August 20, 2001

Alternative Dispute Resolution

The United States Supreme Court and other courts across the country appear to becoming more favorably inclined toward enforcing mandatory arbitration agreements. In addition to evaluating mandatory arbitration provisions, many employers also are considering other forms of alternative dispute resolution (“ADR”), such as formalized employee grievance procedures, open door policies, and the like.

To assist your analysis in determining whether your Company should adopt a binding arbitration process or some other form of ADR, we are providing a review of the current state of the law governing arbitration agreements. SUPREME COURT APPROVES MANDATORY PRE-DISPUTE ARBITRATION On March 21, 2001, in Circuit City v. Adams, the U.S. Supreme Court made it easier for employers to require non-union employees to arbitrate employment disputes instead of filing lawsuits in court. The decision gives broad protections to arbitration agreements under the Federal Arbitration Act.

1. The Federal Arbitration Act

Congress passed the Federal Arbitration Act (“FAA”) in 1925 in response to judicial hostility towards arbitration. Section 1 of the FAA clearly states the courts must enforce private agreements to arbitrate.

[a] written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.

The FAA also contains an exception to the enforcement of arbitration agreements:

[N]othing herein contained shall apply to contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce.

2. The Law Prior to Circuit City

In the 1980s, the U.S. Supreme Court decided a series of cases under the FAA, holding that parties could agree in advance to arbitrate disputes even before they arose. The Court made clear that by agreeing to arbitrate, a party does not forego a legal right, but rather picks a different forum-arbitration instead of court. None of these cases, however, addresses whether the exception to arbitration clause in the FAA applied to all workers or just those involved in the interstate transportation industry.

In 1991, the Supreme Court decided Gilmer v. Interstate/Johnson Lane Corp. In Gilmer, the Supreme Court held that an arbitration agreement contained in a New York Stock Exchange registration statement was enforceable under the FAA. The Supreme Court, however, avoided the issue of whether the FAA applied to all workers. The Court did not have to decide that issue because the contract in Gilmer was between a stock exchange and Mr. Gilmer; it was not an agreement between an employer and employee. The Supreme Court’s decision in Circuit City put that issue to rest.

3. The Issues In Circuit City

St. Clair Adams worked as a sales counselor at a Circuit City store in Santa Rosa, California. When he was hired, Circuit City required Adams to sign an employment application that contained the following provision:

I agree that I will settle any and all previously unasserted claims, disputes or controversies arising out of or relating to my application or candidacy for employment and/or cessation of employment with Circuit City exclusively by final and binding arbitration before a neutral Arbitrator. . . . Two years after he was hired, Adams filed a civil complaint in California state court against Circuit City, alleging claims for discrimination under the California Fair Employment and Housing Act and various state tort claims. The Ninth Circuit Court of Appeals held that the dispute was not arbitrable under the FAA because Adams worked in interstate commerce.

The Supreme Court reversed the Ninth Circuit and decided the FAA requires courts to enforce arbitration agreements in all employment contracts, except for employees working in interstate transportation, such as seamen and railroad workers. Adams was not involved in interstate transportation. The FAA therefore applied and the arbitration agreement he entered into was enforceable under the FAA.


Circuit City continues a trend by the Supreme Court–to provide employers with incentives to implement proactive preventive human resource strategies. In 1998, the Supreme Court decided Faragher v. City of Boca Raton and Burlington Industries v. Ellerth. These cases reward employers with comprehensive policies and procedures to prevent and respond to sexual harassment. In brief, an employer with a meaningful complaint resolution procedure may avoid liability for sexual harassment if the employee unreasonably failed to utilize that procedure.

Then, in 1999, the Court decided Kolstad v. American Dental Association. In Kolstad, the Court established a defense to punitive damages in federal discrimination claims. This powerful defense to punitive damages liability is available to employers that make good faith efforts to comply with civil rights laws such as Title VII of the Civil Rights Act of 1964. These efforts include preventive strategies such as a comprehensive, anti-discrimination policy.

As mentioned, the Circuit City case continues this trend. After Circuit City, employers will find it easier to use well-drafted arbitration agreements to avoid complicated, expensive litigation in court and the uncertainty of jury trials in favor of a more streamlined and informal method of dispute resolution. Thus, the Supreme Court’s recent decisions enable employers investing in preventive measures to significantly reduce their exposure to the costs and uncertainties of employment discrimination litigation.


