their arbitration agreements reviewed to ensure enforceability.