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California Supreme Court:
State Law Governing Arbitration Fees Is Not Preempted
Majority Says Statute Allowing Certain Litigants to Avoid Alternative Dispute Resolution if ‘Drafting Party Fails to Pay Timely Pay Costs Can Be Harmonized With Federal Act; Corrigan, Jenkins Dissent
By Kimber Cooley, associate editor
The California Supreme Court held yesterday, in a 5-2 decision, that a state law providing that a consumer or employee may avoid arbitration if the party that drafted the governing agreement fails to timely pay an arbitrator’s fees is not preempted by the Federal Arbitration Act.
Rejecting a “rigid construction” of the statute, the majority said that the provision can be harmonized with other state law contract principles so that it cannot be said to “disfavor” arbitration in violation of federal law.
At issue is Civil Code of Procedure §1281.98, which provides:
“In an employment or consumer arbitration that requires, either expressly or through application of state or federal law or the rules of the arbitration provider, that the drafting party pay certain fees and costs during the pendency of an arbitration proceeding, if the fees or costs required to continue the arbitration proceeding are not paid within 30 days after the due date, the drafting party is in material breach of the arbitration agreement, is in default of the arbitration, and waives its right to compel the employee or consumer to proceed with that arbitration as a result of the material breach.”
Subdivision (b) specifies that “the arbitration provider shall issue all invoices to the parties as due upon receipt” and that “[a]ny extension of time for the due date shall be agreed upon by all parties.”
The question arose after a split in authority developed over whether the rule runs afoul of §2 of the Federal Arbitration Act (“FAA”) which contains a so-called “equal treatment” principle that affirms that a court may invalidate an agreement based on generally applicable contract defenses but not on legal rules that apply only to arbitration.
Div. Five of this district’s Court of Appeal held last year, in the Hernandez v. Sohnen Enterprises case, that California’s rule violated that principle because it mandates findings of material breach and waiver in ways that do not apply to all contracts. All other courts of appeal to address similar challenges have ruled that the statute is not preempted.
Justice Goodwin H. Liu wrote yesterday’s opinion, joined in by Chief Justice Patricia Guerrero as well as Justices Leondra Kruger, Joshua P. Groban, and Kelli Evans, resolving the split. He said:
“We hold that section 1281.98, properly construed, is not preempted by the FAA. Although section 1281.98 has been interpreted by various Courts of Appeal to impose an inflexible and sometimes harsh rule resulting in loss of arbitral rights, we reject that rigid construction and instead conclude that the statute does not abrogate the longstanding principle, established by statute and common law, that one party’s nonperformance of an obligation automatically extinguishes the other party’s contractual duties only when nonperformance is willful, grossly negligent, or fraudulent.”
So understood, the jurist opined that the statute does not “deviate” from generally applicable contract principles or disfavor arbitration agreements.
Other Opinions
Groban penned a concurring opinion, joined in by Evans, “to highlight a significant question that the majority opinion sensibly leaves open,” asserting that “[w]hen an arbitration agreement incorporates the [California Arbitration Act’s (“CAA”)] procedural rules,” unlike the agreement in the present case in which the parties agreed to follow federal law, “the CAA will apply, and no federal preemption concerns arise.”
Justice Carol Corrigan dissented. In an opinion joined in by Justice Martin J. Jenkins, she argued:
“Neither the parties nor the majority point to any other contracts that our law renders unenforceable on such stringent terms as those defined in section 1281.98.”
The dispute before the court arose after sanitation worker Dana Hohenshelt filed a complaint against his former employer, Golden State Foods Corporation, in 2020, alleging that he was fired in retaliation for reporting acts of sexual harassment. Golden State successfully moved to compel arbitration, citing an agreement between the parties.
JAMS was selected as the provider and the case proceeded without issue for approximately one year before the employer failed to timely pay two invoices that came in during a scheduled leave period for the assigned arbitrator. After the 30-day time-limit lapsed, Hohenshelt moved to withdraw his claims from arbitration.
