Employers Can't Force Waiver of California PAGA Claims

By Kevin McGowan

Sept. 28 — The Federal Arbitration Act doesn't preempt a California court-created rule that an employee's right to bring representative wage and hour claims under the state's Private Attorneys General Act can't be waived by a private arbitration agreement, a divided U.S. Court of Appeals for the Ninth Circuit ruled Sept. 28.

Reversing a district court's dismissal of a former LensCrafters employee's PAGA claims against Luxottica Retail North America Inc., the Ninth Circuit said the California Supreme Court in Iskanian v. CLS Transportation Los Angeles, LLC, 327 P.3d 129, 22 WH Cases2d 1511 (Cal. 2014), correctly held the federal arbitration law doesn't preempt PAGA claims, in which an employee acts as the state's representative to seek redress for alleged California Labor Code violations.

Luxottica argued that under the U.S. Supreme Court decision in AT&T Mobility, LLC v. Concepcion, 131 S. Ct. 1740 (U.S. 2011), which held the FAA preempted a California state court rule that precluded waivers of class arbitration claims, a state rule preluding waiver of PAGA claims likewise is preempted.

Deciding an issue of first impression, the Ninth Circuit said enforcement of a state rule precluding PAGA waivers escapes FAA preemption because it is generally applicable to all contracts and wouldn't obstruct accomplishment of the FAA's pro-arbitration objectives.

In dissent, Judge N. Randy Smith would hold that under Concepcion, the FAA preempts a state rule allowing employees to pursue PAGA claims even if their arbitration agreement expressly waives such claims.

Victory for Employees 

The decision is a victory for employees seeking to press California state law wage claims despite being covered by arbitration pacts that preclude class actions.

“The decision today aligns [the] federal court with the California Supreme Court, and obeys the rules of California contract law,” said Kyle Nordrehaug, who represents Shukri Sakkab, the former Luxottica employee who filed the PAGA lawsuit. “California courts were already following Iskanian, and now federal courts will also have to comply with California law.”

The Ninth Circuit should reach the same result in two other pending PAGA cases, as “they presented the same issue” as Luxottica and were argued together, Nordrehaug said in a Sept. 28 e-mail to Bloomberg BNA.

Luxottica could ask the full Ninth Circuit to vacate the panel decision and rehear the case or seek Supreme Court review. Attorneys for the company weren't available for comment Sept. 28.

The PAGA allows employees essentially to stand in the state's shoes, alleging overtime pay claims and other Labor Code violations on behalf of themselves and similarly situated employees. If the employee succeeds, the state recovers 75 percent of any civil penalties assessed against the employer and the employees split the remaining 25 percent.

In Iskanian, the California Supreme Court said although Concepcion permits employers to enforce class action waivers in arbitration agreements, PAGA claims are different. It would violate state public policy to allow employers to enforce waivers of PAGA claims, as employees bringing such representative claims are aiding the state, which has limited resources to unearth and prosecute labor code violations, the Iskanian court said.

The U.S. Supreme Court subsequently denied the employer's petition to review Iskanian.

‘Generally Applicable' State Rule 

Section 2 of the FAA provides that written agreements to resolve disputes through arbitration “shall be valid, irrevocable and enforceable” except “upon such grounds as exist at law or in equity for the revocation of any contract.”

In Concepcion, the Supreme Court said this FAA Section 2 “saving clause” means arbitration agreements could be invalidated by “generally applicable contract defenses,” such as fraud, duress or unconscionability. But Concepcion said that under the FAA, arbitration agreements can't be invalidated “by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.”

Even if a state law rule is “generally applicable,” the FAA preempts the state rule if it conflicts with the FAA's objectives, the court said in Concepcion.

The court in Concepcion ruled a California state rule prohibiting class action waivers in arbitration pacts was preempted by the FAA because the state rule was aimed specifically at arbitration, and enforcement would interfere with the FAA's objective to protect enforcement of arbitration pacts.

But the Ninth Circuit said the Iskanian rule, which preserves employees' rights to bring PAGA claims as a representative of the state, stands on a different footing than a ban on class action waivers.

The Supreme Court said a contract defense must be “generally applicable” to be saved from FAA preemption, Judge Milan Smith wrote for the Ninth Circuit.

“The Iskanian rule complies with this requirement,” the appeals court said. “The rule bars any waiver of PAGA claims, regardless of whether the waiver appears in an arbitration agreement or a non-arbitration agreement.”

Concepcion supports the interpretation that a state law rule may survive FAA preemption if it applies both to arbitration and non-arbitration contracts, the court said.

But the court in Concepcion said the FAA preempted a state law ban on class action waivers because Congress didn't intend “to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA's objectives,” the appeals court said.

“Following the logic of Concepcion, we conclude that the Iskanian rule is a ‘generally applicable' contract defense that may be preserved by § 2's saving clause, provided it does not conflict with the FAA's purposes,” the court said.

