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Arbitration pact unconscionable; “independent contractors” can pursue overtime suit based on misclassification

By Lisa Milam-Perez, J.D.

Several provisions of an arbitration agreement contained within a “provider services” contract were substantively unconscionable under California law, the Washington Supreme Court held, refusing to compel mental health professionals to arbitrate claims that they were improperly denied overtime pay because they were wrongly classified as independent contractors (Brown v MHN Government Services, Inc, August 15, 2013, Johnson, J.M). The agreement was procedurally unconscionable as well, the high court found, because the contract failed to identify which AAA arbitration rules — commercial or employment — would apply. Permeated with unconscionability, the agreement could not be salvaged by stripping the tainted provisions, notwithstanding its savings clause.

Two mental health care providers accepted short-term positions with the defendant to provide counseling for military personnel and their families. Alleging they were unlawfully misclassified as independent contractors and, as a result, were not paid the proper overtime rate, they filed a putative class action suit under the Washington Minimum Wage Act (WMWA). The employer moved to compel arbitration pursuant to their provider services contract, which contained a mandatory arbitration provision. (The contract also included a California choice of law provision, which the high court honored after finding that state’s unconscionability law did not violate Washington public policy.)

Concepcion narrowly construed. The parties first disputed whether AT&T Mobility LLC v Concepcion applied to the general contract defense of unconscionability under state law. In Concepcion, the U.S. Supreme Court held the Federal Arbitration Act preempted California’s judicial rule concerning the unconscionability of class action arbitration waivers in consumer contracts. There, the Court held that arbitration agreements can be invalidated by “generally applicable contract defenses, such as fraud, duress, or unconscionability,” but not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue. Adopting a narrow reading of Concepcion, the Washington Supreme Court declined to construe the opinion as limiting the power of state courts to refuse to enforce agreements under generally applicable unconscionability principles. Thus, the court turned to the contested arbitration provisions, applying California law on unconscionability.

Which AAA rules apply? The court found no “procedural oppression,” observing that the arbitration clause was in the same typeface, font, and size as the rest of the contract, and had a bold, underlined heading labeled “mandatory arbitration.” The plaintiffs, both sophisticated, highly educated individuals, had ample time to read and consider the agreement before signing. However, the contract nonetheless presented “procedural surprise,” and thus was procedurally unconscionable, because of the ambiguity over which American Arbitration Association rules — the AAA’s employment rules or commercial rules — would apply, particularly in light of the plaintiffs’ claim that they were employees, not independent contractors. The employer changed its position several times as to which set of rules was appropriate: responding to the plaintiffs’ motion to quash arbitration, the employer cited the AAA’s employment rules; in its appellate brief, the defendant argued it was “evident” that the commercial rules should apply. Noting that the California Supreme Court has granted review in two cases that found arbitration agreements unconscionable in part because they did not attach copies of the applicable AAA rules, the court reasoned that its finding that the agreement here was procedurally unconscionable under California law was well supported.

Forum selection provision OK. The arbitration agreement stated that arbitration would be conducted in San Francisco. The plaintiffs argued this provision was substantively unconscionable because a party wishing to arbitrate a claim against the employer would have to obtain local counsel and travel to California at great personal expense. Individuals signing the agreement would be less likely than the employer to have the resources to do so, they asserted, so the provision was unfairly one-sided. But the plaintiffs did not allege any facts as to their own personal circumstances that would show how arbitrating in California would cause them hardship. Thus, the forum selection clause withstood their challenge.

Punitive damages bar passes muster. The plaintiffs also contended a provision limiting punitive damages deprived them of their right to statutory double damages under the WMWA from an employer that willingly and intentionally paid them less than is required by law. The state supreme court found the limit on punitive damages was not substantively unconscionable because Washington law was unclear as to where the WMWA’s damages provision fell on “the spectrum between purely remedial and purely punitive.” Thus, following the U.S. Supreme Court’s lead in PacifiCare Health Systems, Inc v Book, the state high court said it would be premature to determine at this stage whether the punitive damages provision would limit the plaintiffs’ ability to otherwise collect statutory double damages.

However, four justices would have found the punitive damages limit unconscionable as well, finding a plain conflict with the statutory right to such damages. In a separate concurrence, Justice Gonzalez wrote that Washington law was not unclear as to the punitive nature of these double damages. The statute specifically provides that an employer that wrongfully withholds wages “shall be liable in a civil action … for twice the amount of the wages unlawfully rebated or withheld by way of exemplary damages.” Under Washington law, “exemplary damages” is another term for “punitive damages,” Gonzalez argued. State appeals courts have used the terms “exemplary” and “punitive” damages interchangeably, even when interpreting the specific statute at issue. In fact, Black’s Law Dictionary defines punitive and exemplary damage as synonymous terms. “A competent arbitrator would no doubt so find” as well, the concurring justice reasoned.

Six-month limitations period unconscionable. The arbitration agreement required an aggrieved party to submit a written demand for arbitration within six months of a claim arising; failure to do so constitutes an absolute bar to the institution of any proceedings. California authority suggests that a six-month statute of limitations clause in an arbitration agreement is substantively unconscionable where the underlying statute provides a much longer period of time within which to bring a claim. Under the Washington Minimum Wage Act, parties have three years to bring a claim. As such, the clause limiting the claims period to six months was substantively unconscionable.

Arbitrator selection clause unfair. Similarly, the agreement’s arbitrator selection clause was substantively unconscionable on its face. Under the provision, the opposing party would choose one arbitrator from among an employer-provided list of three allegedly neutral arbitrators. According to the employer, because the AAA rules were incorporated by reference into the agreement, some hybrid procedure between what appeared in the agreement and what the AAA rules require would ultimately be used to select an arbitrator, and the employer was bound to select from a list provided by the AAA. But that was not the case, the high court found. Under both the commercial and employment rules, if the arbitration agreement provided its own method for arbitrator selection, that method is to be used and the AAA did not provide a list of neutral arbitrators. Finding this term both one-sided and overly harsh, the court rejected it.

Fee-shifting provision unconscionable. Finally, a mandatory fee-shifting provision that required the losing party to pay the costs of arbitration, including attorney’s fees, was substantively unconscionable because under the WMWA, attorney fees can be recovered only by a prevailing employee, not an employer. “The risk of having to pay the employer’s expenses and fees was a significant deterrent to employees contemplating initiating an action to vindicate their rights,” the court found.

Too tainted to salvage. Although the agreement contained a savings clause stating that once the faulty terms were stricken, the remaining provisions would have full force and effect, the trial court did not abuse its discretion in refusing to sever the problematic provisions and enforce the agreement. The arbitration agreement was permeated with unconscionability, the supreme court found, imposed by the defendant “to put itself at an advantage.” Notably, one of the agreement’s greatest defects — the confusion over which set of AAA rules governed — could not be cured by severance alone. Therefore, the state supreme court affirmed the lower court’s order granting the plaintiffs’ motion to quash the employer’s demand for arbitration.