Los Angeles Superior Court Judge Thomas Falls denied the motion. A divided Div. Eight of this district’s Court of Appeal granted Golden Food’s petition for writ of mandate, directing the trial court to vacate the order and finding that the law furthers rather than frustrates the objectives of the FAA because it promotes the speedy resolution of legal clashes.
Yesterday’s opinion declares that the high court “agrees” that the section is not preempted, but directs Div. Eight to “remand the matter…for consideration of whether Golden State may be excused for its failure to timely pay arbitration fees, such that the stay of litigation should not be lifted and the parties should be returned to arbitration.”
Text of Section
Liu acknowledged that the text of §1281.98 says that a drafting party is in material breach, without exception, if a late payment is made, but wrote that “we do not think the language of section 1281.98 is by itself dispositive of the statute’s operation and effect.” Saying that every statute must be read against the background of the “whole system of law,” he said that courts are to seek interpretations that “harmonize” the two.
As examples of the applicable “system of law,” he cited Civil Code §3275, under which a nonperforming party may seek relief from a legal obligation if he acted in good faith, Civil Code §1511, which provides that a breach may be excused if performance was impossible, illegal or impracticable, as well as Code of Civil Procedure 473(b), which allows for relief from judgment based on mistake, inadvertence, surprise, or excusable neglect.
The jurist remarked:
“When a statute is enacted against a ‘legal backdrop,’ we assume the background legal rules continue to apply absent a ‘definitive indication’ that the Legislature intended to displace them.”
Applying this principle, he noted that “the legislative history of [§1281.98] identifies the willful withholding of fees as the mischief it sought to remedy” and that the statutory scheme provides for “mandatory sanctions” in the event of a breach of the section.
General Contract Law
Under these circumstances, he said:
“Consistent with general contract law, a material breach is enough to trigger an award of compensatory damages, which the mandatory sanctions provision of section 1281.99, subdivision (a) provides for. But other consequences depend on the circumstances: the background statutes discussed above can in some situations prevent a material breach from occasioning a loss of the defaulting party’s right to arbitrate….”
With this interpretation of the law, Liu reasoned:
“We agree that if section 1281.98 were construed to mean that any failure to make timely payment, regardless of the circumstances, invariably results in forfeiture of arbitral rights, the statute would be anomalous in the context of general contract law principles. As we have explained, however, a drafting party can avoid forfeiture of its right to arbitration by showing that the delay was excusable under section 473, Civil Code section 3275, or Civil Code section 1511, the background principles that generally apply to other contractual obligations.”
Saying that “it would be ironic if the FAA’s policy of enforcing agreements to arbitrate effectively cannibalized a state law that aims to keep parties to such agreements moving forward in arbitration by requiring timely payment of arbitration fees,” and disapproved of a line of cases with holdings inconsistent with the court’s opinion.
Corrigan’s Dissent
Corrigan wrote:
“The majority acknowledges that reading these statutory defenses into section 1281.98 is essential to save it from preemption….But the workaround doesn’t quite work….The first problem is that harmonization is merely a tool to ascertain legislative intent, and….[n]either the statutory language nor legislative history points to an intent to limit the harsh consequences of breach, default, and waiver to cases of willful violations. Moreover, even under the majority’s interpretation, section 1281.98 still singles out arbitration agreements for disfavored treatment in two key ways.”
She continued:
“[B]y making payment of arbitration costs presumptively due ‘upon receipt’ and by imposing a short grace period that parties cannot alter with different contract terms, section 1281.98 effectively converts all employment and consumer arbitration contracts into contracts that make time of the essence for paying arbitration fees. This requirement is contrary to the general rule that time is not of the essence in a contract unless the parties so agree…..[Additionally], section 1281.98 ‘mandates findings of material breach and waiver for late payment that do not apply generally to all contracts or even to all arbitrations.’ ”
The case is Hohenshelt v. Superior Court, 2025 S.O.S. 2269.
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