CUSTOMIZING EMPLOYMENT ARBITRATION, PART 3

Erin O’Hara O’Connor

Florida State University College of Law

Kenneth J. Martin

Randall S. Thomas

Customizing Employment Arbitration

Table 9

Regression Results
(/►VALUES IN PARENTHESES)

CARVEDUM = 1 if contract includes at least one carveout, o if there are no carveouts. PCTCARVE = number of carveouts divided by 6 (the maximum number of carveouts), CARVEDUM ex-Prelim is 1 if contract includes at least one carveout that is not for Preliminary Relief, o otherwise. CALIFORNIA is a dummy variable equal to 1 if the firm’s primary location according to Compustat is in California, o if not. IT is a dummy variable equal to 1 if the firm is categorized by Compustat in the GICS information technolog)’ sector. CA x IT is an interaction variable computed as CALIFORNIA times IT. FIRM_SIZE is the In (company sales) in the start year of the CEO’s contract. INDUSTRY_CHANGE is measured by the percentage of companies in a firm’s GICS economic sector deleted from COMPUSTAT due to acquisition, merger, bankruptcy, or liquidation in the year in which the CEO employment contract started. 5- YILAR.AVG.ROC is the five-year average return on capital beginning with the year prior to the start year of the CEO’s contract. ARB_IN_PRIOR_CONTRACT is a dummy variable equal to 1 if a previous CEO contract at the company included an arbitration clause, o if not. YE1AR is equal to the beginning calendar year of the contract.

Dependent Variable	CARVEDUM	CARVEDUM	PCTCARVE	PCTCARVE	Ex-Prelim	Ex-Prelim
Independent Variables	(»)	(2)	(3)	(4)	(5)	(6)
Intercept	-254.30** (0.02)	-250.20** (0.02)	-47.89*** (0.001)	-47-43*** (O.OOl)	-208.70* (0.06)	-205.60* (0.06)
CALIFORNIA	-O.18 (0.49)	-O.61* (0.10)	-0.14*** (0.0003)	-0.17*** (O.OOO4)	-0.84*** (0.005)	-1.08**
INFOTECH	0.26 (0.29)	O.04 (0.88)	-0.03 (0.38)	-0.05 (0.l8)	0.15 (0.56)	0.06 (0.83)
CA x IT		0.96* (0.09)		0.09 (0-23)		0.50 (o-43)
FIRM_SIZE	O.Ol (0.88)	-O.OO5 (0.94)	0.01 (0.27)	0.009 (°-35)	0.06 (°-34)	0.06 (0.40)
INDUSTRY. CHANGE	-i-38 (0.67)	-I.46 (0.65)	0.005 (°-99)	O.OOO3 (°-99)	-O.69 (O.84)	-0.74 (0.83)
5-YEAR. AVG.ROC	-O.OO7 (0.36)	-O.O06 (043)	-0.0008 (0.43)	-0.0008 (0.47)	-O.OO7 (0.36)	-0.007 (°-39)
ARB_IN_ PRIOR. CONTRACT	-0.27 (0.2l)	-O.25 (0.24)	-0.04 (0.15)	-O.O4 (0.16)	-O.08 (0.69)	-O.08 (0.72)
YEAR	O.I3** (0.02)	O.I3** (0.02)	0.02*** (0.001)	0.02*** (O.OOl)	O. IO* (0.06)	O. IO* (0.06)
N	469	469	469	469	469	469

 

Dependent Variable	CARVEDUM	CARVEDUM	PCTCARVE	PCTCARVE	Ex-Prelim	Ex-Preli m
Likelihood ratio Chi- Squared	18.67**	21.69***			21.17***	21.82 ***
(Rvalue)	(0.01)	(o.Ol)			(0.003)	(0.005)
F-value			6.00***	5-43
(p-value)			(<0.0001)	(<0.0001)
Adjusted Rz			0.0696	0.0705

***, **, * indicate statistical significance at the .01, .05, or .10 level, respectively

 

1. Implications and Conclusions

Our findings have significant implications for the arbitrability of employment claims generally and for the advisability of a mutuality doctrine that heavily scrutinizes carveouts designed to protect the value of a company’s information, reputation, and innovation. Our findings also highlight the potential importance of arbitration carveouts for better understanding circumstances under which parties affirmatively demand courts. Subpart A discusses the implications of our study for understanding carveouts more generally, and Subpart B concludes by highlighting the policy implications that can be gleaned from CEO employment contracts.

