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California Federal Court Finds Arbitration Agreement’s Exclusion of Injunctive Relief for Trade Secrets and Unfair Competition Claims Is Not Unconscionable

Posted in Trade Secrets, Unfair Competition

By Joshua Salinas and Grace Chuchla

The fight over an employer’s attempt to enforce arbitration agreements in the face of wage and hour class action claims is a common one in the world of labor and employment law. In fact, this is the very question that a federal district court for the Eastern District of California recently considered in Steele, et. al v. American Mortgage Solutions d/b/a Pinnacle, 2012 WL 5349511 (E.D. Cal., Oct. 26, 2012). Finding for the employer, the court, in its October 26th order, granted the defendant’s motion to compel arbitration and dismissed the plaintiff’s class action claims without prejudice. However, in doing so, the court also provided noteworthy analysis regarding the relationship between arbitration agreements and a company’s efforts to protect its trade secrets, making this order a must-read for both trade secret litigators and those involved with wage and hour class actions and involved in drafting arbitration agreements.

Background Facts

The facts in this case are fairly straightforward. Pinnacle is a Pasadena, California based company that provides maintenance services and personnel. As a prerequisite to employment, Pinnacle required its employees to sign a binding arbitration agreement. Like most arbitration agreements, this agreement covered nearly all claims that could arise between Pinnacle and its employees and required that any disputes be settled “exclusively by final and binding arbitration before a neutral Arbitrator.” Plaintiffs, all of whom signed such an agreement, brought suit under various California and federal laws alleging that Pinnacle required them to work more than forty hours a week without providing timely overtime compensation. After receiving the Complaint, defendant’s attorney sent a letter to opposing counsel stating that Plaintiffs were bound by arbitration agreements. Plaintiffs, however, did not withdraw their complaint, and Pinnacle subsequently filed a motion to compel arbitration.

The court’s analysis of Pinnacle’s arbitration agreement first looks to the agreement’s scope and then to its procedural and substantive conscionability.

Scope of the Agreement

The scope of the agreement does not cause the court concern; citing to various cases interpreting the Federal Arbitration Act (“FAA”), the court found that “the plain language of the Agreement covers plaintiff’s claims in this case, all of which have been held to be subject to arbitration under the FAA.” Additionally, the court dismissed plaintiffs’ arguments that California wage and hour claims are exempt from the FAA. As the court saw it, plaintiffs’ reliance on Gentry v. Superior Court, 42 Cal. 4th 443 (2007), and Hoover v. American Income Life Insurance, 206 Cal. App. 4th 1193 (2012), was for naught, as these cases were “either overruled or inapplicable” to plaintiffs’ claims.

Procedural and Substantive Unconscionability

Under California law, both procedural and substantive unconscionability are required for an arbitration agreement to be enforceable and both elements are analyzed under a sliding-scale test. Plaintiffs in this case received their first win with the court’s finding that the lack of an opt-out clause rendered the arbitration agreement procedurally unconscionable. However, the tables turned back in Pinnacle’s favor with the court’s analysis of the agreement’s substantive unconscionability, which is also where the court’s analysis of trade secret claims and arbitration agreements lies.

When analyzing an arbitration agreement, courts evaluate the arbitration agreement’s individual provisions for substantive conscionability to ultimately determine whether the agreement is “wholly unenforceable.” In this case, suits seeking injunctive relief for unfair competition and/or disclosure of trade secrets received special attention because such suits are one the few types of claims that Pinnacle specifically excluded from mandatory arbitration under its agreement. As the court saw it, following the reasoning in Ting v. AT&T, 318 F. 2d 1126 (9th Cir. 2003), such exclusion raised the possibility of substantive unconscionability because it demonstrates a “stronger party…through a contract of adhesion, impos[ing] a forum on a weaker party without accepting the forum for itself.” Id. at 1149 (quoting Armendariz v. Foundation Health Psychcare Services, 24 Cal.4th at 118, 99 (2000). Additionally, the court cited Ferguson v. Countrywide Credit Industries, Inc., 298 F.3d 778 (9th Cir. 2002), which held that arbitration agreements that exclude claims that an employer is most likely to bring against an employee raise the suspicion of substantively unconscionable.

However, the key to the court’s analysis is one short word – “could.” Nowhere in its analysis does the court say that Pinnacle’s exclusion of trade secret claims from its arbitration agreement unquestionably renders it substantively unconscionable. In fact, after looking at various other aspects of the agreement, the court’s final conclusion is that nothing in Pinnacle’s arbitration agreement is substantively unconscionable. With respect to its exclusion of trade secret claims, there are “valid reasons, entirely independent from any intent to place the employees at a relative disadvantage or to generate one sided results, for excluding claims of unfair competition or trade secret violations from the mandatory arbitration agreement provisions of the Agreement.” More specifically, the court recognized that, given the three-party nature of trade secret claims, arbitration is not the correct forum for such suits. Employers forced to arbitrate trade secret misappropriation claims would be forced to arbitrate against their former employee and bring suit in court against the former employee’s current employer. Needless to say, such an arrangement would be a far cry from the Agreement’s intent to bring efficiency to legal proceedings and could negatively affect the rights of the third-party current employer.

The court ultimately granted Pinnacle’s motion to compel arbitration and to dismiss plaintiffs’ claims without prejudice, thereby denying plaintiffs class relief.

Takeaways

In short, this order may be  a powerful tool for employers who are concerned both with mitigating the potential for class action suits in court and with protecting their trade secrets. With respect to the exclusion of suits for injunctive relief for the misappropriation of trade secrets, the “could be substantively unconscionable” reasoning that one finds in Ting and Ferguson has swung in the “not substantively unconscionable” direction. Indeed, the arbitration agreement’s carve out of injunctive relief for trade secrets and unfair competition in this case is consistent with the Ninth Circuit’s interpretation of the FAA to allow injunctive relief in the court even in arbitrable disputes, and a similar exception under California’s Arbitration Act.

Pinnacle’s exclusion of trade secret claims has stood the test of the court, and a commonsense analysis of how trade secret claims actually play out in the real world has prevailed over what could have been an unforgiving scrutiny of Pinnacle’s exclusion of trade secret claims in the arbitration agreement.