The Circuit City decision will enhance the enforceability of mandatory arbitration agreements between employers and their employees. Among other things, the FAA

  • imposes a strong presumption in favor of arbitrability;
  • provides for streamlined enforcement of agreements and confirmation of awards;
  • authorizes courts to stay lawsuits when an issue in the case is subject to arbitration; and
  • preempts state laws aimed at limiting or restricting arbitration agreements.
  • This last factor perhaps is the most important one for multi-state employers that desire to implement uniform arbitration agreements. For example, in a 1996 decision, Doctor’s Associates v. Casarotto, the Supreme Court held the FAA preempted a Montana law requiring contracts to include any arbitration clauses on the first page of the agreement and in underlined capital letters.


    The Circuit City decision did not resolve all of the outstanding legal issues relating to the enforceability of mandatory, pre-dispute arbitration agreements. A brief discussion of some of the remaining questions follows.

    1. Open questions under federal law regarding mandatory arbitration of discrimination claims

    a. The Civil Rights Act of 1991

    At least until the Ninth Circuit Court of Appeals has the opportunity to consider the Supreme Court’s decision in a later case, discrimination claims brought under Title VII still may be exempt from arbitration in California and other states covered by the Ninth Circuit. In 1998, in Duffield v. Robertson Stephens Co., the Ninth Circuit held that under the Civil Rights Act of 1991 pre-dispute arbitration agreements are unlawful. To date, the Ninth Circuit is the only appellate court to adopt this view. One federal district court in California already has decided that Circuit City indirectly overruled Duffield. The EEOC, however, continues to take the position that mandatory, pre-dispute agreements to arbitrate discrimination claims are unlawful under Title VII, the ADA and the ADEA. Over the course of the next year or so, it is likely the courts will more definitively decide whether Duffield and the EEOC’s position remain valid after Circuit City.

    b. The Older Workers’ Benefits Protection Act

    The Older Workers’ Benefits Protection Act imposes a number of requirements on waivers of substantive rights under the Age Discrimination in Employment Act. Courts have not fully resolved whether a pre-dispute mandatory arbitration clause is subject to this law.

    c. The National Labor Relations Act

    Courts also remain divided over whether a union contract can require arbitration of statutory claims, such as for employment discrimination. In the Alexander v. Gardner-Denver case, the Supreme Court held that a general arbitration clause could not be used to compel arbitration of statutory discrimination claims. In a more recent decision, Wright v. Universal Maritime Services Corp., the Supreme Court held a collective bargaining agreement requirement to arbitrate statutory rights must be “clear and unmistakable” to be enforceable. The language at issue failed to meet this standard. Finding no waiver had actually occurred, the Court declined to resolve the more fundamental question of whether a clear and unmistakable union-negotiated waiver can be enforceable.

    2. Open questions under state law regarding mandatory arbitration of discrimination claims

    The Supreme Court held in Circuit City that even though pre-dispute mandatory arbitration agreements will be enforced under the FAA, employers still must draft contracts for arbitration which comply with and are subject to state contract law requirements. Therefore, even after Circuit City, multi-state employers wishing to adopt a uniform arbitration agreement still must take into consideration individual states’ laws applicable to any contract.

    a. Offer, Acceptance, and Consideration

    State law determines the validity of a contract. Enforceable contracts require a valid offer, acceptance, and “consideration.” Consideration means some sort of value conferred in exchange for the contractual provision. Consideration may involve payment of money, but it also can involve a promise to do something or to give up the right to do something.>

    States are free to apply their own legal standards to these elements. The most variable issue among the states is what constitutes sufficient consideration. For new hires, the employer’s job offer at a given wage generally will be sufficient consideration for the employee’s promise to arbitrate any employment-related claim. State laws may vary considerably, however, regarding what consideration must be furnished to current employees in exchange for an arbitration agreement. For example, in some states, the employer’s permitting the employee to continue working in exchange for the employee’s agreement to arbitrate will be adequate consideration. In other states, however, the employer will have to provide a financial inducement to the employee in exchange for his or her promise to arbitrate. In these latter jurisdictions, the employer may wish to condition eligibility for a bonus or salary increase on the employee’s assent to the arbitration agreement.

    The employer alternatively may elect to pay the employee a financial incentive to sign the arbitration agreement. The amount of the incentive need not be large, but it must be sufficient under the particular state’s standards for valid consideration.

    b. Defenses

    The FAA expressly provides it does not preempt traditional contract defenses under state law, such as unconscionability, fraud, and duress. State courts’ interpretations of these defenses vary considerably from state to state.

    For example, in Armendariz v. Foundation Health Psychare, the California Supreme Court held that pre-dispute agreements to arbitrate statutory employment discrimination claims were “unconscionable” unless they complied with certain requirements, including the following:

    • the employer agrees to bear the costs of arbitration
    • the agreement must require both the employer and employee to arbitrate claims.
    • neutrality of the arbitrator
    • provisions for adequate discovery
    • written arbitrator’s decision permitting judicial review

    In April 2001, after the Circuit City decision, the Washington court of appeals decided the application of compulsory arbitration agreements to retaliatory discharge and overtime claims violate public policy. Other states’ courts may follow suit in an attempt to come within the FAA’s preservation of state law contract defenses. In addition, states may respond to Circuit City by legislating that certain statutes may not be resolved via arbitration.

