Arizona Supreme Court holds State Arbitration Act excludes employment disputes: Does it matter?

For almost 80 years the Arizona Arbitration Act has contained an exclusion for employment agreements. This year, the Arizona Supreme Court was called upon to determine whether that exclusion applied to all arbitration agreements between employers and employees, or just arbitration agreements found in collective bargaining contracts. NorthValley Emergency Specialists, L.L.C. v. Santana, 93 P. 3d 501 ( Ariz. 2003). The Court’s holding is straightforward. The Court held that the exclusion in the Arizona Arbitration Act (the “Arizona Act”) for arbitration agreements “between employers and employees or their respective representatives,” A.R.S. § 12-1517, exempts from the Arizona Act “all arbitration agreements between employers and employees.” Id. at 502.

Does the Court’s opinion mean that arbitration agreements between employers and employees in Arizona are no longer enforceable? No, it does not because the Court was not called upon to consider the relationship between the Arizona Act and the Federal Arbitration Act (the “FAA”).

Because the Court was not asked to consider the relationship between the Arizona Act and the FAA, the practical significance of the Court’s ruling is quite narrow. It is the opinion of the author that the decision has extremely limited impact as the exclusion for employment agreements in the Arizona Act, as interpreted by the Supreme Court, is preempted to the extent the agreement is covered by the FAA. The FAA applies to any “contract evidencing a transaction involving commerce” which under interpretations of the United States Supreme Court, makes the FAA applicable to virtually every employment relationship.

The Federal Arbitration Act

The FAA is not only a procedural statute that may be invoked in federal and state court, the United States Supreme Court has found it to be a substantive statute prohibiting state laws that single out arbitration agreements as unenforceable on grounds not common to all contracts. “In enacting § 2 of the [FAA], Congress declared a national policy favoring arbitration and withdrew the power of the states to require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration.” Southland Corp. v. Keating, 465 U.S. 1, 10 (1984).

In subsequent decisions, the Supreme Court has found that the FAA preempts state laws which interfere with or limit the ability of parties to enter into arbitration agreements. Although parties may challenge arbitration agreements on the same grounds applicable to all contracts, states may not impose barriers to arbitration that are unique to those agreements.

Courts may not, however, invalidate arbitration agreements under state laws applicable only to arbitration provisions. [W]e have several times said, Congress precluded States from singling out arbitration provisions for suspect status.

Doctor’s Assoc., Inc. v. Casarotto, 517 U.S. 681, 687 (1996). In Doctor’s Assoc., the Supreme Court invalidated a Montana statute finding it preempted by the FAA. The statute required that for an arbitration provision to be enforceable, notice of arbitration must be typed on the first page of the contract in underlined capital letters. The Court found the Montana law to be one not applicable to contracts generally and therefore preempted by the FAA.

Because the Arizona Act has been interpreted by the Arizona Supreme Court to apply to all employment contracts and not just those involving collective bargaining agreements (which are not covered by the FAA), A.R.S. § 12-1517 constitutes a state law restricting arbitration on grounds not applicable to contracts generally. Thus, for those contracts “evidencing a transaction involving commerce,” the FAA governs and the Arizona Act is preempted. The important question that must be answered then is what is meant by a “transaction involving commerce.”

There is a preliminary subject that must be covered first. There is an exclusion in the FAA for “contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce.” 9 U.S.C. § 1. Most courts of appeal found this exclusion to be limited to transportation workers. The Ninth Circuit Court of Appeals, however, held that the exclusion applied to all employment agreements, thus calling into question the applicability of the FAA to every employment relationship.

But in 2001, the United States Supreme Court rejected the Ninth Circuit interpretation, holding that the exclusion in the FAA was narrow, applicable only to those workers engaged in interstate transportation. Circuit City Stores, Inc. v. Adams, 532 U.S. 105 (2001). Thus, so long as workers are not actually engaged in interstate transportation, and as long as the arbitration agreement is contained in a contract “evidencing a transaction involving commerce,” all other employment relationships are covered by the FAA.

So, what is a transaction involving commerce? It is to that question we now turn.

