To the frustration of unwary California employers, California Code of Civil Procedure §§ 1281.97 and 1281.98 mandate that if the employer in an arbitration agreement fails to pay its portion of the required arbitration fees or costs within 30 days after they are due, the employer is in material breach of the arbitration agreement and faces a waiver of arbitration.
On May 22, 2024, a California Court of Appeals for the Second Appellate District weighed in on the California Arbitration Act (“CAA”) and section 1281.97, along with the larger battle regarding the enforcement of arbitration agreements in California. In Hernandez v. Sohnen Enterprises, Inc. (May 22, 2024, No. B323303) [2024 Cal. App. LEXIS 330] a Court of Appeals, for the first time, held that the Federal Arbitration Act (“FAA”) preempts section 1281.97 concerning the forfeiture of arbitration rights for failure to pay arbitration fees timely. While not rending section 1281.97, et al. moot, this decision creates a split in authority, and the question is now ripe for review by the California Supreme Court.
The Case
In 2016, Massiel Hernandez (“Hernandez”) entered an arbitration agreement with her employer, Sohnen Enterprises, Inc. (“Sohnen”). The agreement expressly stated that the FAA governed it. In 2021, Hernandez filed a civil action against Sohnen, alleging Fair Employment and Housing Act and Labor Code-related violations. The parties agreed to stay the civil action and proceed with arbitration, and Hernandez submitted her claims to JAMS. On May 13, 2022, Sohnen paid the initial JAMS arbitration fees, although five days late. Hernandez capitalized on this error and moved the Superior Court to withdraw from arbitration and vacate the stay. Hernandez argued that under Code Civ. Proc. § 1281.97, Sohnen breached the arbitration agreement and waived its right to arbitrate by missing the payment deadline. Sohnen did not dispute the untimely fee submission but countered that the FAA and the Fed. Rules Civ. Proc. applied, thus preempting the CAA (i.e., the Code Civ. Proc. § 1281.97, et al.) The Superior Court held that since Sohnen had paid the required arbitration fees late, it breached the arbitration agreement, the FAA did not preempt section 1281.97, and Hernandez was not required to arbitrate her claims. Sohnen appealed.
The Appellate Court’s Analysis
In its May 24, 2024, decision, the Hernandez Court thoroughly explored California common law regarding breach of arbitration agreements, the CAA (focusing on Civ. Code § 1281.97 and § 1281.98), along with the FAA. Initially, the Court noted that the parties explicitly agreed the FAA governed their agreement; thus, the CAA did not apply:
The parties selected the procedural provisions of the FAA and the Federal Rules of Civil Procedure, and therefore, the procedures of the CAA, including section 1281.97, do not apply. The order based on section 1281.97 must be reversed.
However, the Court went further and held that even if the parties had not designated the FAA as governing their agreement, section 1281.97 would still not apply. The Court clarified that when parties have not explicitly elected the CAA or California law, and the agreement falls within the scope of the FAA, the FAA preempts the CAA, including section 1281.97. The Court reasoned that the FAA and its “equal treatment” doctrine mandates that arbitration agreements cannot be singled out from other contacts and can only be invalidated by California Courts under generally accepted contract defenses such as fraud or unconscionability. As such, section 1281.97 conflicts with and obstructs the purpose of the FAA. CAA provisions, like section 1281.97, which discriminate on their face against arbitration or discourage the formation and enforcement of arbitration agreements, are preempted by the FAA. Conversely, the Court pointed out that state laws regulating arbitration agreements without conflicting with the FAA are not preempted.
Takeaway for Employers and Counsel
While the Hernandez decision provides employers with a welcomed avenue to combat an inadvertent failure to timely pay arbitration fees and waiver, the best practice is to avoid the fight in the first place. The Hernandez Court underscores the need for employers and counsel to expressly designate the FAA as the governing law in arbitration agreements. Equally important, employers must be diligent about meeting each arbitration payment deadline.
