California Supreme Court Issues Important Decisions Regarding Disability Discrimination, Bonus Programs, and Class Action Waivers in Arbitration Agreements

September 19, 2007

In August 2007, the California Supreme Court issued three decisions of interest to California employers. The first, Green v. State of California, resolves the question of whether an employee alleging disability discrimination under the state law must prove that he is qualified for the job in question. The second, Prachasaisoradej v. Ralphs Grocery Company, addresses "a significant question of California wage law" in the context of bonus or incentive programs. Finally, the California Supreme Court's decision in Gentry v. Superior Court addresses the enforceability of a class action waiver in an employment arbitration agreement.

Green v. State of California

In Green v. State of California, the California Supreme Court established that when an employee sues an employer for disability discrimination under the Fair Employment and Housing Act (FEHA), the employee first is required to prove that he or she is qualified to perform his or her job duties, with or without accommodation. While the court's conclusion is seemingly obvious, it has now resolved a question that previously troubled both lower courts and practitioners. The court itself wrestled with the outcome, as reflected in its 4-3 decision favorable to California employers.

In reaching its decision, the court notably relied heavily on the federal Americans with Disabilities Act (ADA), and what it perceived as the legislature's intention to mirror some of its key provisions—including who was entitled to protection under the anti-disability discrimination statute. The ADA explicitly requires the plaintiff to prove that he or she is a "qualified individual" with a disability. In other words, a plaintiff alleging discrimination on the basis of a disability must prove that he or she, with or without reasonable accommodation, is able to perform the essential functions of the position in question. The court rejected the plaintiff's argument that, under FEHA, an employee did not have that burden and that, instead, the employer could prove an employee's inability to do the job as an affirmative defense. Rather, the court made clear that FEHA's prohibition on disability discrimination excludes from coverage "those persons who are not qualified, even with reasonable accommodation, to perform essential job duties."

The court also drew support for its holding from Evidence Code Section 500, which articulates the general rule in California that "a party has the burden of proof as to each fact the existence or nonexistence of which is essential to the claim for relief...that he is asserting." As a result, the court concluded, "it is reasonable to require a plaintiff who alleges a FEHA violation as a basis for recovery to prove the elements of a claim for violation of the Act, including by proving the element that the defendant impermissibly discriminated because the plaintiff was able to do the job with or without reasonable accommodation."

In Green, the California Supreme Court has reaffirmed that employment anti-discrimination laws are about prohibiting discrimination based on prohibited factors, and that it is the plaintiff's burden to prove such discrimination—including the element in question here. The court's heavy reliance on the ADA's use of the term "qualified individual with a disability" also signals to courts and lawyers alike that they increasingly should look to the ADA for guidance as to how the California Supreme Court will resolve FEHA disability discrimination issues.

Prachasaisoradej v. Ralphs Grocery Company

In Prachasaisoradej v. Ralphs Grocery Company, the California Supreme Court held that an employee incentive compensation plan (ICP) based on total profit calculations that included deductions for workers' compensation insurance costs, cash and inventory losses, breakage, and third-party tort claims, did not violate certain sections of California's Labor Code or Regulation 11070. The court concluded that nothing in statutes, regulations, or case law prohibited Ralphs or any other California employer from offering its employees, over and above their guaranteed base wages, supplementary incentive compensation on the basis of business profits that remain after legitimate business expenses.

The plaintiffs argued that the ICP structure violated Labor Code sections 221, 400 through 410, and 3751, as well as Regulation 11070, by requiring employees to bear expenses that the law requires the employer to bear, such as workers' compensation expenses, cash shortages, costs of merchandise damage or loss, and third-party tort claims that are not attributable to the eligible employee's own dishonesty, willfulness, or gross negligence. Moreover, the plaintiffs argued that the stated and expected wage impermissibly was subjected to unanticipated deductions, withholdings, and/or reimbursement to the employer for expenses beyond the employee's control.

Emphasizing that Ralphs' ICP was a supplementary incentive compensation system plan, the California Supreme Court rejected the arguments brought on behalf of an alleged class of employees. The plan at issue provided compensation that was openly contingent on profitability, separate and in addition to an employee's regular and anticipated wage. In determining ICP compensation under the plan, and "pursuant to normal concepts of profitability," Ralphs factored in ordinary business expenses, such as storewide workers' compensation costs, and storewide cash and merchandise losses, along with such other store expenses as the electric bill and the cost of goods sold. By its nature, therefore, the ICP was to be fluctuating and uncertain, and the plan made clear that any final compensation amount would be contingent upon events subsequent to performance of services. Ralphs' ICP did not offer or promise its employees a specified bonus or commission, based on individual efforts, that the employer subsequently subjected to deductions to cover the employer's costs.