1. Information; Reputation; Innovation; and the Need for Further

Carveout Studies

Carveouts should receive more attention in academic literature. The phenomenon has so far received little systematic study. Only Christopher Drahozal has thought it worthwhile to observe contracting party use of carveouts, although carveouts are but a small piece of his empirical projects.-⁰* Our study contributes to an understanding of carveouts and their function because we observe many of the same types of carveouts in CEO employment contracts that were observed in franchise agreements. The similarities in carveout use are potentially instructive in that they provide information about the perceived advantages of courts relative to arbitration. However, the available empirical evidence raises many more questions than it answers.

Like the CEO employment contracts, approximately 45% of Drahozal’s franchise contracts include arbitration clauses.-°s One might therefore conclude that contracting parties in both contexts perceive the relative ^{[1] [2]} advantages of arbitration and litigation to be about equal. Far more franchise contracts provide carveouts from arbitration than do the CEO employment contracts, however. Only about half of the CEO employment contracts with arbitration clauses contain carveouts, but virtually all of the franchise agreements contain them.^[3] Why are there fewer carveouts in the CEO employment contracts? One explanation is that a higher fraction of franchise contracts are not negotiated; thus, the franchise contracts could more closely represent the preferences of the franchisor, which are muted in the CEO contracts by the ability of CEOs to have their preferences observed. This possibility is strengthened by the fact that the franchise contracts studied are the company’s standard-form contract, so even if individual franchisees can bargain to change the agreement, those changes would not appear in the empirical results. Another explanation, explored below, is that legal restrictions force the parties in the CEO employment contract negotiations to incorporate fewer carveouts in their agreements than appear in franchise contracts. And finally, because guidelines for standard-form contracts are publicly available,^[4] franchise contracts might have achieved a greater degree of industry standardization than have CEO employment contracts. Obviously, more study of these carveouts is needed.

Other questions beg for the further study of carveouts from arbitration. Are carveouts equally present in other types of arbitration clauses? There is evidence that consumer contracts often carve out consumers’ small claims,^[5] probably because the major arbitration associations^[6] (and some courts)^[7] require that consumers be granted these protections.

Is the frequency of the use of carveouts positively or negatively correlated with the use of arbitration clauses in the first place? Put differently, do carveouts make parties more comfortable with arbitration, increasing the use of arbitration clauses, or do carveouts signal problems with arbitration such that a high incidence of carveouts may serve as a proxy for a relatively low demand for arbitration? As an initial matter, in the regression, the presence of an arbitration clause in a prior contract did not significantly affect the likelihood of the presence of a carveout, suggesting that parties long comfortable with arbitration seemed to use carveouts just as often (or as rarely) as other parties. We can glean relatively little from this observation, however. Some carveouts might be positively correlated and some negatively correlated with the use of arbitration clauses. For example, it is likely that some carveouts aid or facilitate arbitration, and we would expect those to be positively correlated with the use of arbitration clauses.

Preliminary relief carveouts might serve this function. Others, especially carveouts for the resolution of claims rather than remedies, might signal general disadvantages to arbitration. Here, a negative correlation is more likely. A comparison of California and non-California firm contracts, presented below, shows this basic pattern, but again, much more study is needed.

Are carveouts equally common for contracting parties outside the U.S.?^[8] Are they perhaps less common in cross-border contracts, where concerns about a neutral litigation forum might arise?^[9] Are different types of carveouts present in contracts drafted by parties outside of the U.S.? To the extent that carveouts reflect the relative advantages of courts and arbitration, a country with a weaker or stronger judiciary and/or weaker or stronger arbitral forums might generate very different carveout behaviors.^[10]

Despite a large number of unanswered questions, the carveouts studied in the CEO employment contracts are instructive and can be used to reach tentative conclusions. For one, the carveouts present in these contracts, as well as in the franchise contracts, seem primarily focused on using courts to protect the value of the firm’s information, reputation, and innovation. These carveouts suggest that although arbitration may provide a cost- effective and otherwise efficient mechanism for parties to enforce standard contractual rights and for recovering standard legal remedies, courts are needed to provide property-type protections, including the provision of equitable relief. Property-type protections can provide relief swiftly,^[11] they can help prevent future violations,^[12] and they can help parties protect against loss to third parties.^[13] These features are especially important in cases where money damages are likely hard to prove and are, therefore, often unrecoverable.^[14]

Of course these insights could be sharpened with further study. For example, when parties carve out disputes for courts, which courts do they choose? Are the parties seeking the advantages of particular courts, or do they wish to preserve the right to obtain relief in any court where the contract rights are likely to be violated (rights to information, reputation, and innovations are intangibles)? To the extent that parties contract for particular courts at least some of the time, those choices can provide lessons to other courts about how to better protect and promote these interests. Future studies should also identify any links between the use of carveouts and the parties’ choice of arbitral forum. Some arbitral forums may better provide quick relief to the parties prior to the start of formal arbitral proceedings, or they might provide for expedited arbitration in certain circumstances.^[15] Do contracts choosing these arbitral forums contain fewer carveouts? If so, the results could provide guidance to other arbitration associations regarding their services.

