Daniel D. McMillan

Partner Jones Day (Los Angeles)

Co-Leader of the Jones Day Global Construction Practice with a focus on Construction Domestic and International Arbitrations

Email: ddmcmillan@jonesday.com

Loyola Law School; Los Angeles CA

Dan's practice focuses on complex commercial, business, and construction litigation. As co-chair of the Firm's global construction practice, he represents owners, design professionals, and contractors in large construction disputes and in negotiating and drafting the full panoply of contracts for large projects.

Michael S. McCauley

Partner Jones Day (Los Angeles)

Represents clients in complex construction disputes, including at trial and in arbitrations

Eric C. Tung

Partner Jones Day (Los Angeles)

Appeals and Motions Practice in Commercial Litigation

For decades, a court could not find that a party waived its right to arbitrate unless the failure to invoke that right "prejudiced" the other party. In the wake of last week's decision by the California Supreme Court in Quach v. California Commerce Club, Inc., S275121 (July 25, 2024), overruling St. Agnes Medical Center v. PacifiCare of California, 31 Cal. 4th 1187 (2003), that prejudice requirement is no more--an outcome suggested by our previous article ("Goodbye Saint Agnes?"). Following the lead of the United States Supreme Court holding that waiver did not require a showing of prejudice under the Federal Arbitration Act (FAA) (Morgan v. Sundance, Inc., 142 S. Ct. 1708 (2022)), the California Supreme Court reached the same conclusion under the California Arbitration Act (CAA). As both Courts held, the enforceability of an arbitration agreement should be treated like any other contract, and thus courts should not impose an arbitration-specific prejudice requirement to find waiver. But while the U.S. Supreme Court left open what role state law played in assessing waiver, the California Supreme Court answered the waiver question under California law and provided important guidance for future cases.

This case began when Peter Quach sued his employer for wrongful termination. Although the parties had an arbitration agreement, the employer did not invoke it right away. Instead, it engaged in discovery--deposing the plaintiff and propounding form interrogatories, special interrogatories, requests for admission, and a request for production of documents. In its case management conference statement, too, the employer requested a jury trial and did not check the box indicating it was willing to participate in "binding private arbitration." And it failed to list a motion to compel arbitration in the space provided for expected motions (writing only a "dispositive motion"). While in its answer to the complaint the employer had asserted as an "affirmative defense" that the plaintiff "should be compelled to arbitrate," the employer did not move to compel until 13 months into the litigation.

Naturally, the plaintiff cried foul, claiming the employer had waived its right to arbitrate. Yet at the time, the St. Agnes precedent permitted the employer to invoke its arbitration rights late in the case, even after some discovery, so long as the plaintiff was not prejudiced. In St. Agnes, the California Supreme Court had relied on federal caselaw interpreting the FAA in holding that prejudice is required to find waiver under the FAA and its state analogue (the CAA). These federal cases and the St. Agnes decision relied largely on a general policy that the law favors arbitration and not on a detailed interpretation of statutory language. And so, leaning on that precedent, the employer in Quach argued that it did not lose its right to arbitrate because the plaintiff was not prejudiced, even though the plaintiff incurred court costs and legal expenses. The trial court disagreed and found waiver. But the court of appeals reversed and adopted the employer's position, despite the employer extensively litigating the case for 13 months before moving to compel arbitration. Both the trial court and the court of appeals applied the binding St. Agnes prejudice standard but reached different results.

The litigation twists did not end there. Just two weeks after the appellate court's decision, the Supreme Court of the United States decided Morgan v. Sundance, Inc. (2022), which held that the FAA did not demand a showing of prejudice before the right to enforce an arbitration agreement is deemed waived. In doing so, the U.S. Supreme Court did away with federal circuit precedents that had required prejudice on the premise that federal policy favored arbitration. The U.S. Supreme Court clarified that the "policy favoring arbitration" does not permit courts to fashion an "arbitration-specific rule demanding a showing of prejudice." Rather, the policy merely seeks to place arbitration agreements "upon the same footing" as other contracts and reflects the FAA's correction of "the judiciary's longstanding refusal" to enforce agreements to arbitrate. In other words, arbitration agreements are to be enforced like other contracts--"but not more so." The U.S. Supreme Court's decision jettisoning the prejudice requirement under the FAA is about as clear as it gets. Yet it did not address "the role state law might play in resolving when a party's litigation conduct results in the loss of a contractual right to arbitrate."

The California Supreme Court took its cue in granting review of the court of appeals' decision in Quach. Following Morgan, the California Supreme Court held that neither the FAA nor the CAA required prejudice to find waiver. "Because our state-law arbitration-specific prejudice requirement is based upon the federal precedent that Morgan overruled," the Court held in Quach, "we now abrogate it." "California policy, like federal policy, puts arbitration agreements on equal footing with other types of contracts." Thus, under California law, as under federal law, the same principles that apply to waiver of other contractual rights apply with equal force to waiver of arbitration rights.

