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Arbitration in employment agreements; and beyond

Arbitration provisions in employment agreements are generally considered controversial.  Proponents of employment arbitration believe arbitration is a faster and more economical way for employees to resolve their disputes with employers.   On the other hand, opponents claim that employment arbitration drastically favors employers. [i]  

Under Maryland law, arbitration provisions in employment contracts are enforceable, as long as they comply with Maryland contract law principles. Arbitration provisions are considered to be separate contracts from the underlying contract containing the provision.  As the provisions are governed by contract law, any valid contract defense, such as fraud, duress or unconscionability, may be applied to invalidate an arbitration provision.    

Unconscionability is characterized as extreme unfairness, which can be evidenced by one party’s lack of meaningful choice and by contractual terms that unreasonably favor the other party. Walther v Sovereign Bank, 386 Md. 412 (2005). There are two types of unconscionability, procedural and substantive. Procedural unconscionability deals with the process of contract formation and can be summarized as whether or not a person had meaningful choice in entering into a contract.  Procedural unconscionability also covers the form of the contract, including the use of fine print or unclear language used to disguise a provision.  Alternatively, substantive unconscionability deals with contractual terms that are illegal, contrary to public policy, or unreasonably favor the party with the most bargaining power. Id.

The Maryland Court of Special Appeals recently considered whether or not a contractual provision to arbitrate in an employment contract between a company and its C.E.O. was unconscionable. In the matter of Falls v. 1CI, Inc. et al., Anthony Falls was employed as the company C.E.O., and shortly thereafter, entered into a formal employment contract with 1CI, Inc.  While employed, Falls worked out of an office in Gaithersburg, Maryland.  1CI, Inc. is a wholly owned subsidy of Cape Fox Co., located in Alaska.  The arbitration provision in Falls’ employment contract required arbitration between the parties to take place in Seattle, Washington.  After Falls was terminated from 1CI, Inc., he filed suit in the Circuit Court for Montgomery County under the Maryland Wage Payment and Collection Law.  The Circuit Court required Falls submit his claims to arbitration based upon his employment agreement’s arbitration provision.  In his appeal, Falls argued that the provision to arbitrate was substantively unconscionable due to the requirement that arbitration take place in Seattle, Washington. Falls’ main argument centered on the inconvenience and burden he would suffer should he be required to travel from Maryland to Washington in order to pursue his claims, especially in light of the fact that he was newly unemployed.  208 Md.App. 643 (2012).

The Court ultimately held that the arbitration provision was not unconscionable. The Court reasoned that the arbitration provision was a part of the agreement negotiated between Falls and his employer.  At the time that the employment agreement was negotiated, Falls was already employed with 1CI, Inc.  The Court found Falls did have bargaining power during the negotiations, and felt he could have chosen not to sign the employment contract if he had a real problem with the venue provision in the arbitration clause.  The Court additionally based its decision on Falls’ failure to show, 1) that the venue was unreasonably favorable to 1CI, Inc., and 2) his own inability to financially prosecute his claims in Seattle, Washington.  Id.

In making its ruling, the Court considered Falls’ employment status and classified him as a “sophisticated employee.”  Although the Court didn’t define what it meant by “sophisticated employee,” the Court made a distinction between Falls’ employment contract, a contract negotiated between a corporation and its C.E.O, and pre-employment contracts. Pre-employment contracts are generally contracts that most employees must sign in order to accept a position with an employer.  They are typically unilaterally drafted by the employer and offered to an employee on a take-it-or-leave-it basis.  Accordingly, an employee signing a pre-employment contract has little to no bargaining power when it comes to the contract terms. Falls’ position with ICI, Inc. and the type of employment contract at issue were factors the Court considered heavily in making its decision regarding unconscionability.  This ruling leaves open the question as to whether the Court would have come to the same conclusion in this case on the unconscionability issue if Falls was not an officer of the corporation or considered a “less sophisticated employee." 

In 2003 the Court of Appeals addressed arbitration in employment agreements and found the provision at issue to be invalid due to a lack of mutual consideration. Cheek v. United Healthcare of Mid-Atlantic, Inc., 378 Md. 139, (2003). Mutual consideration required for an arbitration provision must be distinguishable and separate from the consideration that supports the contract containing the arbitration clause. In short, for an arbitration provision to be valid, both parties must exchange promises to arbitrate disputes arising from the underlying contract. The arbitration provision in Cheek was found invalid because the employer was not bound to arbitrate and was able to change the terms of the agreement at any time without notice to the employee.

While not addressing mutual consideration for an arbitration provision located in an employment contract, the United States Court of Appeals for the Fourth Circuit addressed mutual consideration in the context of a consumer transaction and came to the same conclusion. In Noohi et al. v Toll Brothers, Inc. et al., the consumer entered into a contract with Toll Brothers for the purchase and construction of a luxury home and tendered a substantial down payment.  Noohi was unable to obtain financing before the closing date and requested his deposit back, however, Toll Brothers retained the deposit. The contract between the parties contained an arbitration provision that Toll Brothers sought to enforce.  Applying Maryland law, the Fourth Circuit looked to the language of the arbitration provision and found it to be wholly one-sided. The provision sought only to bind the homebuyer to arbitration. The provision failed to bind both parties to arbitration and appeared to favor Toll Brothers.  Specifically, the Court took notice that the provision only referenced the buyer’s obligations, and outlined procedures that only the buyer would have to perform in order to initiate arbitration. In addition, the types of claims referenced in the provision subject to arbitration were limited to claims that only the buyer would raise against the seller. In light of the provision’s failure to bind both parties to arbitration, the Fourth Circuit found the provision lacked mutual consideration as required by contract law and held the provision to be unenforceable.[ii] 

 Whether you plan to incorporate an arbitration provision into an employment contract or contract for sale of goods and services, in order for the provision to be upheld as valid under Maryland law, the arbitration provision must be clearly supported by mutual consideration. Language in the provision should be clear that both parties intend to arbitrate disputes.  Procedural and substantive unconscionability issues should be considered as well.  The provision should be clearly labeled and easy to locate in the document.  In addition, when considering arbitration provisions in employment agreements, it is very likely that the more bargaining power the employee had when negotiating the agreement, the more likely the provision will be considered valid by the Courts as to its specific terms.  

[i] Falls v. 1CI, Inc. et al., 208 Md.App. 643 (2012) discussing “Customizing Employment Arbitration”, O’Conner, Martin & Thomas, 98 Iowa Law Review 133 (2012).

[ii] Noohi et al. v Toll Brothers, Inc. et al., No. 12-1261, February 26, 2013.

For a discussion regarding the scope of a broadly worded arbitration clause, see Arbitration: scope and enforcement of “any dispute arising out of, or related to,”

For a discussion of the continuing duty to arbitrate post contract termination, see Arbitration: the duty to arbitrate after the end of the contract

For a discussion on judicial review of an arbitrator’s decision, see Arbitration: the finality of arbitration awards

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