Severing Unconscionable Terms in an Arbitration Agreement: Guidance from the California Supreme Court

Employers use arbitration agreements to try to accomplish two main things: to force employees out of court and into a form that is less favorable to the employees and to prevent employees from bringing class actions. However, employers cannot force employees to comply with arbitration agreements that are unfairly one-sided. Such agreements can be voided if they are both procedurally and substantively unconscionable.

On July 15, 2024, the California Supreme Court issued its opinion in the case of Ramirez v. Charter Communications Inc. (2024) 16 Cal.5th 478, clarifying four issues that often arise when plaintiffs are challenging arbitration agreements as unconscionable:

1. Whether excluding from arbitration claims that the employer is more likely to bring is unconscionable;
2. Whether a shortened limitations periods for filing is unconscionable;
3. Whether limitations on discovery such as a limited number of permitted depositions are unsconscionable; and
4. Whether arbitration agreements can provide for the potential of an unlawful award of attorney fees.

The Lack of Mutuality

First, the California Supreme Court agreed with the Court of Appeal that an arbitration agreement is unfairly one-sided where it compels arbitration of “the claims more likely to be brought by an employee, the weaker party, but exempts from arbitration the types of claims that are more likely to be brought by an employer, the stronger party.” This is consistent with the holdings in two earlier decisions, Mercuro v. Superior Court (2002) 96 Cal.App.4th 167 and Fitz v. NCR Corp. (2004) 118 Cal.App.4th 702.

Specifically, the Court found that it was one-sided for the employer to exempt from arbitration claims that it was likely to want to bring: claims related to intellectual property rights and severance or noncompete agreements, claims for equitable relief related to unfair competition or the disclosure of trade secrets or confidential information, and claims for theft or embezzlement. Because the employer failed to justify this one-sidedness, the Court found it to be unconscionable.

Limits on When an Employee Must File a Claim

Second, the California Supreme Court confirmed that the unreasonable shortening of limitations periods (such as reducing a three year statute of limitations to one year) was unconscionable.

Limits on Discovery

Third, the California Supreme Court turned to the issue of a provision that limited discovery to up to four depositions, among other limitations on discovery. In addressing this issue, the Court made the following observation:

The assessment of whether a discovery clause is unconscionable should focus on general factors that can be examined without relying on subsequent developments.
Those factors include the types of claims covered by the agreement, the amount of discovery allowed, the degree to which that amount may differ from the amount available in
conventional litigation, any asymmetries between the parties with regard to discovery, and the arbitrator’s authority to order additional discovery.

The Court then concluded that because the arbitrator could order more discovery, limiting the parties to four depositions was not unconscionable.

Interim Award of Attorneys’ Fees

Finally, the California Supreme Court considered the provision of the arbitration agreement that allowed for an award of attorneys’ fees against a party that opposed a motion to compel arbitration and lost. The Court noted that the Fair Employment and Housing Act permits defendants to recover attorneys’ fees and costs only where the action is deemed to have been “frivolous, unreasonable, or groundless when brought, or where the plaintiff continued to litigate after it clearly became so.” (Gov. Code, § 12965(c).) Furthermore, under well-established law, an arbitration agreement cannot require an employee to bear any type of expense that the employee would not be required to bear in court.

In light of these basic principles, the Court concluded that “an arbitration agreement imposed as a condition of employment cannot require an employee to pay attorney
fees to the employer in the arbitration of a statutory claim, unless the arbitrator finds that the action was frivolous, unreasonable, or groundless when brought, or that the
employee continued to litigate after it clearly became so.”

Severance

The California Supreme Court then turned to the question of whether the trial court should have severed the substantively unconscionable provisions. The Court rejected the idea that the number of unconscionable provisions dictated how courts must rule on severance:

[N]o bright line rule requires a court to refuse enforcement if a contract has more than one unconscionable term. Likewise, a court is not required to
sever or restrict an unconscionable term if an agreement has only a single such term. Instead, the appropriate inquiry is qualitative….

The Court then clarified the test that courts should use when considering whether to sever such provisions:

Courts may liberally sever any unconscionable portion of a contract and enforce the rest when: the illegality is collateral to the contract’s main purpose; it is possible to
cure the illegality by means of severance; and enforcing the balance of the contract would be in the interests of justice.

The Court then provided the following helpful rules:

First, courts should not augment arbitration agreements in order to avoid unconscionability.

Second, courts should not sever unconscionable provisions unless to do so would further the interests of justice. “This part of the inquiry focuses on whether mere severance of the
unconscionable terms would function to condone an illegal scheme and whether the defects in the agreement indicate that the stronger party engaged in a systematic effort to impose
arbitration on the weaker party not simply as an alternative to litigation, but to secure a forum that works to the stronger party’s advantage. If the answer to either question is
yes, the court should refuse to enforce the agreement.”

Third, while there are no bright line numerical rules regarding severance, “it is fair to say that the greater the number of unconscionable provisions a
contract contains the less likely it is that severance will be the appropriate remedy.”

Finally, the Court further noted that even if an arbitration agreement contained a clause allowing the severance of unconscionable provisions, the parties to such an agreement could not divest a trial court from its discretion regarding whether to sever. (Civ. Code, § 1670.5.)

If you have questions about your rights in the workplace, please feel free to contact Hunter Pyle Law PC and to make us of  our free and confidential intake process. We can be reached at hunterpylelaw.com or at (510) 444-4400.