Justices Take On Another California Rule – When An Arbitration Agreement Is Too Flawed To Enforce

The U.S. Supreme Court has agreed to review whether the Federal Arbitration Act (FAA) preempts a California state court rule on unconscionable provisions that is purportedly applied more stringently to arbitration agreements than to other contracts. Under the California rule, arbitration agreements with more than one unconscionable provision may not be enforced despite an express severability clause.

In MHN Government Services, Inc., et al. v. Zaborowski, et al., Case No. 14-1458 (cert. granted 10-1-15), the justices will consider the Ninth Circuit's 2-1 opinion that denied arbitration of Fair Labor Standards Act (FLSA) and state court claims brought by consultants who offer short-term financial, child services, and victim-advocacy counseling at U.S. military installations.

The consultants filed a putative class action in district court against MHN Government Services, Inc. (MHN), contending they were incorrectly classified as independent contractors rather than employees, which denied them overtime pay and other benefits. MHN subsequently moved to compel arbitration under the Provider Services Task Order Agreements the named consultants had signed, which included mandatory arbitration provisions as well as an express severability clause.

Based on California law, the district court concluded that multiple provisions in the arbitration agreement were unconscionable; for example, the arbitration provision was placed as "paragraph 20 of 23" in the agreement, had a six-month statute of limitations, allowed MHN to select the pool of arbitrators, prohibited punitive damages, and would force plaintiffs to pay a $2,600 filing fee.

The district court thus concluded that the contract contained multiple substantively unconscionable provisions which allowed it to find that the agreement was "permeated by an unlawful purpose." The court then held that the unconscionable provisions were not severable and denied MHN's motion to compel arbitration despite the severability provision.

At the Ninth Circuit

On December 17, 2014, a divided Ninth Circuit affirmed, finding that the district court correctly held "multiple aspects of the arbitration provision [were] substantively unconscionable." Zaborowski v. MHN Government Services, Inc., et al., No. 13-15671.

The appellate court agreed that five of the agreement's clauses were substantively unconscionable. They included: (1) the arbitrator selection clause which "[g]ranted MHN near-unfettered discretion to...