Fifth Circuit Finds Arbitration Clause in Employee Handbook Was “Illusory”

Though federal policy strongly favors arbitration, there are limits. (See our other arbitration posts here.) Last month, in Carey v. 24 Hour Fitness USA Inc., the Fifth Circuit held that an employer’s arbitration clause was invalid because it was illusory.

The employee filed a class action under the Fair Labor Standards Act on behalf of employees who were allegedly denied overtime pay. The employer tried to compel arbitration by relying on an arbitration provision in the employee handbook. The handbook, however, also stated that the employer “has the right to revise, delete and add to the employee handbook.” The district court found that the arbitration provision was illusory under Texas law. The Fifth Circuit affirmed on the grounds that, under Texas law, arbitration agreements are invalid unless they specify that unilateral changes made by an employer will not have a retroactive effect against the employee. The Court noted:

Where one party to an arbitration agreement seeks to invoke arbitration to settle a dispute, if the other party can suddenly change the terms of the agreement to avoid arbitration, then the agreement was illusory from the outset.

This decision demonstrates another line of attack plaintiffs can use to attempt to defeat arbitration agreements under state law. But will this stand up in light of the Supreme Court’s recent arbitration rulings that favor federal policy over state law theories, such asAT&T v. Concepion? Let us know your thoughts in the comments, and stay tuned.

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3 Responses to Fifth Circuit Finds Arbitration Clause in Employee Handbook Was “Illusory”

  1. Eric Griesel says:

    Hi Oni,
    Sadly, this sounds more like a 9th Circuit decision to me.

    From a practical application perspective on the employer’s side, the court is forcing them into a very tight corner. With the proper disclaimers, the Handbook has never been viewed as a contract. However, what the Court now seems to be doing is to elevate that status through the back door. There is no telling what sort of hornet’s nest this decision will usher into the employment law arena.

  2. Michael E. Miller says:

    This case (Carey) seems not to be about arbitration clauses so much as generally about the effect of the reserved right of one party unilaterally to amend provisions of a contract (or rules incorporated into a contract), specifically whether that makes the amendable provisions illusory. My problem with the case is the Court’s misunderstanding (perhaps going back to the Torres case or earlier) of the so-called “savings clause” in the Halliburton case. Of course, a contract will not be illusory if it specifies that no amendment will have retroactive effect (i.e., apply to an event that occurred before notice of the amendment is given to the other parties). But that doesn’t determine what the proper ruling should be in the absence of such a “savings clause” (I use scare quotes here because this is not a true savings clause unless one begs the question about what the rule of law would be in its absence). The Court assumes without any good reason that any amendment will have retroactive effect unless the contract specifies that it won’t. That seems like an odd rule, especially if the effect is to render a contract illusory, since it seems to run counter to the rule that one should interpret contracts to give effect to the parties’ intention, rather than to interpret them so as to make them invalid or unenforceable, unless the contract language cannot be understood any other way. If the contract does not specify one way or the other whether an amendment will have retroactive effect, it seems wrong for a court to interpret the parties as having meant that it will have retroactive effect, thereby rendering the provision illusory.

  3. Steve Badger says:

    Thanks Eric and Michael for your thoughtful comments to Oni’s piece. It certainly seems like a better rule — and one consistent with the strong policy in favor of arbitration — would be to deny an employer from actually exercising any right to modify the arbitration clause retroactively after a dispute has arisen. That would seem to me to avoid the problem of an illusory “contract,” while not disrupting the expectation disputes would be subject to arbitration.

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