The Court analyzed in depth the text, context, and legislative history of the CAA to bolster its holding that prejudice was not required. That statutory analysis stands in contrast to its prior decision (St. Agnes), which failed to undertake such an analysis. And rather than remanding the matter for the trial court to apply its newly announced "no prejudice" standard, the Court applied its standard to the facts to find waiver--namely, that the employer intentionally relinquished its known contractual right to arbitrate. This finding of waiver is not surprising given that the employer knew of its arbitration right (e.g., its director of human resources had attested that the employer required all employees to sign arbitration agreements), and it extensively litigated the case for 13 months without invoking its arbitration right.

In reaching this conclusion, the Court did not address whether its holding should be applied retroactively. While a court's interpretation of a statute generally applies retroactively, a narrow exception can arise "when a judicial decision changes a settled rule on which the parties below have relied." Vazquez v. Jan-Pro Franchising International, Inc., 10 Cal. 5th 944, 953 (2021) (quotation marks omitted). In any event, holding that its ruling was not retroactive would likely have done little to benefit the employer because it likely waived its right to arbitrate regardless of any prejudice requirement given the degree of litigation activity it undertook, as the trial court found. But it is notable that the Court did not even address the issue, and other litigants may now be found to have waived valued arbitration rights through their conduct without a showing of prejudice even though St. Agnes, which required that showing, appeared to have been settled law.

By adopting Morgan's "no prejudice" rule for the CAA, the Court also avoided other difficult issues. The Court noted the practical reality that creating a different rule under the CAA than the FAA would create uncertainty and lead to additional litigation (contrary to the purposes of arbitration), as a different rule would entail resolving "tricky choice of law and preemption questions." For instance, while parties can choose to have their arbitration process governed by state procedural law (generally not preempted by the FAA), the question of whether a state law should be considered procedural or substantive in the first place is not always clear. See, e.g., Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 470 (1989) (holding FAA did not foreclose stay of arbitration under California law pending resolution of related litigation where parties agreed to state rules of arbitration); see also Cronus Invs., Inc. v. Concierge Servs., 35 Cal. App. 4th 376, 394 (2005) (holding FAA does not apply to California court proceedings unless the parties to arbitration agreement "expressly designate that any arbitration proceeding should move forward under the FAA's procedural provisions rather than under state procedural law").

What are the consequences regarding the waiver issue that the Court did decide? In favor of a cleaner waiver rule, the Court abandoned St. Agnes's prejudice requirement and multi-factor test for assessing whether a party waives arbitration--whether (1) a party's actions are inconsistent with the right to arbitrate; (2) the litigation machinery has been substantially invoked; (3) a party requested arbitration enforcement close to the trial date or delayed for a long period before seeking a stay; (4) a defendant seeking arbitration filed a counterclaim without asking for a stay; (5) important intervening steps had taken place; and (6) the delay affected, misled, or prejudiced the opposing party.

As the Quach Court explained, a party opposing arbitration can now show waiver through "clear and convincing evidence that the waiving party knew of the contractual right and intentionally relinquished or abandoned it"--an inquiry "exclusively focused on the waiving party's words or conduct," not on the "effect" on the party opposing arbitration. The Court noted, however, that other legal grounds for denying a party its right to arbitrate may require something akin to prejudice--for example, the defense of estoppel that "generally requires that a party's words or acts have induced detrimental reliance by the other party." As a result, the Court explained that future courts "should separately evaluate each generally applicable state contract law defense raised by the party opposing arbitration" and "not lump distinct legal defenses into a catch-all category called 'waiver.'"

But even without a prejudice requirement now, courts will continue to engage in a fact-intensive analysis to decide whether a party has waived its right to arbitrate. Furthermore, the "clear and convincing standard" may still prove a substantial burden. In conducting the waiver inquiry, state courts in California are likely to look to post-Morgan federal court rulings as persuasive authority, which there already are several. See, e.g., Armstrong v. Michaels Stores, Inc., 59 F. 4th 1011, 1015 (9th Cir. 2023) (holding that a defendant did not waive its right to arbitrate where it pleaded arbitration as an affirmative defense in its answers and repeatedly stated its intent to move to compel arbitration in case management statements, even though the defendant had served interrogatories and requests for production in litigation); Schwebke v. United Wholesale Mortgage LLC, 96 F. 4th 971, 977 (6th Cir. 2024) (finding waiver where party waited seven months before moving to compel arbitration and had produced tens of thousands of pages of documents, took and defended depositions, and issued third-party subpoenas without mentioning arbitration).

But whatever facts courts may deem sufficient to find waiver, the bottom line is this: going forward, parties greatly risk waiving any contractual right to arbitrate if they meaningfully participate in litigation without compelling arbitration, as they cannot simply point to a lack of prejudice to overcome a waiver argument. Hence, as was the case before the Quach decision, a party seeking to preserve its contractual right to arbitrate will be well-served by invoking the right as soon as possible through a motion to compel arbitration and avoiding any conduct suggesting a preference for proceeding in court. At least if a motion to compel arbitration is denied, if new evidence is discovered bearing on the propriety of arbitration, it may be possible to renew the motion to compel (assuming the standards for reconsideration can be met) with less risk of a party arguing that one has consented to arbitration.

Disclaimer: The views expressed in this article are of the authors themselves and not of their Firm or their clients.