Court Refuses to Enforce "Misleading" and "Sham" Arbitration Agreements

PDF

Courts usually enforce mandatory arbitration agreements in the employment context if the agreements are not too one-sided. 

But last month, in Degidio v. Crazy Horse Saloon & Restaurant, 2018 WL 456905 (4th Cir. Jan. 18, 2018), a three-judge panel of the U.S. Fourth Circuit Court of Appeals affirmed a trial court judge’s decision that an employer could not enforce arbitration with  workers who had opted in to a Fair Labor Standards Act (FLSA) collective action.  (The Fourth Circuit is the federal appeals court with jurisdiction over the Carolinas.)  And last week, the court denied the employer’s petition for rehearing by the entire court (4th Cir. Feb. 13, 2018).

The case started in August 2013 when an “exotic dancer” at a club in Myrtle Beach, South Carolina, filed suit under the FLSA claiming she and other dancers were wrongly classified as independent contractors and denied minimum wage and overtime pay.  Soon thereafter, several dancers joined the lawsuit.  At the time, none of the dancers had arbitration agreements with the club. 

In late 2014, after 15 months of discovery, the club required some of its dancers to sign arbitration agreements.  One month later, the club moved for summary judgment on the merits, arguing that the dancers were properly classified as independent contractors, but not mentioning the arbitration agreements.  A month after that, the club filed a motion to compel arbitration against dancers who had signed the agreements. 

In September 2015, the trial court ruled that the dancers were employees under the FLSA; at the same time, it raised concerns about the enforceability of the arbitration agreements.  Thereafter, new plaintiffs joined the suit, and the club eventually filed a new motion to compel arbitration against dancers who had opted into the case since its first motion.  That new motion to compel was also denied. 

The employer appealed.  In upholding the trial court’s ruling, the Fourth Circuit cited the club’s failure to timely seek to compel arbitration, concluding that a “litigant may waive its right to invoke [arbitration] by so substantially utilizing the litigation machinery that to subsequently permit arbitration would prejudice the party opposing the stay.”  The appeals court also noted that “Crazy Horse employed judicial proceedings to pursue a litigation strategy for over three years … [i]nstead of filing a motion to compel arbitration at an early stage in the litigation process, … forcing plaintiffs and the district court to spend unnecessary time and resources.”

The Fourth Circuit further determined that the arbitration agreements were “misleading” and a “sham.” In an effort to persuade the dancers to sign the agreements and not join the lawsuit, the appeals court found that the club had falsely told the dancers that they could only keep tips and set their own schedules if they were independent contractors.  As such, the club obtained the agreements in a “furtive manner” that was “ripe for duress” and “rendered [the club’s] conduct indefensible.”

Arbitration generally allows employers to resolve disputes in a potentially quicker and more efficient manner without risking the uncertainties caused by juries and the potential for a runaway verdict.  As the Fourth Circuit stated in Degidio, “Arbitration is a valuable means of resolving disputes expeditiously, but this case shows that it can sometimes be abused.” 

The employer in Degidio appears to have misrepresented the law in an effort to convince employees to sign arbitration agreements, as well as abused the judicial and arbitration processes.  When developing an alternative dispute resolution program, it is important for employers to use arbitration agreements that are objectively evenhanded.  It is equally important that communications with employees about the agreements—and about any pending litigation—be factual and free of duress.

Our Insights are published as a service to clients and friends. They are intended to be informational and do not constitute legal advice regarding any specific situation.