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5 lessons in drafting and implementing an enforceable mandatory arbitration agreement in the US

Written by
FordHarrison LLP, nationwide U.S. law firm with a singular focus on HR law.
A recent California Supreme Court decision offers some guidance on how to draft and implement a mandatory arbitration agreement to improve the chances of it being enforceable. 

Recently, the California Supreme Court held that a mandatory arbitration agreement was invalid in OTO, LLC v. Kho (29 August 2019), finding the agreement was both procedurally and substantively ‘unconscionable’ (that is, unjust or very one-sided).

The case involved arbitration of a former employee’s wage claims. Under California law, employees have access to an inexpensive administrative process to pursue wage disputes. The Court previously had ruled that an arbitration agreement is not categorically unconscionable solely because it requires a waiver of that administrative process. An agreement to arbitrate wage claims can be enforceable so long as it provides an accessible and affordable process for resolving those disputes.

The salient facts for purposes of this article are that Kho was a service technician for a Toyota dealership. Three years after his employment started, Kho was approached by a low-level employee who asked him to sign several documents, including an arbitration agreement. He was required to sign them immediately while the employee waited for them. According to the Court, Kho had no opportunity to read them nor were their contents explained to him. He was not provided a copy. The Court noted that Kho’s first language is Chinese; however, it is unclear what his level of English proficiency is. The Court stated that the arbitration clause was contained in a dense, single-spaced paragraph filling almost an entire page in very small typeface. The allocation of arbitration costs was not explicitly addressed. The agreement did not explain how to initiate arbitration.

The Court stated that generally applicable contract defences (that is, defences that can be argued against a breach of contract action) such as unconscionability (unfairness) can be applied to invalidate arbitration agreements. Procedural unconscionability relates to the circumstances of contract negotiation and formation. Substantive unconscionability addresses the fairness of an agreement’s actual terms. Both procedural and substantive unconscionability must be established to invalidate an arbitration agreement. The burden of proving unconscionability rests on the party who is claiming it.

The Court found that the arbitration agreement’s execution involved a high degree of procedural unconscionability. The Court stated that ‘the agreement appears to have been drafted with an aim to thwart, rather than promote, understanding.’ The Court then stated that, given the high level of procedural unconscionability, even a low degree of substantive unconscionability could render the agreement unenforceable.

The Court concluded the agreement was not enforceable stating:

‘Had One Toyota set out the terms of its agreement in a legible format and fairly understandable language, or had it given Kho a reasonable opportunity to seek clarification or advice, this would be a different case.’

Although the test of unconscionability varies from state to state, lessons can be drawn from this case about how to draft and implement an arbitration agreement:

  • The agreement should be drafted in simple, understandable English, plus other languages as needed.
  • Employees should be given a period of time to read the agreement and an opportunity to ask questions before signing.
  • Employees should be provided a copy of the agreement.
  • Make the process clear, including but not limited to, the allocation of arbitration costs and how to initiate the arbitration process.
  • The agreement should be a legible, stand-alone document, double-spaced, and prominently advise employees of waivers of their rights.


Employers’ Bottom Line

A number of courts are hostile to mandatory arbitration agreements in the employment context. Unconscionabilty can be a ground for ruling an arbitration agreement to be unenforceable. Employers should draft and implement these agreements in a manner to maximise enforceability. This California case provides a roadmap of some of the things to avoid in order to improve the likelihood of an arbitration agreement being enforceable.

Frederick (Rick) L. Warren
FordHarrison LLP