In a significant win for California employers, the Ninth Circuit Court of Appeals, in Chamber of Commerce v. Bonta,¹ affirmed a district court injunction striking down California Assembly Bill 51 (“AB 51”) as preempted by the Federal Arbitration Act (FAA), after nearly three years of legal challenges.  As a result, California employers may continue to implement mandatory employment arbitration agreements for employee claims for unpaid wages, discrimination, and numerous other causes of action under the Labor Code and the Fair Employment and Housing Act (FEHA).

Banning Mandatory Arbitration: California AB 51’s Purpose

Congress enacted the FAA to promote agreements to arbitrate and combat the longstanding “hostility towards arbitration.”² The FAA has been described repeatedly as “embodying a national policy favoring arbitration and a liberal federal policy favoring arbitration agreements.”³ The U.S. Supreme Court has routinely found the FAA preempts state laws which would otherwise prevent the enforcement of arbitration agreements.⁴  

Since 2015, the California legislature has engaged in a “prolonged effort to craft legislation that would prevent employers from requiring employees to enter into arbitration agreements as a condition of employment, avoiding conflict with the FAA.”⁵ Following a history of vetoes of similar measures, Governor Gavin Newsom signed AB 51 into law, with an effective date of January 1, 2020. AB 51 attempted to prohibit employers from requiring employees to waive, as a condition of employment, the right to litigate claims under the FEHA and the California Labor Code. An employer that violated AB 51 could have been subject to civil and criminal penalties and found to have committed a misdemeanor.  In an effort to avoid a conflict with the FAA, AB 51 stated if an employee did enter into a mandatory arbitration agreement, it would nevertheless be enforceable.⁶ The law created an “oddity” whereby an employer with a mandatory arbitration policy could be subject to criminal prosecution but could nevertheless enforce the agreement. 

AB 51 in Limbo: The Unconventional Procedural History of Chamber of Commerce v. Bonta

The U.S. Chamber of Commerce and several other business groups filed suit in the Eastern District of California seeking a temporary restraining order and a preliminary injunction, arguing the FAA preempted AB 51.  Two days before AB 51 took effect, the district court granted a temporary restraining order to prevent enforcement of the law. Ultimately, the district court found AB 51 violated the FAA by putting arbitration agreements on an unequal footing with other contracts, as it imposed a higher consent requirement and levied civil and criminal penalties against employers.

The State of California appealed, and the Ninth Circuit initially reversed – in part – the ruling. Judge Carlos Lucero wrote the original majority opinion, concluding the FAA does not preempt AB 51 to the extent the law seeks to regulate an employer’s conduct prior to executing an arbitration agreement. In a noteworthy dissent, Judge Sandra Ikuta likened the ruling to “holding that a statute can make it unlawful for a dealer to attempt to sell illegal drugs, but if the dealer succeeds in completing the drug transaction, the dealer cannot be prosecuted.”

The Chamber filed a petition for review before the full Ninth Circuit. In December 2021, the Ninth Circuit issued an order deferring any decision until the United States Supreme Court decided another case, Viking River Cruises v. Moriana, which involved another California limitation on arbitration agreements. In a surprising turn of events, following the release of Viking River Cruises opinion,⁷ the Ninth Circuit withdrew its original decision, in favor of a panel rehearing.  The fate of AB 51 had remained in the balance, leaving uncertain whether implementing mandatory arbitration agreements would lead to criminal prosecution.

Ninth Circuit Decides the Federal Arbitration Act Preempts AB 51

On February 15, 2023, the Ninth Circuit panel released its new opinion holding the FAA preempts AB 51. The panel ruled AB 51 created a burden to the formation of an arbitration agreement, and was preempted by the FAA, and therefore unenforceable.

The Ninth Circuit analyzed AB 51 under the principles of conflict preemption, which occurs when it is “impossible for a private party to comply with both state and federal requirements” or, where a state law “creates an unacceptable obstacle to the accomplishment and execution of the full purposes and objectives of Congress.” Noting the “equal treatment principal” as set forth by the U.S. Supreme Court requires courts to “place arbitration agreements on equal footing with all other contracts,” the Ninth Circuit found the FAA preempts a state law if it “interferes with the fundamental attributes of arbitration” or has a “disproportionate impact on arbitration.” Accordingly, if a state law either interferes with arbitration on its face or covertly, such a rule cannot stand in harmony with the purposes of the FAA. The Ninth Circuit ruled this principal applies to both formation and enforcement of arbitration agreements.

In its decision, the Ninth Circuit applied the rationale from prior Supreme Court cases⁸ where state laws were fashioned to make the formation of any arbitration agreement invalid and ultimately gave no purpose and meaning to the FAA. The Court found the FAA preempts a state rule that limits or prevents parties from entering into arbitration agreements in the first place. If AB 51 could criminalize the act of offering an employment arbitration agreement, it would defeat the purpose of the FAA and “eviscerate Congressional intent to place arbitration agreements upon the same footing as other contracts.”

The Ninth Circuit also recognized AB 51, while not expressly barring arbitration agreements, disfavored the formation of arbitration agreements and therefore imposed a “severe” burden on contract formation. The civil and criminal penalties create a deterrent effect on employers and inhibited their willingness to create an arbitration agreement with employees. AB 51 also “singles out arbitration provisions as an exception to generally applicable law,” noting employers can mandate employees to enter contracts for compensation and drug usage, but not arbitration agreements.  Further, the penalty-based scheme of AB 51 violated the “equal treatment principal” and was a device “evincing hostility toward arbitration.” In reaching its decision, the Ninth Circuit joined two sister circuits, the First and Fourth Circuits, which previously had rejected state laws regulating the formation of arbitration agreements, finding such laws treated arbitration agreements “more harshly than other contracts” and was thus preempted.

The Ninth Circuit rejected California’s argument AB 51 was intended to regulate “employer conduct,” not the formation of the arbitration agreement, and thus was not in conflict with the FAA.  California also argued AB 51 shielded employees from involuntary contracts “forced upon them by employers” and protected them from being “forced to sign arbitration agreements that are illegal.” The Ninth Circuit noted these arguments misunderstand the meaning of consent: “a contract may be ‘consensual’ as that term is used in contract law, even if one party accepts unfavorable terms due to some degree of unequal bargaining power.” A contract of adhesion is enforceable “unless certain other factors are present.”  Finally, the Ninth Circuit also refused to sever AB 51, finding “all provisions of AB 51 work together to burden the formation of arbitration agreements.” As AB 51 would still include a civil penalty if severed, it still impedes the ability of employers to enter into arbitration agreements and “flouts the FAA’s command to place those agreements on an equal footing with all other contracts.”

Takeaways from the Decision

While Bonta could be subject to further appeals, California employers may continue to implement mandatory arbitration agreements and are not restricted by AB 51. The decision is important because the Ninth Circuit joined the First and Fourth Circuits in placing obstructions to arbitration agreement formation on the same footing as scrutiny to enforcement of arbitration provisions.

The key takeaways are as follows:

• State statutes or judge-made rules creating obstacles to formation of arbitration agreements are contrary to and likely preempted by the FAA.
• Arbitration agreements are on an equal footing as other contracts and will be analyzed in the Ninth Circuit in accordance with FAA principles of “equal protection treatment.”
• California employers may continue to implement mandatory arbitration agreements for employees and new hires, absent any additional appeals, and should consult with their attorneys on the implementation process.
• Employers should review existing employee arbitration agreements in light of this decision.