Hooters of America, Inc. v. Phillips
75 Empl. Prac. Dec. (CCH) 45,822, 1999 U.S. App. LEXIS 6329, 173 F.3d 933 (1999)
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Rule of Law:
An employer's promulgation of egregiously unfair and one-sided arbitration rules constitutes a material breach of its contractual obligation to provide a neutral arbitration forum, rendering the arbitration agreement unenforceable. This breach violates the implied covenant of good faith and fair dealing.
Facts:
- Annette R. Phillips worked as a bartender for Hooters of Myrtle Beach (HOMB).
- As a condition of eligibility for raises, transfers, and promotions, Hooters required its employees, including Phillips, to sign an 'Agreement to arbitrate employment-related disputes.'
- The agreement stated that disputes would be resolved according to company rules which Hooters could create and modify 'from time to time,' but a copy of these rules was not provided to employees when they signed.
- Phillips signed the agreement in November 1994 and again in April 1995.
- In June 1996, Phillips alleged that Gerald Brooks, a Hooters official, sexually harassed her by grabbing and slapping her buttocks.
- After Phillips' manager advised her to 'let it go,' she quit her job.
- When Phillips, through her attorney, threatened a Title VII lawsuit, Hooters responded by demanding arbitration and providing her with a copy of its arbitration rules.
- The rules required only the employee to provide a list of all fact witnesses, allowed Hooters to exclusively create the list of all potential arbitrators, and gave Hooters the unilateral power to modify the rules at any time without notice.
Procedural Posture:
- Hooters filed suit against Annette R. Phillips in the United States District Court to compel arbitration under the Federal Arbitration Act.
- Phillips defended by arguing the arbitration agreement was unenforceable and asserted individual and class counterclaims against Hooters for violations of Title VII.
- Hooters moved to stay the proceedings on the counterclaims pending the outcome of arbitration.
- The district court denied Hooters' motion to compel arbitration, finding the agreement was illusory, unconscionable, and void for reasons of public policy.
- Hooters (appellant) filed an interlocutory appeal of the district court's decision to the U.S. Court of Appeals for the Fourth Circuit, where Phillips was the appellee.
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Issue:
Does an employer materially breach an arbitration agreement by creating a dispute resolution process with rules so one-sided and biased that they undermine the neutrality of the proceeding, thereby making the agreement unenforceable?
Opinions:
Majority - Wilkinson, Chief Judge
Yes. An employer materially breaches an arbitration agreement by creating a dispute resolution process with rules so one-sided that they undermine the proceeding's neutrality, making the agreement unenforceable. Hooters and Phillips agreed to resolve disputes in a neutral arbitral forum, and Hooters had a contractual duty to establish such a system. However, the rules Hooters promulgated were so egregiously unfair—by giving Hooters exclusive control over the selection of arbitrators, imposing unequal discovery obligations, allowing Hooters to unilaterally modify the rules, and granting Hooters procedural advantages not available to the employee—that they created a 'sham system.' This constituted a material breach of the agreement and a violation of the implied covenant of good faith and fair dealing. The proper remedy for such a material breach is rescission, which cancels the contract and prevents Hooters from compelling arbitration.
Analysis:
This decision establishes that while federal policy strongly favors arbitration, courts will not enforce arbitration agreements where the process is fundamentally unfair. It carves out an important exception to the general rule that procedural challenges are for the arbitrator, holding that when one party's duty to create the rules results in a system that is a 'sham,' a court can find a material breach and rescind the agreement before arbitration begins. This case serves as a significant check on employer-mandated arbitration, requiring that such systems adhere to the 'rudiments of even-handedness.' It puts drafters of arbitration agreements on notice that procedural fairness is a prerequisite to enforceability, particularly when one party has unilateral control over the rules.
