Armendariz v. Foundation Health Psychcare Services, Inc.

Facts

Marybeth Armendariz and Dolores Olson worked for Foundation Health Psychcare Services. (24 Cal.4th at pp. 91–92.) As a condition of employment, each signed an application and employment agreement containing an arbitration clause. (Ibid.) The clause was one-sided: it required arbitration of “wrongful termination” claims brought by employees, but did not bind the employer to arbitrate its own claims. (Id. at pp. 91–92, 115–117.) It also limited an employee’s recoverable damages to lost backpay, excluding other relief available under the FEHA. (Ibid.) After about a year, both women were terminated; they alleged they were fired “because of” their perceived sexual orientation, in violation of the FEHA. (Id. at p. 92.) They sued, and Foundation Health moved to compel arbitration. (Ibid.)

Procedural history

The trial court denied the motion to compel, finding the arbitration agreement unconscionable. (24 Cal.4th at pp. 92–93.) The Court of Appeal reversed in part, severing the unlawful damages limitation and ordering arbitration. (Ibid.) The Supreme Court granted review and affirmed the denial of arbitration in its entirety, holding the agreement unenforceable. (Id. at pp. 92–93, 122–127.)

Issue

May an employer compel arbitration of an employee’s unwaivable FEHA claims; what conditions must such an arbitration agreement satisfy to be enforceable; is a one-sided, damages-limiting agreement unconscionable; and, if so, should the offending provisions be severed or the entire agreement be unenforceable? (24 Cal.4th at pp. 90–91.)

Holding

Reasoning

1. Unwaivable statutory rights survive arbitration — if the forum is adequate. The Court reaffirmed that “a party does not forgo the substantive rights afforded by the statute” by agreeing to arbitrate; arbitration substitutes a forum, not the law. (24 Cal.4th at pp. 98–101.) To ensure an employee “effectively may vindicate his or her statutory cause of action in the arbitral forum,” the Court derived the five minimum requirements from the FEHA’s public-policy purposes and the federal arbitration case law. (Id. at pp. 101–113.) The Court situated its analysis within the Federal Arbitration Act, noting that although the FAA “incorporates a strong federal policy of enforcing arbitration agreements,” section 2’s saving clause permits “generally applicable contract defenses, such as fraud, duress, or unconscionability,” to “be applied to invalidate arbitration agreements.” (Id. at pp. 97–98, 113–114.) The minimum requirements, the Court reasoned, flow not from hostility to arbitration but from the principle that an employee compelled to arbitrate an unwaivable right must be able to vindicate it as fully as in court. (Id. at pp. 100–103.)

2. The damages limitation was unlawful. The clause capping recovery at backpay was independently invalid because it stripped employees of remedies the FEHA guarantees — including other compensatory and punitive damages and injunctive relief. (24 Cal.4th at pp. 103–104.) An arbitration agreement may not curtail the substantive relief available for an unwaivable statutory claim. (Ibid.) Relatedly, the fifth requirement bars the imposition of arbitration-specific costs on employees: the agreement may not “require the employee to bear any type of expense that the employee would not be required to bear if he or she were free to bring the action in court.” (24 Cal.4th at pp. 110–111.) Because an employee compelled into arbitration could otherwise face “substantial forum costs” — arbitrator fees and administrative charges with no analog in court — the Court placed those arbitration-unique forum costs on the employer as a condition of enforceability. (Id. at pp. 107–113.)

3. Unconscionability requires both prongs, on a sliding scale. The Court restated the doctrine: unconscionability “has both a procedural and a substantive element, the former focusing on oppression or surprise due to unequal bargaining power, the latter on overly harsh or one-sided results.” (24 Cal.4th at pp. 113–114.) “[B]oth . . . must be present,” but they operate on a sliding scale: “the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required.” (Id. at p. 114.) Procedurally, the agreement was a “contract of adhesion” — “a standardized contract . . . imposed and drafted by the party of superior bargaining strength” on a take-it-or-leave-it basis. (Id. at pp. 113–115.)

