United States: Seventh Circuit Invalidates Arbitration Agreement Which Required Each Party To Pay Its Own Attorneys’ Fees

Co-authored by James E. Bayles & Barry A. Hartstein

Many employers have sought to limit their litigation expenses and potential liabilities by instituting mandatory arbitration agreements with their employees. In Gilmer v. Interstate Johnson Lane Corp., 500 U.S. 20, 26 (1991), the U.S. Supreme Court held that private arbitration agreements may be enforceable as to claims brought under federal statutes as long as they do not prevent a plaintiff from effectively vindicating statutory rights in the arbitral forum or interfere with the statute’s remedial and deterrent purposes. Following Gilmer, employers have sometimes struggled to draft arbitration agreements which both protect their interests and do not impermissibly interfere with the statutory rights granted to employees by Congress.

The Seventh Circuit Court of Appeals recently had occasion to rule on the enforceability of an arbitration agreement which required each party to pay its own costs and attorneys’ fees regardless of the outcome of the case. In McCaskill v. SCI Management Corp., 285 F.3d 623 (7th Cir. 2002), the Seventh Circuit reversed the District Court’s decision to compel arbitration and dismiss the federal court case, finding that the agreement’s attorneys’ fees provision impermissibly infringed on the plaintiff’s right, granted by Congress under Title VII, to collect attorneys’ fees if she prevailed on her claim.

In deciding that Title VII’s attorney’s fees provision rendered unenforceable the entire arbitration agreement, the Court reiterated the important policy reasons behind awarding attorney’s fees to a prevailing plaintiff:

Although not cited as part of its rationale for invalidating the arbitration agreement, the Court noted in passing that the agreement required arbitration for most employment-related suits which would be brought by employees, but excluded the types of claims likely to be brought by the employer, such as enforcing noncompetition or confidentiality agreements or suits based on fraud, theft or other employee misconduct. The Court may have perceived these exclusions to be unfairly one-sided in favor of the employer.

The employer argued that, if the plaintiff were successful, the attorneys’ fees provision allowed an arbitrator to award the plaintiff her attorneys’ fees as long as she used the award to pay her attorneys. The Court flatly rejected this argument and stated that the provision meant that "neither party can be required to pay the attorney’s fees of the other party, either directly or through the straw-man approach advocated by [the defendant]." The Court held that the attorneys’ fees provision prevented the plaintiff from "effectively vindicating her rights in the arbitral forum by preemptively denying her remedies authorized by Title VII," and thus rendered the entire arbitration agreement unenforceable.

Two other points are worth noting – if only for what the Court declined to do. First, the arbitration agreement required each party to pay one-half of the arbitrator’s compensation and any other costs of the arbitration. The plaintiff argued that this provision also rendered the agreement unenforceable. While noting cases in which such an argument succeeded or was considered, the Court did not rule on the issue because its determination regarding the attorneys’ fees provision made further inquiry unnecessary.

Second, the Court also did not rule on whether the attorneys’ fees provision was "severable" from the rest of the arbitration agreement, which would have allowed the Court to invalidate the attorneys’ fees provision while enforcing the rest of the arbitration agreement. The Court noted, however, that the Ninth Circuit had rejected a similar argument in Graham Oil Co. v. ARCO Product Co., a Div. of Atlantic Richfield Co., 43 F.3d 1244 (9 Circuit 1994).

The Seventh Circuit’s ruling likely comes as no surprise to most employers who have attempted to draft enforceable arbitration agreements. This decision is consistent with previous cases dealing with mandatory arbitration agreements. The McCaskill decision illustrates the following rule of thumb. Private arbitration agreements between employers and employees may be useful to employers in reducing potential exposure to unpredictable jury awards. However, if an employer drafts an arbitration agreement which attempts to gain advantages beyond the change from a judicial to an arbitral forum, and thereby limits the rights or remedies provided by Title VII or another federal statute, that agreement likely will be unenforceable in the courts.