    It remains to be seen whether the state court decisions such as Armendariz are attacked as “end runs” around FAA preemption. At present, employers seeking to enforce arbitration agreements should ensure they comply with state law. Multi-state employers desiring uniform agreements will have to draft them to comply with the most demanding standards.

    c. Blue Pencil

    In some states, courts have the power to strike or modify illegal provisions in contracts to make them enforceable. This is referred to as “blue penciling” the agreement. However, other states do not permit application of the blue pencil and a court will strike down the entire unlawful section of the contract without attempting to modify it.


    1. What Are the Benefits?

    Your Company should evaluate the pros and cons of requiring its employees to execute arbitration agreements. Advantages of arbitration include:

    • potentially quicker and more efficient dispute resolution;
    • arbitration generally is less costly than court litigation;
    • some argue awards by arbitrators are (or will be) lower than jury awards for comparable claims;
    • arbitration usually is procedurally simpler and less costly than going to court;
    • arbitrators are believed to be “expert” decision-makers bringing specific knowledge and experience to the table, as opposed to jurors, who are not;
    • similarly, it is assumed arbitrators are not as easily swayed as juries by passionate arguments and sympathy;
    • employers may benefit from being “repeat players” before arbitrators;
    • the lower costs of arbitration may mean lower employment practices liability insurance premiums; and
    • access to a dispute resolution procedure such as arbitration can lower the risks of unionization.

    2. What Are the Risks?

    Some of the potential concerns surrounding binding arbitration include the following:

    • easier access to arbitration may mean a proliferation of employee disputes over relatively minor matters;
    • courts have given arbitrators virtually unrestricted discretion to decide issues of law, including evidentiary rulings, without interference by courts. Under the FAA, appeal of an award is very limited: the limited grounds include corruption, fraud, actual bias, violation of public policy;
    • arbitrators generally do not dismiss claims on motions;
    • arbitrators also are known to “split the baby,” appeasing both sides of a dispute by awarding part of the relief requested;
    • arbitrators are not accountable to the electorate, the press, or politics. While federal judges have life tenure, most state court judges do not. Additionally, court proceedings are subject to appellate review;
    • the EEOC continues to take the position that mandatory arbitration agreements are unlawful with respect to federal discrimination claims; and
    • political or public relations concerns as arbitration is viewed negotiations by some civil rights groups.


    We generally recommend that employers should thoroughly analyze their history of employment disputes over a three to five year period in order to decide whether the advantages of requiring arbitration outweigh the risks. The review should include the following

    • defense costs;
    • the number of lawsuits and discrimination charges;
    • the number of settlements and settlement value;
    • the cost of implementation of the program, including administering the agreement and cost of consideration for current employees; and
    • the effects implementation will have on employee morale and public relations.

    In deciding whether to enforce an arbitration contract, courts will consider whether the agreement provides employees with adequate “due process.” Some of the factors a court will consider and you should evaluate before implementing a mandatory arbitration process include whether:

    • The agreement requires both the employer and the employee to arbitrate;
    • costs are borne by the employer or shared;
    • any limitations on discovery and remedies that would be available in court;
    • the arbitrator is independent; and
    • the arbitrator’s decision is in writing and provides a sufficient basis for court review in limited circumstances.


    The Equal Employment Opportunity Commission in 1997 issued a report on “Best Employment Practices of Private Sector Employers.” The report outlines the programs the EEOC believes comprise the “best practices” in alternative dispute resolution. Not surprisingly, mandatory arbitration programs are not included in the EEOC list. Instead, the EEOC focuses on formalized programs providing means for employees to resolve disputes by open door policies, peer review programs, employee hot lines, mediation with minimal cost to the employee, or arbitration where the employee may elect whether or not the decision will be binding. We suggest that you review the “best practices” list with an eye toward determining whether such programs might be more appropriate for your Company than binding arbitration.


    The Circuit City decision has opened the door for employers to consider arbitration, as well as other forms of alternative dispute resolution. Arbitration may or may not be efficient and appropriate way to minimize the risk and cost of employment litigation. Jackson Lewis has assisted a wide array of employers in developing arbitration and other forms of alternative dispute resolution programs. We would be pleased to assist you in analyzing or developing a mandatory arbitration program or other form of alternative dispute resolution. Members of our Alternative Dispute Resolution group can be reached at our website, or by calling Marty Payson at (914) 328-0404.