Quick Hits

• The Supreme Court of California ruled that the FAA does not preempt a state law requiring prompt payment of arbitration fees, interpreting the requirement in the context of other statutes and legal principles that may excuse an untimely payment.
• The court clarified that employers may not automatically forfeit their right to arbitration for late fee payments if those delays are not willful or grossly negligent.
• The ruling emphasizes that parties can negotiate their own payment timelines in arbitration agreements.

In Hohenshelt v. Superior Court of Los Angeles County (Golden State Foods Corp., Real Party in Interest), the California high court addressed a state court split over whether the FAA preempts Code of Civil Procedure Section 1281.98, which imposes a thirty-day deadline to pay arbitration fees. California courts have interpreted the statute as deeming a failure to pay in a timely manner to be a material breach of the arbitration agreement, regardless of the circumstances, and automatically deny companies their rights to arbitration.

Some courts have held that such an inflexible rule hinders arbitration and conflicts with the FAA, which requires states to place arbitration agreements on equal footing as other contracts. According to those courts, because other contracts are not forced to comply with this stringent rule, the FAA preempts this law. Other courts have held that the statute is not preempted because it promotes the goals of the FAA by ensuring the timely payment of invoices and keeping arbitration proceedings moving without unnecessary delay.

In Hohenshelt, the California supreme court rejected a “rigid construction” of the statute The court held that the statute is not preempted by the FAA, but also concluded that the law does not stop a court from excusing the untimely payment based on established contract principles unless the “nonperformance is willful, grossly negligent, or fraudulent.” Importantly, the court also held that the parties to the arbitration agreement can set by agreement the due date for arbitration fees payments.

Background

Section 1281.98 was added as part of the 2019 amendments to the California Arbitration Act in Senate Bill (SB) 707. The statute provides that when an employment or consumer arbitration requires the drafting party to pay arbitration fees and costs, “if the fees or costs 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.” The statute then allows the employee or consumer to “unilaterally … [w]ithdraw the claim from arbitration and proceed” to court. The employee or consumer is entitled to mandatory sanctions and attorneys’ fees accrued in arbitration upon return to court.

In Hohenshelt, an employee of Golden State Foods Corp. sought to withdraw his claims from arbitration after the employer paid arbitration fees more than thirty days after the arbitrator invoiced them, but before a final payment deadline set by the arbitrator.

The California Second District Court of Appeal ruled that the clear language of Section 1281.98 requires that payments are “due upon receipt,” any extension of time for fee payment must be agreed upon by all parties, and that the statute does not let an arbitrator cure a party’s missed payment. The appellate court sent the claims back to the trial court even though the arbitration proceedings had been ongoing for a year and the employer had spent more than $50,000 in arbitration fees and costs.

FAA Preemption

The Supreme Court of California read the statute in a way that saves it from FAA preemption. The court said Section 1281.98 must be considered in the context of the “backdrop of longstanding statutes that authorize courts to prevent unjust forfeitures of contractual rights” and legislative history suggesting the law was meant to stop parties from “strategically withholding” the payment of arbitration fees and costs as a tactic to delay and frustrate the arbitration proceedings. (Emphasis in the original.)

The court interpreted Section 1281.98 as not mandating that fees “invariably be paid within 30 days of the arbitrator’s invoice regardless of the parties’ preferences.” Instead, the statute imposes a “default rule” for when fees are due, and “parties are free to contract for any due date they want by adopting their own ‘provision in the arbitration agreement stating the number of days in which the parties to the arbitration must pay any required fees or costs.’”

In this context, the supreme court found that the statute does not treat arbitration agreements differently from other contracts and does not undermine the goals of the FAA. The supreme court admitted that if the statute were read only by the plain text, without incorporating other elements of California law, “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.” This would result in FAA preemption. However, the court explained that “a drafting party can avoid forfeiture of its right to arbitration by showing that the delay was excusable” under other laws and background legal principles that generally apply to contracts.

Key Takeaways

The Supreme Court of California’s decision in Hohenshelt found that the FAA does not preempt Section 1281.98, by allowing courts to keep claims in arbitration even if arbitration fees are not paid in accordance with the statute. The ruling states that mere technical violations or oversights could excuse employers’ late payment so long as there is no evidence that the late payment was deliberate or due to gross negligence.

Additionally, the court said parties may agree to other terms as the statute only provides a “default rule.” That means employers concerned with the time limits in Section 1281.98 may include a provision in arbitration agreements setting when invoices are due. Employers may want to consider adding such a provision or revising and updating existing arbitration agreements with such a provision to avoid the deadline in Section 1281.98.