“A Transaction Involving Commerce”

Because the FAA preempts state laws that target the enforceability of arbitration agreements, the Arizona Supreme Court decision in North Valley Emergency Specialists will impact employment agreements only to the extent the ruling is not preempted by the FAA. As the FAA applies to all contracts “evidencing a transaction involving commerce,” to ascertain the impact of North Valley Emergency Specialists one must determine the scope and breadth of the FAA’s preemptive power.

The United States Supreme Court has considered this question in two recent cases. In the first case, Allied-Bruce Terminix Companies, Inc. v. Dobson, 513 U.S. 265 (1995), the Court considered whether “commerce” should be viewed broadly, extending the FAA to the limits of Congress’s Commerce Clause power, or narrowly limiting the coverage of the FAA to cases where interstate commerce is contemplated by the parties. In finding the expansive interpretation correct, the Court first observed that the words “involving commerce” are broader than the more commonly used words “in commerce,” therefore concluding that the words cover more than simply persons or activities within the “flow of interstate commerce.” Thus, the Court held that the term “involving commerce” as used in the FAA “signals an intent to exercise Congress’s commerce power to the full.” Id. at 277.

The Court also examined whether the words “evidencing a transaction” involving commerce meant that the transaction must turn out to have involved interstate commerce. Even if the parties did not “contemplate” involvement with interstate commerce, the FAA will apply so long as the parties’ agreement does, in fact, “involve” interstate commerce. The Court was not called upon to address the obvious next question—must the contract at issue itself involve commerce, or is it the type of contract in general, that involves commerce. The Supreme Court answered that question last year.

In Citizens Bank v. Alafabco, Inc., 539 U.S. 52 (2003), the Court was asked to decide whether the parties’ debt restructuring agreement was a contact evidencing a transaction involving commerce within the meaning of the FAA. In that case, an Alabama lending institution sought to compel arbitration in a dispute with an Alabama corporation. The Supreme Court held that the agreement between only Alabama businesses nevertheless involved commerce. Noting that Alafabco did business outside of Alabama, and that its security for the debt included inventory outside Alabama, the Court went on to explain its dispositive reason.

The Court said that the proper focus of the inquiry is not upon the individual transaction, but upon “consideration of the ‘general practice’ those transactions represent.” Id. at 58. The Court further stated that the broad impact of commercial lending on the national economy was certainly subject to Congress’s power to regulate that activity pursuant to the Commerce Clause.

Thus, the proper focus to determine whether the FAA applies to a particular agreement is to look beyond the individual agreement to ask whether in the aggregate such agreements would fall within the purview of the Commerce Clause. One federal district court put it this way:

[I]f the aggregation of the impact of performing a certain discrete activity has a substantial affect on interstate commerce, then an individual’s performance of the activity may be regulated by Congress, even if the individual’s acts are local in nature.

University of Alabama Foundation v. Walley, 2001 WL 237309 (M.D. Ala. 2001). And in a case not involving the FAA but one examining the scope of Congress’s Commerce Clause power, the United State Supreme Court has made clear that “[e]ven activity that is purely intrastate in character may be regulated by Congress, where the activity, combined with like conduct by others similarly situated, affects commerce among the States.” Fry v. United States, 421 U.S. 542, 547 (1975).

It is difficult to imagine any employment relationship taken in the aggregate, that would not affect commerce. Indeed, Congress has exercised broad power in regulating employment through such statutes as Title VII, the Americans with Disabilities Act, the Age Discrimination in Employment Act, and the Family and Medical Leave Act. Although these statutes are not applicable to smaller employers, such limitations do not manifest a limitation on Congress’s Commerce Clause power, but rather reflect a legislative judgment by Congress to not place employment restrictions on smaller employers.

Conclusion

In view of the broad scope of the Commerce Clause power of Congress and because the FAA’s reach extends to the fullest limit of that power, it would appear that most employment relationships are governed by the FAA. Therefore, the Arizona Supreme Court’s holding in NorthValley Emergency Specialists, L.L.C. v. Santana is interesting, but in practical terms, it should not affect the enforceability of the vast majority of arbitration provisions in employment relationships.