In 2019, California enacted Senate (SB) Bill 707, a law codified as California Code of Civil Procedure sections 1281.98 and 1281.99, that automatically deems an employer’s failure to pay fees required for the commencement or continuation of arbitration within 30 days of the payment’s due date a material breach of the arbitration agreement. A finding of material breach allows the employee to take unilateral action to move the case to court and seek sanctions against the employer.

Since SB 707’s enactment, California courts have consistently upheld the law as consistent with, and therefore not preempted by federal law. However, in a recent decision, Hernandez v. Sohnen Enterprises, Inc., the Second Appellate District of the California Court of Appeal concluded that an arbitration agreement governed by the Federal Arbitration Act (FAA) is not subject to California’s law requiring a finding of a material breach due to an employer’s failure to pay arbitration fees. In other words, when an agreement falls within the scope of the FAA and does not expressly adopt California arbitration laws, the FAA preempts the provisions that mandate findings of breach and waiver.

Underlying Action

Sohnen Enterprises and its employees executed arbitration agreements that specifically stated that the FAA governed the agreement and any arbitration proceeding conducted pursuant to the agreement. The agreement referenced the FAA and federal law in several areas and made no mention of California arbitration law. For example, the agreement stated that the agreement “is governed by the [FAA],” a party could “seek court appointment of an arbitrator pursuant to the FAA,” discovery and motions during the arbitration would be conducted in accordance with the Federal Rules of Civil Procedure, and the parties waived class actions “to the fullest extent permitted by the FAA.”

On July 16, 2021, Massiel Hernandez initiated a civil action against the company for alleged disability discrimination, Labor Code violations, and related claims. However, four months later, the parties stipulated to arbitrate the claims pursuant to the arbitration agreement described above. Accordingly, the trial court entered an order consistent with the terms of the parties’ stipulation, including the statement that the company must pay the arbitration costs on or before any deadline specified by the arbitrator.

Hernandez subsequently initiated arbitration, and on April 7, 2022, the arbitration provider sent an invoice to the parties stating the filing fee ($1,750) was due upon receipt. The company paid the filing fees on May 13, 2022 – more than the 30 days allowed by SB 707.

Hernandez then filed a motion in the trial court to withdraw from the arbitration based upon the company’s failure to pay the arbitration fees timely. The trial court ruled that pursuant to California law, the company had breached the arbitration agreement and granted the motion to withdraw. The trial court held that the FAA did not preempt California’s law deeming an employer’s failure to pay fees timely as a material breach of the arbitration agreement. 

The Court of Appeal disagreed and reversed the trial court’s decision. The Court of Appeal held that SB 707 is preempted and invalidated by the FAA because California’s law treats arbitration agreements less favorably than other contracts. Whereas a breach of a contract generally requires a factfinder to evaluate potential defenses such as “substantial compliance,” breaches of arbitration agreements under California law do not. Rather, under California law, the breach is deemed automatic as a matter of law without any room for defenses. This, according to the Court of Appeal, “make[s] it harder to enforce arbitration agreements,” in violation of the FAA.

Notably, the Court of Appeal acknowledged that five other California appellate courts have reached the opposite conclusion – i.e., that the FAA does not preempt SB 707. But the Court of Appeal was not persuaded by the reasoning of those courts and stressed its conviction that “[i]mposing a higher standard for enforcement of arbitration agreements in consumer and employee disputes is contrary to the FAA’s policy to ensure arbitration agreements are as enforceable as other contracts.”

Finally, the Court of Appeal held that the company did not violate the trial court’s stipulated order, which stated that the company must pay the arbitration costs on or before any deadline specified by the arbitrator. The Court of Appeal held that the court order did not set a deadline for payment that the company violated, the arbitrator provider’s invoice itself was ambiguous as to the payment’s deadline, and the court order did not reasonably advise the company of the consequences for violating any payment deadline.

 Takeaway

This is potentially good news for employers. The consequences for failing to pay arbitration fees on time can be harsh, even if the untimely payment was unintentional or not otherwise the employer’s fault. This decision, however, is unlikely the final word on the issue. As noted above, this decision splits with other appellate decisions on the issue and could be appealed now, or through a different case later, to the California Supreme Court. Therefore, employers should continue to follow developments in this area closely.