Third Circuit Rules Arbitration Clause Unconscionable, Unenforceable

On June 15, 2010, the Third Circuit Court of Appeals issued a significant opinion in which it ruled that an arbitration provision in an employment contract was so unconscionably one-sided against the employee that it would not require the employee to litigate his claim before an arbitrator rather than a court. Instead of severing the unconscionable provisions and enforcing the rest, the court invalidated the entire provision. The court also ruled that by litigating the case for more than a year before moving to compel arbitration, the employer had waived its right to arbitrate and would be compelled to try the case in court.

In Nino v. Jewelry Exchange, Inc., the Plaintiff, Rajae Nino (“Nino”), worked for the Jewelry Exchange (doing business as Diamonds International) (“DI”). Nino’s employment contract with DI stated that arbitration was the “sole, final, binding and exclusive remedy for any and all employment related disputes.” It also laid out a very specific time frame in which employees must invoke their rights to arbitration or lose the right to pursue their claims. The same was not true of DI – if DI missed any of its deadlines, then “the last decision given by [DI] shall be a final and binding resolution of the grievance.”

Another key provision was that if the process proceeded to arbitration, DI had to submit a request to the American Arbitration Association for a panel of four arbitrators. DI was then allowed to strike one member from the list, followed by the employee striking a member, followed by DI striking a third member. The remaining candidate would hear the arbitration. Thus, in each instance, DI was allowed to strike two arbitrators while the employee could strike just one.

The arbitration agreement also required that each side bear its own attorneys’ fees, costs and expenses.

After working for DI for about six years at multiple locations, Nino sued DI, alleging discrimination on the basis of gender and national origin. In its Answer, DI alleged that Nino was “contractually barred to any remedy other than one achieved by arbitration.” Nevertheless, DI continued to litigate the case for the next 15 months without further mention of the arbitration provision.

After 15 months, DI sought to dismiss the suit based upon the arbitration clause. The federal trial court granted DI’s motion. The court held that, although some portions of the arbitration agreement were unconscionable, those provisions could be severed, and the remainder of the agreement could be salvaged. The court also held that although DI had waited 15 months to file its motion, it had not waived the right to arbitrate, because (1) it had notified Nino of the issue in its affirmative defenses, and (2) DI had not made any substantive motions prior to its motion to dismiss.

The Third Circuit reversed. Addressing the arbitration agreement, the court held that it was both procedurally and substantively unconscionable. The agreement was procedurally unconscionable because it was a take-it-or-leave-it contract presented by a party (the employer) with significant leverage. As for substantive unconscionability, the court focused on the agreement’s requirements identified above, each of which was skewed heavily in favor of DI. The fact that an employee had only five days to bring a grievance was significantly shorter than any time period the court had previously permitted. The time limits for the grievance process caused the employee to waive his rights by missing them, while DI could simply revert to its last response – another provision weighing heavily in DI’s favor. The arbitrator selection process allowed DI to strike two arbitrators while the employee could strike only one – which the Third Circuit held “confers an advantage upon DI for no discernable purpose other than to stack the deck in its favor.” Regarding the payment of fees, the court held that requiring the parties to bear their own fees and costs was unconscionable because it undermines the legislative intent behind statutes, like Title VII, that allow fee shifting. Arbitrators should be allowed to award fees and costs when the statutes so permit.

Having ruled the arbitration agreement unconscionable, the court then determined that “the one-sided nature of the arbitration agreement reveals unmistakably that DI ‘was not seeking a bona fide mechanism for dispute resolution, but rather sought to impose a scheme that it knew or should have known would provide it with an impermissible advantage.’” The court ruled that such a one-sided agreement “forecloses any possibility of severing the unfair provisions from the remainder of the agreement,” and declined to enforce the agreement at all.

Turning to the issue of waiver, the Third Circuit ruled that the lower court had erred in ruling that DI had not waived its right to arbitrate. Applying prior precedent on waivers, the Court found that the 15-month delay in attempting to enforce the defense outweighed the factors on which the court below had relied. Consequently, the Court held that DI had waived its right to arbitrate, and remanded the case to the lower court for further proceedings.

What the Nino Decision Means for You

The Third Circuit’s opinion in Nino provides compelling cautions for employers that include arbitration provisions in their employment agreements. An employer must be wary when drafting these provisions to be sure that the agreement is relatively even-handed in its approach. Where an agreement is unjustifiably one-sided, a court will be prone to completely disregard the agreement rather than severing the onerous portions while enforcing the rest. Employees should be given ample time (more than 30 days) in which to file a grievance. Each side should be given identical rights in the selection of arbitrators and the agreement should not limit the arbitrator’s right to award attorneys’ fees.

In terms of implementing and enforcing the arbitration agreement, it is crucial that employers keep the possibility of waiver in mind when a case is proceeding to litigation. Employers should invoke the arbitration provisions early in the case, before significant discovery has occurred and before the parties have expended resources on litigation. An employer must therefore decide at the outset of the litigation process whether it intends to enforce an arbitration provision, and act promptly to do so. Unwarranted delays are likely to be held against an employer that decides too late that it prefers arbitration as the method of resolution.

For More Information

For more information, contact Paul R. Lewis at 610.205.6047 or the Stevens & Lee attorney with whom you regularly speak.

This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.