Fifth Circuit Finds Arbitration Clause Illusory

The United States Court of Appeals for the Fifth Circuit held that an agreement was illusory because the defendant retained the unilateral right to modify or terminate the arbitration provision at any time.

In Carey v. 24 Hour Fitness, USA, Inc. No. 10-20845 (5th Cir. Jan. 25, 2012) John Carey (“Carey”) is a former sales representative for 24 Hour Fitness, USA, Inc. (“24 Hour Fitness”). During Carey’s period of employment, 24 Hour Fitness issued an employee handbook (the “Handbook”). The Handbook provided that all employment-related disputes would be “resolved only by an arbitrator through final and binding arbitration” under the the Federal Arbitration Act (“FAA”). It also specified that disputes under the Fair Labor Standards Act (“FLSA”) were among those subject to the mandatory arbitration policy and provided that disputes cannot be brought as class actions or in representative capacities.

Carey signed the the Employee Handbook Receipt Acknowledgment (the “Acknowledgment”). The Acknowledgment also stated that the terms of the Handbook are subject to change (“Change-in-Terms Clause”):

I acknowledge that, except for the at-will employment, 24 Hour Fitness has the right to revise, delete, and add to the employee handbook. Any such revisions to the handbook will be communicated through official written notices approved by the President and CEO of 24 Hour Fitness or their specified designee. No oral statements can change the provisions of the employee handbook.

Carey’s employment ended and he filed the underlying class action against 24 Hour Fitness on allegations that it had violated the FLSA by failing to pay adequate compensation for overtime work. 24 Hour Fitness moved to compel arbitration pursuant to the dispute resolution clause contained in the Handbook. Carey argued that the arbitration agreement was illusory because 24 Hour Fitness retained the right to unilaterally amend the agreement. The District Court denied 24 Hour Fitness’ motion to stay and compel arbitration and 24 Hour Fitness appealed.

The Fifth Circuit first highlighted the standard in determining whether the parties agreed to arbitrate: (1) whether there is a valid agreement to arbitrate; and (2) whether the dispute in question falls within the scope of that arbitration agreement.

The Court said that courts apply ordinary state-law principles that govern the formation of contracts to determine whether there is a valid agreement to arbitrate. Under Texas law, an arbitration clause is illusory if one party can “avoid its promise to arbitrate by amending the provision or terminating it altogether.” In re 24R, Inc., 324 S.W.3d 564, 567 (Tex. 2010) (read more here). The Court found that the arbitration provision in 24 Hour Fitness’ Handbook was illusory because the Change-in-Terms Clause would have allowed 24 Hour Fitness to unilaterally avoid its promise to arbitrate by modifying the Handbook. Accordingly, the Fifth Circuit affirmed the District Court’s judgement.

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