No Conflict With Federal Law 

Unlike the class arbitration waiver ban involved in Concepcion, enforcing the Iskanian rule that prohibits waiver of PAGA claims won't conflict with the FAA's purposes, the court decided.

The Supreme Court has identified the FAA's principal purpose as ensuring that private arbitration agreements are enforced according to their terms and as stating a “liberal federal policy” favoring arbitration, notwithstanding state substantive or procedural rules to the contrary, the Ninth Circuit observed.

Read broadly, those statements “would require strict enforcement of all terms contained in an arbitration agreement, including those that are unenforceable under generally applicable state law,” the court said. “Such a broad construction of the FAA's purposes is untenable, of course, because it would render § 2's saving clause wholly ‘ineffectual.' ”

Congress didn't intend in the FAA to preempt all generally applicable state contract defenses, only those that “interfere with arbitration,” the court said.

Compelling the arbitration of class claims interferes with arbitration if the parties had contemplated only individual arbitrations, the court said. Class arbitration would require a more procedurally complex process, with arbitrators forced to decide class certification issues, and that could erase the presumed advantages of arbitration as a quick, relatively inexpensive dispute resolution mechanism, the court said.

For those reasons, the Concepcion court said the FAA preempts a state law rule that disallowed an arbitration provision barring class actions, the court said.

But a PAGA action differs substantially from a class action, as no due process rights of absent class members are implicated and it doesn't trigger the complex procedural mechanisms of a class claim, the court said.

“We do not read Concepcion to require the enforcement of all waivers of representative claims in arbitration agreements,” the court said.

“Instead, Concepcion requires us to examine whether the waived claims mandate procedures that interfere with arbitration, as the class claims in Concepcion did,” the court said. “Here, they do not.”

“In sum, the Iskanian rule does not conflict with the FAA, because it leaves parties free to adopt the kinds of informal procedures normally available in arbitration,” the court said. “It only prohibits them from opting out of the central features of the PAGA's private enforcement scheme—the right to act as a private attorney general to recover the full measure of penalties the state could recover.”

The conclusion the FAA doesn't preempt the Iskanian rule is “bolstered by the PAGA's central role in enforcing California's labor laws,” the court said.

States' historic police powers aren't preempted by federal law, unless that is Congress's “clear and manifest purpose,” the court said. Both the PAGA statute and Iskanian reflect California's judgment about the best way to enforce its labor laws, the court said.

Qui Tam Actions Predate Arbitration Act 

PAGA enforcement actions by employees resemble “qui tam” actions in which an individual litigates on the government's behalf, the court said. Qui tam actions “predate the [Federal Arbitration Act] by several centuries,” the Ninth Circuit said.

“The FAA was not intended to preclude states from authorizing qui tam actions to enforce state law,” the court said. “Nor, we think, was it intended to require courts to enforce agreements that severely limit the right to recover penalties for violations that did not directly harm the party bringing the action.”

“That qui tam actions can be difficult to arbitrate does not mean that the FAA requires courts to enforce private agreements opting out of the state's chosen method of enforcing its labor laws,” the court said.

Judge Joan H. Lefkow joined in the decision.

Dissent Would Find Preemption 

Meanwhile, the dissent would hold Concepcion applies to PAGA claim waivers to the same extent as class action waivers. The Federal Arbitration Act preempts a state ban on PAGA waivers contained in arbitration agreements, the dissent said.

“Because the majority should have applied Concepcion and deferred to the FAA's ‘liberal federal policy favoring arbitration,' rather than circumventing it, I must dissent,” Judge N. Randy Smith wrote.

Although the majority emphasizes differences between class actions and PAGA claims, those asserted differences “do not change the fact that a rule prohibiting the waiver of either type of action in an arbitration agreement” interferes with the parties' freedom to limit arbitration “only to those claims arising between the consenting parties,” the dissent said.

Applying Concepcion, a state rule banning waivers of PAGA claims interferes with the FAA's objectives just as much as a state law ban on class action waivers, Smith wrote.

“By requiring the arbitration of representative PAGA claims in arbitration (i.e., claims not specific to the contracting parties), the Iskanian rule interferes with the fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA,” the dissent said.

In addition to Nordrehaug, Sakkab was represented by Norman B. Blumenthal and Aparajit Bhowmik of Blumenthal Nordrehaug & Bhowmik in La Jolla, Calif. Keith A. Jacoby, Scott M. Lindman and Judy M. Iriye of Littler Mendelson in Los Angeles represented Luxottica.

To contact the reporter on this story: Kevin McGowan in Washington at kmcgowan@bna.com

To contact the editor responsible for this story: Susan J. McGolrick at smcgolrick@bna.com

Text of the opinion is available at http://www.bloomberglaw.com/public/document/SHUKRI_SAKKAB_an_individual_on_behalf_of_himself_and_on_behalf_of.