1. Carveouts and Unconscionability

The arbitration clauses in CEO employment contracts have important policy implications for the regulation of employment arbitration clauses more generally. For most employment contracts, the employer unilaterally drafts the agreement with the vast majority of terms offered to the employee on a take-it-or-leave-it basis. Recently, attention has focused on arbitration clauses in employment contracts. Although arbitration can provide cheap and quick dispute resolution that carries the promise of preserving the employment relationship, it can also be used to disadvantage employees in unfair ways. First, in some cases the costs of arbitration are so high that, if forced to pay them, the employee can be effectively prevented from vindicating some or all of her claims.^[16] Cost concerns have been addressed by employers, who have in many cases agreed to pay some or all of the arbitration costs,^[17] and by arbitration associations, which now offer low-cost arbitration of employment disputes.^[18]

Second, arbitration agreements can have the effect of circumventing procedural and other statutory safeguards provided to employees.^[19] Here too some of the arbitration associations have provided for the protection of employees with Due Process Protocols,^[20] and a review of the case law indicates that employers have responded to judicial and private pressures by incorporating fairer provisions into their arbitration clauses. The difficulties, however, have not been fully resolved, due in part to weaker discovery rules, fee-shifting provisions, and other procedural devices put in place to provide cheaper employment arbitration.^[21]

Third, even with ostensibly fair cost and procedural provisions, some express concern that arbitration is inevitably biased toward the employer. Specifically, the concern is that some arbitrators feel beholden to the employer, as a repeat player and the party responsible for the arbitration bill; and moreover, the employer, knowing more about how arbitrators are likely to resolve disputes, is able to make a self-interested choice.^[22] In response to this concern, at least one California court has determined that it is suspect for a large employer to designate an arbitral forum and district with a small number of available arbitrators.^[23] Note that the larger firms’ contracts in our sample were more likely to choose the larger AAA dispute resolution. Perhaps this is a result of active bargaining on the part of the CEOs.

As mentioned earlier, members of Congress have responded to these and other concerns by introducing a bill entitled the Arbitration Fairness Act that would prohibit the enforcement of predispute mandatory binding arbitration clauses in employment and consumer contracts.^[24] In an earlier article we argued that the CEO contracts provided evidence that a blanket prohibition on the enforcement of employment arbitration clauses would be overly broad.^[25] After all, the CEO contracts were jointly negotiated by sophisticated parties who were often represented by attorneys, and half of these contracts called for employment arbitration typically specifying the same arbitration forums and rules that are chosen for other employment contracts. The CEO contracts provide a glimpse of what employment contracts would look like if employees had roughly equal bargaining power with their employers, and they therefore indicate that arbitration likely is often in the interests of employees. To be sure, the unilaterally imposed contracts should be scrutinized to ensure that individual arbitration provisions are fair to employees, but a blanket prohibition on the enforcement of arbitration clauses seemed unwarranted.

Our analysis also indicates that the California court condemnation of the types of carveouts that we observed is misplaced. Recall that the California courts will strike the arbitration clause from an employment contract when the employer has carved out some of its claims for court resolution. Although California state law purports to permit these carveouts if the employer proves that they serve a legitimate business justification, to date it appears that no California appellate court has deemed an offered justification to be sufficient. And yet, the justifications offered by employers—a need for quick relief in order to effectively protect information and intellectual property, a need to protect against future violations, and a need to establish intellectual-property rights as against third parties—do seem to be legitimate justifications for the carveouts. The CEO contracts lend credence to these justifications, especially since these carveouts seem to be valuable enough to firms to commonly appear in heavily negotiated agreements. In fact, taken as a whole our CEO contract analysis provides substantial evidence that the types of carveouts we observe with some frequency should be considered per se justified by legitimate business purposes. Court protection of overreaching by employers in the context of employment arbitration provisions might well make sense, but this particular form of paternalism is not necessary.^[26]

Indeed, our study suggests that California court paternalism is more than simply unnecessary; it has the effect of denying firms a tool they apparently find valuable for protecting the value of the firm’s information, reputation, and innovation. Specifically, as our study indicates, firms primarily located in California are significantly less likely to carve out claims for resolution by courts than are firms located elsewhere. Given that firms located elsewhere seem to derive value from the carveouts, the California doctrine has the effect of destroying economic value and should not be adopted by other courts.

