Arbitration Plan Which Did Not Include a Savings Clause Prohibits Employer From Compelling Arbitration of Employee's Dispute

Nelson v. Watch House International, LLC - Fifth Circuit Court of Appeals

Facts:  Michael Nelson ("Nelson") worked at Watch House International, LLC ("Watch House") from March 2010 until March 2014.  Upon being hired, Nelson was provided with an employee handbook which included an Arbitration Plan which set out, among other things, that any disputes that arose during the employment would be arbitrated.  Nelson alleged that during his time at Watch House, his coworkers harassed him based upon his religion and race.  

He subsequently filed suit and alleged he was discharged from Watch House in violation of Title VII of the Civil Rights Act of 1964 and Chapter 21 of the Texas Labor Code.  Watch House moved to compel arbitration based upon the Arbitration Plan.  Nelson objected to the Arbitration Plan on the grounds that it was illusory because it did not include a savings clause in regard to existing claims and disputes and failed to require advance notice of termination.  The District Court granted Watch House's motion to compel arbitration on the grounds that the arbitration agreement and dismissed Nelson's claims.

Holding:  The Fifth Circuit noted, initially, that the Federal Arbitration Act reflects a liberal policy of favoring arbitration, but that policy does not apply when a determination is made as to the validity of an arbitration agreement between parties.  Under Texas law, an arbitration agreement is illusory if one party has the unrestrained unilateral authority to terminate its obligation to arbitrate, unless there is a savings clause.  In this instance, a three prong test had been established to determine whether a savings clause sufficiently restrains an employer's unilateral right to terminate its obligation to arbitrate.  "Retaining termination power does not make an agreement illusory so long as that power

1. Extends only to prospective claims;
2. Applies equally to both the employer's and employee's claims; and
3. So long as advance notice to the employee is required before termination is effective."

Based upon the facts in this case, the Court held that the Arbitration Plan was illusory because it failed to include a savings clause that required advance notice of to the employee before termination or amendment to the Plan would become effective.  According to the language of the Arbitration Plan, Watch House could make unilateral changes to the Plan, including termination, and that such changes "shall be immediately effective upon notice to" employees.  (Note I emphasized the fact that the termination/changes to the Plan would become immediately effective...without giving the employee advance notice).  Based upon prior caselaw, this retention of unilateral power to terminate the Plan without advance notice rendered it illusory and thus doomed Watch House. 

Judgment:  The Fifth Circuit Court of Appeals reversed the District Court's granting of Watch House's motion to compel arbitration on the grounds that the Arbitration Plan at issue was illusory because it failed to include a savings clause which would provide advance notice to the employee before termination or amendment to the Plan became effective.

The Takeaway:  This was a very interesting case that I highlight for the sole reason that the Fifth Circuit did a good job walking through some rather complex caselaw in regard to the validity of arbitration agreements.  While some/many arbitration agreements are certainly slanted in favor of employers, this Arbitration Plan likely would have been upheld had Watch Hose included a saving clause as required by the three prong test.  The failure to include the all important third prong proved to be fatal to an otherwise (likely) enforceable arbitration agreement.  

Lesson learned employers:  Take care to ensure that when dealing with arbitration provisions, all the requirements are satisfied before implementing these types of plans.  Failure to do so could mean that instead of arbitrating an employee's dispute, the case would go before an oftentimes employee friendly jury to decide...which can result in a less than favorable outcome for employers.

Majority Opinion Judge:  Chief Judge Stewart

Date:  March 2, 2016

Opinion:  hr.cch.com/eld/NelsonWatch030216.pdf