4. The “modicum of bilaterality.” Substantively, the agreement was unconscionable because it lacked mutuality. An arbitration agreement imposed by an employer “must contain at least a modicum of bilaterality,” and this one bound only the employee to arbitrate. (24 Cal.4th at pp. 117–120.) The “one-sidedness . . . was compounded by the fact that the agreement did not permit full recovery of damages for the employee,” limiting her “to lost backpay without allowing for other . . . damages.” (Id. at pp. 120–121.) Absent “some reasonable justification for such one-sidedness based on ‘business realities,’” the lack of mutuality is substantively unconscionable. (Id. at pp. 117–120.)

5. Severance refused — the agreement was “permeated.” Finally, the Court addressed remedy. Under Civil Code section 1670.5, a court faced with an unconscionable agreement “may refuse to enforce the contract,” “may . . . sever . . . the unconscionable clause,” or “may . . . limit the application” of the clause. (24 Cal.4th at pp. 121–122.) But where “the central purpose of the contract is tainted with illegality” or the agreement is “permeated by . . . unconscionability,” severance is inappropriate. (Id. at pp. 122–124.) Here there were “more than one unlawful provision” — the unilateral arbitration obligation and the unlawful damages limitation — indicating “a systematic effort to impose arbitration . . . as an inferior forum,” which “permeated” the agreement and could not be cured by striking a single clause. (Id. at pp. 124–125.) The Court therefore voided the arbitration agreement entirely. (Id. at pp. 124–127.)

6. The concurrence. Justice Brown, joined by Justice Chin, concurred. She agreed the agreement was unenforceable but wrote separately to express reservations about aspects of the majority’s unconscionability analysis and its derivation of the minimum requirements. (24 Cal.4th at pp. 127 et seq. (conc. opn. of Brown, J.).)

Significance

Armendariz is the cornerstone of California employment-arbitration law. Its “five minimum requirements” (the “Armendariz factors”) govern the enforceability of mandatory arbitration of unwaivable statutory claims, and its unconscionability framework — procedural plus substantive on a sliding scale, with the “modicum of bilaterality” requirement — is applied in virtually every motion to compel arbitration in California. Much of Armendariz survived the Federal Arbitration Act preemption wave that began with AT&T Mobility LLC v. Concepcion (2011) 563 U.S. 333, because its rules derive from generally applicable unconscionability principles rather than a hostility to arbitration — though later cases (e.g., OTO, L.L.C. v. Kho (2019) 8 Cal.5th 111) continue to refine the line. Its companion holding, that class-waiver or representative-claim restrictions and one-sided terms are scrutinized for unconscionability, framed the Discover Bank/Gentry/Iskanian line. Armendariz remains the first authority any California practitioner consults on arbitration enforceability. See the Review’s coverage of the arbitration line.

Key quotes

An arbitration agreement is lawful if it “(1) provides for neutral arbitrators, (2) provides for more than minimal discovery, (3) requires a written award, (4) provides for all of the types of relief that would otherwise be available in court, and (5) does not require employees to pay either unreasonable costs or any arbitrators’ fees or expenses as a condition of access to the arbitration forum.” (Armendariz, supra, 24 Cal.4th at p. 102.)

Unconscionability “has both a procedural and a substantive element . . . [;] the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required.” (Id. at p. 114.)

An employer-imposed arbitration agreement “must contain at least a modicum of bilaterality.” (Id. at p. 117.)

Read the full opinion (California Supreme Court — full text) →

Practice pointer

Open questions

The continuing tension between Armendariz and FAA preemption — how far generally applicable unconscionability principles may police arbitration terms after Concepcion, Epic Systems Corp. v. Lewis (2018) 584 U.S. 497, and Viking River Cruises, Inc. v. Moriana (2022) 596 U.S. 639 — remains the central battleground. Courts also continue to litigate when an agreement is “permeated” such that severance is unavailable, and how the “modicum of bilaterality” requirement survives federal scrutiny.