A New Strategy for Regulating Arbitration

Confidential arbitration is a standard precondition to employment. But confidential arbitration prevents a state from ensuring or even knowing whether employees’ economic, civil, and due process rights are respected. Further, employers regularly require employees to waive rights to class proceedings (thereby foreclosing small claims) and to arbitrate under the laws of another jurisdiction (thereby evading mandatory state law). In response, states have tried to regulate arbitration provisions, arbitral awards, and arbitral processes. But these efforts have all failed because the Supreme Court says they are preempted by the Federal Arbitration Act. In this Article, I argue that states can and should adopt a new strategy: Deter parties from forming such contracts in the first place. The Article proceeds in three parts. First, I explain the problem. Over the last fifty years, the Supreme Court systematically immunized arbitration provisions against every plausible contract defense. Yet the Supreme Court continues to insist that, just as the Federal Arbitration Act requires, arbitration agreements are still subject to “generally applicable contract defenses, such as fraud, duress, or unconscionability.” This is false. Second, I present the first large-scale evidence on the pervasiveness of arbitration. The Supreme Court’s arbitration precedents have effect only to the extent private parties agree to arbitrate their disputes. To study this, I use machine-learning protocols to parse millions of filings with the Securities and Exchange Commission and create a database of nearly 800,000 contracts formed by public companies. These contracts include employment agreements, credit agreements, joint ventures, purchases, and others. Employment contracts are by far the most likely to include a mandatory arbitration provision. Finally, I argue that, because the Supreme Court has all but stripped states of their power to enforce contracts, states should adopt policies that deter formation of objectionable contracts. For example, states cannot prohibit forced arbitration of sexual harassment claims. They can, however, prohibit sexual harassment as a subject matter for employment contracts; they can also enforce this with civil penalties and whistleblower rewards. Similarly, states cannot stop an employer from arbitrating under the laws of another jurisdiction, thereby evading mandatory limits on noncompete agreements. But states can declare noncompetes illegal, levy civil fines on employers that form them, and again offer employees whistleblower rewards to report violations. These approaches work because they create a cause of action for a third party—the state—who is not subject to the arbitration agreement. And unlike past efforts, these laws would not be preempted because they do not “derive their meaning from the fact that an agreement to arbitrate is at issue.