The court determined that Ralphs' plan did not illegally shift those costs to employees, and that "[t]o hold otherwise would make every kind of achievement-based supplementary incentive compensation system, whether based on individual or overall business performance, illegal."

Of additional significance to employers, however, is that the court reaffirmed established concepts in California wage and hour law. First, California law zealously protects earned wages, and carefully scrutinizes deductions from those wages to ensure that they are not impermissible efforts to recapture wages already earned or paid. In particular, employers cannot deduct from wages amounts representing cash shortages, breakage, or loss of equipment not caused by the employee's dishonesty, willful acts, or culpable negligence. Generally speaking, employers cannot make employees the insurers of their business losses, subjecting employee wages to unpredictable deductions for losses due to factors beyond the employee's control. Nothing in Ralphs changes this traditional body of law. Second, Ralphs reaffirms that "where parties so understand and agree, final compensation, or at least a portion thereof, may be contingent on events that occur after the employee has performed service, and even where he or she has already received advance sums." Third, and finally, the decision underscores the importance of having written bonus or incentive compensation plans that clearly set forth how amounts above and beyond regular wages already owed will be calculated and establishes precisely when those amounts will be earned.

Ralphs carefully considered each of these concepts in concluding that profit-based supplementary compensation based on total profit, even if it takes into account expenses that are out of an employee's control, does not necessarily violate the wage protection policies of the Labor Code and Regulations.

Gentry v. Superior Court (Circuit City Stores, Inc.)

In a decision less favorable to California employers, the California Supreme Court in Gentry v. Superior Court addressed the question of whether class arbitration waivers in employment arbitration agreements are enforceable. While the use of such waivers is not widespread, many in the employer community eagerly awaited the decision. In Gentry, a (once again) narrowly divided court provided no definitive answer. While the court rejected the proposition that all class arbitration waivers in overtime cases are unenforceable, it concluded that under some circumstances such a provision would lead to a de facto waiver of the statutory right to receive overtime pay and would therefore impermissibly interfere with employees' ability to vindicate unwaivable rights and to enforce the overtime laws.

The case arose after Gentry, a Circuit City employee, filed a class action lawsuit on behalf of salaried customer-service managers he alleged were illegally misclassified by Circuit City as exempt employees not entitled to overtime pay. At the time of his hiring, Gentry signed an arbitration agreement that contained a class arbitration waiver. The trial court granted Circuit City's motion to compel arbitration pursuant to the agreement and, in light of the class arbitration waiver, ordered Gentry to arbitrate his claims on an individual basis.

Remanding the case to the Court of Appeal with instructions to remand to the trial court, the court directed the trial court to consider four factors prior to determining whether the waiver was enforceable: (1) the modest size of the potential individual recovery; (2) the potential for retaliation against members of the class; (3) the fact that absent members of the class may be ill informed about their rights; and (4) other real-world obstacles to the vindication of class members' right to overtime pay through individual arbitration. The court explained that "[i]f [the lower court] concludes, based on these factors, that a class arbitration is likely to be a significantly more effective practical means of vindicating the rights of the affected employees than individual litigation or arbitration, and finds that the disallowance of the class action will likely lead to a less comprehensive enforcement of overtime laws for the employees alleged to be affected by the employer's violations, it must invalidate the class arbitration waiver to ensure that these employees can 'vindicate [their] unwaivable rights in an arbitration forum.'"

In another setback for California employers, the court also reversed the Court of Appeal's decision that a 30-day opt-out provision in Gentry's arbitration agreement, which gave Gentry the ability to opt out of the arbitration agreement entirely, rendered Circuit City's arbitration agreement not procedurally unconscionable. The California Supreme Court stated that "there are several indications that Gentry's failure to opt out of the arbitration agreement did not represent an authentic informed choice." First, the court found that Circuit City's explanation to its employees of the benefits of arbitration was "markedly one-sided" and omitted information about disadvantageous terms of the arbitration agreement. Second, the court pointed out that it was not clear that someone in Gentry's position would have felt free to opt out, because Circuit City's "pro-arbitration stance" was made clear by the fact that arbitration was the default dispute resolution procedure.

Following Gentry, significant doubts remain regarding the enforceability of a class arbitration waiver in the wage and hour context. Moreover, in light of the apparent judicial skepticism (or outright hostility) toward such waivers, their utility remains questionable, given what may amount to the need for a "mini-class certification" hearing regarding their enforceability. Indeed, given the court's continued scrutiny of employer arbitration agreements generally, use of such waivers may further jeopardize the enforceability of the arbitration agreement itself.

For more information about any of the above California Supreme Court rulings and their implications, please contact Fred Alvarez, Rico Rosales, or Marina Tsatalis in Wilson Sonsini Goodrich & Rosati's Employment Law practice.