March 2, 2016

March 2, 2016:

Fifth Circuit holds that an arbitration agreement in an employee handbook is unenforceable because it did not require that the employer provide advance notice to the employee before terminating the arbitration agreement.  Nelson v. Watch House International, L.L.C., 815 F.3d 190 (5th Cir. 2016).

Watch House International, L.L.C. hired Michael Nelson and provided him with its employee handbook and arbitration plan.  The arbitration plan provided that it could not be altered "except by consent of the Company," that any change would "only be effective upon notice" to the employee, and that any change "shall only apply prospectively."  815 F.3d at 191-92.  The arbitration plan did not require that Watch House provide advance notice to Nelson before terminating the plan.  Nelson filed a discrimination action in federal court, and Watch House moved to compel arbitration.  Finding that the arbitration plan was not illusory under In re Halliburton Co., 80 S.W.3d 566 (Tex. 2022), the district court granted Watch House's motion to compel arbitration and dismissed the case.  The Fifth Circuit reversed, finding the arbitration plan illusory and, therefore, unenforceable for lack of consideration.

Under governing Texas law, an agreement to arbitrate is illusory, and therefore unenforceable for lack of consideration, "'[w]here one party has the unrestrained unilateral authority to terminate its obligation to arbitrate.'"   815 F.3d at 193 (quoting Lizalde v. Vista Quality Markets, 746 F.3d 222, 225 (5th Cir. 2014)).  In Halliburton, the Texas Supreme Court held that an arbitration agreement was not illusory, and was therefore enforceable, when the employer could terminate the arbitration agreement only upon ten days advance notice to the employee and termination of the arbitration agreement would not apply to disputes that arose before the termination.  80 S.W.3d at 569-70.  Following Halliburton, in Lizalde v. Vista Quality Markets, the Fifth Circuit "articulated a simple, three-prong test to determine whether a Halliburton-type savings clause sufficiently restrains an employer's unilateral right to terminate its obligation to arbitrate."  815 F.3d at 193-94.  "'[R]etaining 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 an advance notice to the employee is required before termination is effective.'"  Lizalde, 746 F.3d at 226 (citing Halliburton, 80 S.W.3d at 569-70).  Based on a review of relevant Texas and Fifth Circuit cases, the Fifth Circuit in Watch House rejected Watch House's claim that only the first prong of the Lizalde test need be met for enforceability of an arbitration agreement and concluded that "Lizalde's three-part test remains an accurate statement of Texas law."  815 F.3d at 195.  The Watch House arbitration plan did not meet the third prong of the Lizalde test because it did not require advance notice to the employee of termination of the plan.  Accordingly, the arbitration plan was illusory, and therefore, unenforceable for lack of consideration.

The lesson of Watch House is straightforward.  For an arbitration agreement in an employee handbook to be enforceable, all three prongs of the Lizalde test must be met.  An employer's power to terminate the arbitration agreement must extend only to prospective claims.  The power to terminate must apply equally to both employer and employee claims.  And advance notice to the employee must be required for termination of the arbitration agreement.  If the arbitration agreement fails to meet even one of these requirements, the agreement is illusory and unenforceable for lack of consideration.   

 

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