[1]         See supra note 21.

[2]         Drahozal, Unfair Arbitration Clauses, supra note 21, at 726—27.

[3]         Id. at 739-40.

[4]         See, e.g., 2008 Franchise Registration and Disclosure Guidelines, N. Am. Sec. Adm’RS Ass’n, Inc., http://mn.gov/commerce/images/NASAA_guidelines.pdf (last visited Aug. 27, 2012).

[5]         Rutledge & Drahozal, supra note 60, at 5, 15.

[6]          See Am. Arbitration Ass’n, supra note 61.

[7]         Rutledge & Drahozal, supra note 60, at 2.

[8]         One of us is in the process of studying carveouts in technology firm business contracts. For example, in contracts involving two Chinese firms, no carveouts were found. O’Connor, supra note 22.

[9]         See id. (finding that carveouts are also popular for cross-border contracts, but the sample is small, and almost all contracts include one U.S. contracting party).

[10]       Id. (comparing contracts between U.S. companies with contracts between Chinese companies).

[11]       Cf. Alisha Kay Taylor, What Does Forum Shopping in the Eastern District of Texas Mean for Patent Reform?, 6 J. MARSHALL REV. INTELL. PROP. L. 570, 577 (2007) (noting that in intellectual- property litigation, quick injunctive relief is sought “because time is of the essence”).

[12]       This was a business justification offered in Mercuro v. Superior Court, 116 Cal. Rptr. 2d 671, 677-78 (Ct. App. 2002).

[13]       Cf. Eileen M. Kane, Patent-Mediated Standards in Genetic Testing, 2008 UTAH L. Rev. 835, 864 (2008) (discussing use of injunctions to prevent third-party violations of patent rights as a property protection).

[14]        See Mercuro, 116 Cal. Rptr. 2d at 677-78.

[15]       See, e.g., IP Law 360, Alternative Dispute Resolution for Copyright and TRADEMARK MATTERS 4 (2006), available at http://www.foreclosuremediationfl.adr.org/si.asp? id=4328; Peter J.W. Sherwin & Douglas C. Rennie, Interim Relief Under International Arbitration Rules and Guidelines: A Comparative Analysis, 20 Am. Rev. Int’L Arb. 317, 322-29 (2009).

[16]       See generally Michael H. LeRoy & Peter Feuille, When Is Cost an Unlawful Barrier to Alternative Dispute Resolution? The Ever Green Tree of Mandatory Employment Arbitration, 50 UCLA L. Rev. 143 (2002) (surveying federal court cases addressing concerns regarding the employee’s arbitration costs).

[17]       See Christopher R. Drahozal, Arbitration Costs and Forum Accessibility: Empirical Evidence, 41 U. MICH. J.L. Reform 813, 823-25 (2008) (discussing studies demonstrating an employer’s willingness to pay for an employee’s arbitration costs).

[18]       See, e.g., Am. Arbitration Ass’n, Employment Arbitration Rules and Mediation PROCEDURES 40-42 (2010), available at http://www.adr.org/aaa/ShowProperty?nodeId=/ UCM/ADRSTG_004362&revision=latestreleased (documenting the costs of an arbitration “For Disputes Arising Out of Employer-Promulgated Plans”).

[19]       See Martin H. Malin, Ethical Concerns in Drafting Employment Arbitration Agreements After Circuit City and Green Tree, 41 BRANDEIS L.J. 779, 786 (2003) (discussing such possibility).

[20]        See, e.g, Am. ARBITRATION ASS’N, supra note 61 (including the Due Process Protocol).

[21]       See, e.g, Trivedi v. Curexo Tech. Corp., 116 Cal. Rptr. 3d 804 (Ct. App. 2010) (finding unacceptable a provision entitling the prevailing party to recover attorney fees because it has the effect of circumventing state antidiscrimination law protections for employees); Fitz v. NCR Corp., 13 Cal. Rptr. 3d 88 (Ct. App. 2004) (striking arbitration clause for multiple problems, including curtailment of an employee’s discovery rights).

[22]        See supra note 114-16 and accompanying text.

[23]        See supra note 128.

[24]        See supra note 122 and accompanying text.

[25]        See Thomas, O’Hara & Martin, supra note 50, at 999-1000.

[26]      Note that California courts might well be trying to keep employees from having to arbitrate whenever possible, but that this systemic hostility to arbitration is not permitted under the FAA. See AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011) (striking down California’s unconscionability rule that had the effect of nullifying class arbitration waivers).