08 / 17 / 2016

Fifth Circuit Finds Arbitration Agreement Unenforceable

fifth_circuit_texas_arbitration_clause_ruling_illusory_unenforceable.jpgBack in early March, the Fifth Circuit issued an opinion over Nelson v. Watch House International, LLC. This was a federal court ruling and thus takes precedence over a state appellate ruling outside the Texas Supreme Court under federal law.

The court held that:

an employment arbitration agreement [is] unenforceable where the savings clause did not expressly require advance notice to employees of amendments and/or termination of the arbitration agreement.

When is an arbitration clause considered illusory?

Generally, federal courts apply state-law when deciding whether a contract agreement to arbitrate is valid. In Texas, an arbitration clause is considered illusory, and thus unenforceable, if one side can avoid arbitration entirely by solely amending the arbitration provision or choosing to terminate the agreement altogether.

In Watch House, a former employee brought an action against their former employer, alleging he was discharged in violation of Title VII (discrimination and wrongful termination) and Texas law. The employer moved to compel arbitration of the dispute under the arbitration plan of the company.

The employee, Nelson, sought the review of the district court because:

  1. He intended for the court to find the employer’s action to terminate a violation of Title VII.
  2. He claimed he did not sign the arbitration plan and therefore was not bound by it.

An exception to the rule on illusory arbitration plans

The district court held that the arbitration plan was not illusory under the seminal Texas case, In re Halliburton Co. That case provided an exception to the general rule on illusory arbitration plans: an arbitration plan is not illusory if the plan “provided that amendments to the agreement would not apply retroactively” and would “not be effective until ten days after notice of the termination” was given to the employee.

Nelson appealed the district court’s decision and the 5th Circuit reversed the district court, holding that Watch House’s notice provision did not meet the Halliburton exceptions, thus causing the arbitration agreement to be illusory.

Could your company be vulnerable?

It is general practice for an employer to reserve the right to unilaterally change or entirely terminate an arbitration provision, so long as notice is given. After all, an arbitration agreement is there to protect the company from frivolous or unwarranted allegations.

Therefore, it is reasonable that a company, when providing proper notice to its employee, concludes it sensible to amend or remove a provision in its arbitration plan.

Naturally, a company should be able to amend and terminate without concern since it is their arbitration agreement. However, according to Watch House, a company could be vulnerable if it:

  1. Does not provide advance notice to its employees.
  2. Does not ensure that all applications of amendments to its arbitration plan affect prospective claims only.
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