What is the question (Is the dispute arbitrable)? and Who gets to answer it (the court or the arbitrator)? Kubala v. Supreme Prod. Svcs., Inc.

by Maretta Comfort Toedt and D. C. Toedt III

(Maretta Comfort Toedt (Member of the Board of Governors, National Academy of Arbitrators) and D. C. Toedt III are attorneys and arbitrators (and a married couple) in Houston,TX.)

Introduction

Many employers adopt written workplace policies that require disputes to be arbitrated, often on a one-by-one individual basis. When an employer seeks to compel arbitration on that basis, sometimes the employee responds that the particular dispute is not arbitrable, and so the dispute must be heard in court, for example as a class- or collective-action.  As a general rule, courts decide such gateway issues of arbitrability, but a July 2016 opinion from the Fifth Circuit reminds us that when a valid arbitration agreement expressly delegates such disputes about arbitrability to the arbitrator, then the court’s role is much-more limited.  See Kubala v. Supreme Proc. Svcs., Inc., No. 15-41507 (5th Cir. July 20, 2016) (hereinafter, “Kubala”).

The decision, though, could easily have gone the other way if the arbitration policy’s unilateral-modification provision had been badly drafted. And an arbitrator will still have to determine whether, on the facts of the case, the arbitration provision does or does not apply to the dispute by its terms.

An employer announces an arbitration policy

On March 11, 2015 ­— dates are significant here — Supreme Production Services announced that in two days, an arbitration policy would go into effect to govern all employment-related disputes:

This Policy becomes effective as of the date of your signature, but in no event later than March 13, 2015.

If an employee accepts or continues his/her employment after the effective date, the employee shall be subject to this Policy and shall, as a result, agree that all Covered Disputes against the Company, as defined above, shall be resolved through arbitration instead of through the court system. Exhibit A-1 of Kubala v. Supreme Prod. Svcs., Inc., No. 2:15-cv-0116, electronic document no. 9-1, at 4 (S.D. Tex.) (hereinafter, “Kubala Arbitration Agreement”) (emphasis and extra paragraphing added).

Under Texas law, continued employment can be sufficient to support a modification to the terms of at-will employment. See Kubala at part III, slip op. at 5, citing In re Halliburton Co., 80 S.W.3d 566, 568 (Tex. 2002). The employee-plaintiff, Mr. Kubala, continued to work and receive payment after the effective date of the arbitration policy.

The arbitration policy contained a delegation provision, which stated that disputes regarding the applicability or interpretation of the agreement were to be resolved by the arbitrator:

The arbitrator shall have the sole authority to rule on his/her own jurisdiction, including any challenges or objections with respect to the existence, applicability, scope, enforceability; construction, validity and interpretation of this Policy and any agreement to arbitrate a Covered Dispute. Kubala Arbitration Agreement at 3.

But Kubala had just filed a collective-action lawsuit against Supreme

As it happened, on March 9 — two days before Supreme’s announcement of its new arbitration policy — Kubala had filed a collective-action overtime lawsuit against Supreme under the Fair Labor Standards Act.  Supreme asserted that it had no knowledge of the lawsuit until after it announced the new policy, see Kubala II, slip op. at 2; the Fifth Circuit does not mention any finding or evidence to the contrary. If Supreme had had actual knowledge of the dispute, then the new arbitration policy, by its terms, would not have covered Kubala’s claim:

This Arbitration Agreement does not cover any alleged Covered Dispute of which the Company had actual knowledge before the effective date. Kubala Arbitration Agreement at 4.

In Kubala’s lawsuit, Supreme moved unsuccessfully to dismiss Kubala’s claims or alternatively to compel arbitration. The district court held that the new arbitration policy did not apply to Kubala’s case because the policy did not address pre-exiting disputes.  See Kubala at part I, slip op. at 3.

The Fifth Circuit says that the delegation agreement controls

The Fifth Circuit disagreed with the district court procedurally, but it took no position as to whether in fact the dispute was or was not arbitrable. The Fifth Circuit said:

Enforcement of an arbitration agreement involves two analytical steps. The first is contract formation—whether the parties entered into any arbitration agreement at all.  The second involves contract interpretation to determine whether this claim is covered by the arbitration agreement.  Ordinarily both steps are questions for the court.  But where the arbitration agreement contains a delegation clause giving the arbitrator the primary power to rule on the arbitrability of a specific claim, the analysis changes. See First Options of Chi., Inc. v. Kaplan, 514 U.S. 938, 942 (1995). … Delegation clauses are enforceable and transfer the court’s power to decide arbitrability questions to the arbitrator.

