Advance Notice, Savings Clauses and Illusory Arbitration Agreements in Texas

If you have an arbitration clause in your company’s employee handbook, it is time to dust it off and review the provisions governing arbitration of employee disputes. The United States Court of Appeals for the Fifth Circuit, applying Texas law, recently issued its opinion in Michael Nelson v. Watch House International, LLC., No. 15-10531 (5th Cir. Mar. 2, 2016) reversing the district court’s order granting Watch House’s motion to compel arbitration and dismissing Nelson’s claim for discrimination. The language of the arbitration agreement is worth noting.

In Watch House, the company’s employee handbook contained an arbitration agreement that stated “This Agreement may not be altered except by consent of the Company and shall be immediately effective upon notice to Applicant/Employee of its terms, regardless of whether it is signed by either Agreeing Party. Any change to this Agreement will only be effective upon notice to Applicant/Employee and shall only apply prospectively.” Nelson argued to the district court that he was not an employee under the plan’s definition and that the plan was was unenforceable because it was illusory. The district disagree and Nelson appealed. On appeal, Nelson argued that the arbitration plan was illusory because it failed to include a savings clause related to existing claims and disputes and did not require advance notice of termination because any changes were effective immediately upon notice.

Agreeing with Nelson, the Fifth Circuit stated that to arbitrate, two questions must be asked. First, whether there is a valid agreement to arbitrate between the parties and then, whether the dispute in question falls within the scope of the arbitration agreement.  Michael Nelson v. Watch House International, LLC., No. 15-10531 (5th Cir. Mar. 2, 2016), citing, JP Morgan Chase & Co. v. Conegie ex rel. Lee, 492 F.3d 596, 598 (5th Cir. 2007). Nelson’s challenge was to the validity of the arbitration plan because it was illusory, but not the scope of the clause.

Relying on its prior decision in Lizalde v. Vista Quality Markets, 746 F.3d 222 (5th Cir. 2014), the Fifth Circuit restated its three-prong test to evaluate agreements where the employer has a unilateral right to terminate its obligation to arbitrate. The Court in Watch House held that retaining termination power does not make an arbitration agreement illusory so long as that power (1) extends only to prospective claims, (2) applies equally to both employer and employee claims, and (3) so long as advance notice to the employee is required before termination is effective.  Michael Nelson v. Watch House International, LLC., No. 15-10531 (5th Cir. March 2, 2016), citing, In re Halliburton Co., 80 S.W.3d 556, 569-570 (Tex. 2002). As a result, a Halliburton-type savings clause is insufficient unless it provides both advance notice and a limitation to only prospective claims. Because the Watch House  arbitration plan made changes immediately effective upon notice, the arbitration plan was illusory. Based on Lizalde, the Court also suggested that advance notice of 10 days would be a reasonable notice to an employee.

All employers should review their employee handbooks in light of the Watch House decision. Where an employer has the sole power to terminate, amend or supplement the arbitration agreement, the agreement will be held to be illusory unless advance notice is provided to employees (preferably 10 days advance notice) and the changes only affect prospective claims that arise after the date of the changes. The opinions contained in the blog are solely the author’s and comments, replies and suggestions should be sent to