Should Your Employment Agreement Include An Arbitration Clause?

Synopsis: When is an arbitration clause the best strategy for your agreement? There's no absolute right answer. It all depends on who you are, what rights are at stake, and how much bargaining power you have in the negotiation.

This question arises with increasing frequency in our practice. Is arbitration good or bad; less or more costly; less or more fair? Is the clause enforceable? Can I/we get out of it? The answers depend both upon the circumstances, the precise terms of the arbitration clause and who is doing the asking. There is a substantial body of conventional wisdom on each of these questions, but in fact, there are no constant answers. Here are some thoughts on how you should look at arbitration in the context of the employment relationship:

How does a”pre-dispute” arbitration clause come up?

A pre-dispute arbitration clause is one purportedly agreed to by the parties before any dispute arises. In a commercial context, where each party has at least some significant bargaining power, pre-dispute arbitration clauses are largely non-controversial. Where the parties’ bargaining power is vastly disproportional, however (as in the employment or the patient/HMO context), the reality is that the less powerful party really needs the job (or the medical care) and has no meaningful option to signing the pre-dispute arbitration clause if he or she is going to get it. One can, of course (as the courts regularly do) pretend that such an agreement is freely entered into, but everyone knows it really isn’t. You want a job? Sign here. That’s a pre-dispute arbitration clause.

By the way, pre-dispute arbitration clauses remain a lively issue in California, as illustrated by last year’s California Supreme Court decision, Grafton Partners v. Superior Court. In Grafton, the Court invalidated a pre-dispute clause that provided not for arbitration, but for waiver of a jury trial in favor of having all disputes decided in court by a judge. We’ve analyzed this odd result for you in a separate article.

Does it matter if an agreement provides for arbitration?

You bet. If it didn’t, employers would not require it as condition to the employment relationship. Arbitration is different from judicial dispute resolution in all sorts of ways. Arbitration affords far less discovery (interrogatories, compelled document production, depositions) than does litigation. This handicaps an employee-plaintiff seeking the facts to prove his or her case. Arbitration eliminates the jury, which in turn eliminates jury sympathy for a wronged employee, virtually precluding punitive damages and assuring minimal if any emotional distress damages. Arbitration by its nature discourages settlement, thus hugely reducing the likelihood of a negotiated result that would put something in an employee-plaintiff’s pocket. Courts, on the other hand, apply tremendous pressure on parties to settle pretrial, frequently requiring parties to engage in highly effective mediation processes. And arbitration affords no meaningful right to appeal, a given in the judicial system.

Most importantly, the courts are largely free. Sitting judges don’t get paid by litigants. Commercial arbitrators (most frequently former judges) can easily run over $600 an hour. And while current California law requires that the employer pay most arbitration fees in most cases, there is a huge hidden cost to the employee. The California Supreme Court has recognized (though done nothing about) this cost and given it a name: the “repeat customer” phenomenon. Since arbitrators are working for the money and are selected by the parties, they tend to be concerned about their reputations among the community of “repeat customers;” i.e., institutional employers and their (generally large firm) legal counsel. The last thing an arbitrator wants is to have a big-firm litigator return to her office, email her partners and warn that Judge so-and-so just awarded a wrongful termination or sexual harassment plaintiff half a million dollars. Judge so-and-so would see no more business from that law firm.

So, should your employment agreement contain an arbitration provision?

The answer, of course, is: it depends.

  • If you are an employer – particularly a substantial one — you virtually always want a pre-dispute arbitration clause. There is an advantage in arbitration – and that advantage is yours! The only down-side is the cost of the arbitration proceedings (including the arbitrator’s hourly fees), which, with few exceptions, will be your responsibility.
  • If you are an at-will employee without a written employment agreement, you probably do not want an arbitration clause (not that you’ll necessarily have a choice). Your claims are likely to be either statutory or public policy wrongful termination claims (discrimination, harassment, whistle-blower), fraud-in-the-inducement (of employment) claims, or unpaid compensation claims. In all but the last category, you are far better off in court. There will be judicial pressure to settle before trial, and the risk of a substantial jury verdict is likely to persuade the employer to settle at a higher number.
  • If you are a high level executive – particularly an executive with a written employment agreement containing a specific severance provision in the event of a not-for-cause termination – the analysis is more complicated. You are less likely to have a statutory or public policy claim than a rank and file employee, and you are more likely to simply be fighting about contractual issues, such as the proper level of compensation due at termination. Arbitration is not a terrible forum for such disputes. On the other hand, if you have been induced to accept new employment by representations that are not contained within the written employment agreement, or if you must move your residence (and leave a secure position) to take the new job, you will regret agreeing to that pre-dispute arbitration clause if pre-employment representations made to you prove false and the new job is not what you were promised.

As in most contexts, whoever you are, legal input at the front end of the employment relationship is likely to be more effective and more cost-effective than legal input at the back end. At worst, it will enable you to understand your risks when “voluntarily” signing up for arbitration. At best, your lawyers will be able negotiate the most effective clause for your specific situation.