Thus, a valid delegation clause requires the court to refer a claim to arbitration to allow the arbitrator to decide gateway arbitrability issues. Rent-A-Ctr., W., Inc. v. Jackson, 561 U.S. 63, 68-69 (2010). Kubala at part II, slip op. at 3-4 (some citations omitted, emphasis added, paragraphing edited).

Accordingly, the Fifth Circuit reversed and remanded, directing the district court to enter an order compelling arbitration.

A sloppy unilateral-modification provision might have led to a different result

The Kubala court properly recognized that a delegation agreement might not be valid under state law.  That possibility is a real one in employment cases, because, for example:

  • An employer arbitration policy is very likely to provide that the employer may unilaterally modify the policy.
  • If the unilateral-modification provision did not exclude pending disputes from such modification (known as a Halliburton exception), then both the arbitration agreement and the delegation agreement might well be “illusory” and thus unenforceable under Texas law.

See Halliburton, 80 S.W.3d at 569-70; see also Lizalde v. Vista Quality Markets, Inc., 746 F.3d 222 (5th Cir. 2014), where the court reversed denial of an employer’s motion to compel arbitration, because the unilateral-modification provision included a Halliburton exception; Harris v. Blockbuster Inc., 622 F. Supp. 2d 396 (N.D. Tex. 2009), where the court denied Blockbuster’s motion to compel arbitration because the arbitration agreement could be unilaterally modified by Blockbuster, with no Halliburton exception.  See generally also Professor Eric Goldman’s series of blog postings on this subject, recapped most recently in “Modified Clickwrap” Upheld in Court–Moule v. UPS (July 2016), (EricGoldman.org).

The Kubala arbitration policy does indeed contain a unilateral-modification provision, but it also contains a Halliburton exception for disputes:

The Company retains the right, in the future, to amend or terminate this Policy. An amendment to or termination of the Policy shall not be effective until 30 days after notice of termination [sic] is given to the employees. The amendment or termination of the Policy shall not be effective as to any Covered Dispute for which demand had been made hereunder or that the Company has actual knowledge of prior to the effective date of the amendment or termination of the Policy.  …  Kubala Arbitration Agreement at 4 (emphasis and extra paragraphing added).

As a result, the illusory-agreement issue does not seem to arise in Kubala; in due course, presumably an arbitrator will decide the threshold issue of arbitrability.

The arbitration agreement might end up not applying after all

The Kubala arbitrator will not necessarily end up deciding the dispute on the merits: as noted above, by its own terms the arbitration policy might not apply. It would not be surprising if Kubala tried to show the arbitrator that Supreme had actual knowledge of his collective-action lawsuit before Supreme announced its imposition of the arbitration policy.  If Kubala were to succeed in doing so, then the arbitration policy would not apply to his dispute — and the parties would have essentially wasted the time and money it took for the threshold arbitrability dispute to bounce between arbitration and the judicial system.

Judge Higginbotham warns of other troubling issues

In his concurring opinion in Kubala, Judge Patrick Higginbotham (appointed by President Reagan) warned of other troubling issues that might need to be addressed in future cases:

Ted Kubala sued Supreme for denying him overtime pay. Two days later, Supreme presented him with a “take it or leave it” arbitration agreement. Supreme now claims that that agreement’s delegation clause governs Kubala’s preexisting suit.

Supreme’s claim has troubling implications. The Fair Labor Standards Act (FLSA) affords employees a federal forum for their claims. It is beyond dispute that an employer may not fire an employee for filing a FLSA suit. Similarly, an employer’s threat to discharge an employee who refuses to withdraw a suit would sit uneasily with the law. But what if a Texas employer with no extant arbitration agreement, once notified of an employee’s FLSA suit, threatens to fire the employee unless he agrees to arbitrate the suit? Its threat would coerce the plaintiff into relinquishing his FLSA-given right to decision by an independent judiciary for private decision by appointed private arbitrators, just as powerfully as if the employer had demanded he drop the suit outright.  With all deference to the judiciary’s recent and warm embrace of arbitration, who decides whether it is a public or private proceeding matters a great deal, arriving on stage as it does redolent with large concerns attending a regime of contracting out justice — when consent so often must be blind to inequality of bargaining power.  Kubala, slip op. at 9-10 (Higginbotham, J., concurring) (emphasis and extra paragraphing added).