Mandatory Arbitration: Should Your Small Business Use It
What a mandatory arbitration agreement does, what it really costs an employer, the sexual harassment carve-out, and the state laws that limit it.
A lawyer once sent me a two-page arbitration clause to drop into our offer letters, with a note saying that every client of his used one. I approved it in about four minutes. When I finally read it properly, a good part of it would not have survived a serious challenge, and I could not have told you what it was supposed to save us.
That is the pattern with mandatory arbitration. It gets adopted as a default, copied out of a template, without anybody pricing what it buys or what it costs. Then something happens, and the employer discovers that the clause either does not reach the claim, or reaches it at a price nobody had budgeted.
I build the people and records tooling for businesses without an HR department at FirstHR, so this is the analysis I wish I had done before signing off. Here is what the agreement actually does, what the federal framework allows, what Congress took off the table, what the states have tried, and whether the math works for a small employer. This is general information, not legal advice.
What a Mandatory Arbitration Agreement Is
A mandatory arbitration agreement is a contract, signed before any dispute exists, in which an employee agrees to resolve legal claims against the employer through private arbitration rather than in court. It is mandatory because signing is a condition of getting or keeping the job, not a choice made once the argument has already started.
Three distinctions get blurred constantly. The first is that predispute is not the same as post-dispute: an agreement to arbitrate a live dispute is a different legal animal and faces almost none of the same objections.
The second is that mandatory is not the same as binding: an agreement can be voluntary and still binding once accepted. The third is that an arbitration clause is not a confidentiality clause, though the two travel together often enough that people assume one implies the other.
Scale first, because it explains why this feels like a settled default. Cornell ILR School research published in 2017 found that mandatory arbitration reaches 56 percent of private-sector nonunion employees, about 60 million American workers, up from 20 percent in the early 2000s and 6 to 7 percent in the 1990s. Whatever you decide, you are not deciding it in a vacuum.
The Federal Arbitration Act Framework
The Federal Arbitration Act is the whole reason these agreements work. Section 2 makes a written arbitration provision in a contract involving commerce valid, irrevocable and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.
The saving clause is not decoration. It is the opening through which every unconscionability argument, meaning a claim that the agreement is too unfair to enforce, arrives.
The transportation exemption deserves more attention than small employers usually give it. Section 1 of the statute excludes contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce, and the Supreme Court has read that phrase narrowly to mean transportation workers rather than everyone in commerce.
What changed is who counts. In Southwest Airlines Co. v. Saxon, decided in 2022, the Court looked at what the individual actually does, holding that a class of workers directly involved in transporting goods across state or international borders falls inside the exclusion.
The Court then widened the test in Bissonnette v. LePage Bakeries Park St., LLC, decided unanimously on April 12, 2024. It held that a transportation worker need not work in the transportation industry at all. The case involved bakery distributors who delivered products to stores, and the Court sent it back for the lower court to apply the corrected test.
The Supreme Court went further on May 28, 2026. In Flowers Foods, Inc. v. Brock, a unanimous Court held that a worker who carries goods on an in-state leg of an interstate journey can fall inside the exclusion without ever crossing a state line. The distributor in that case drove baked goods from a Colorado warehouse to local stores.
The practical consequence for a small business is narrow but real. If part of your workforce moves goods on an interstate journey, including drivers who handle only an in-state leg of it, a federal court may refuse to compel arbitration for those people even though the identical clause binds everybody else.
State arbitration statutes can sometimes fill the gap, but you should know before you rely on the clause, not after.
What These Agreements Can No Longer Cover
Sexual assault and sexual harassment claims are outside the reach of any predispute arbitration agreement, at the claimant’s option. The Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act, signed March 3, 2022, amended the federal arbitration statute.
Under the amended statute, no predispute arbitration agreement or predispute joint-action waiver is valid or enforceable in a case relating to a sexual assault or sexual harassment dispute, if the person alleging the conduct so elects. A joint-action waiver is an employee’s promise not to bring or join a class, collective or other group claim.
Read the mechanics carefully, because the drafting is broader than the headline. The election belongs to the claimant, so the employee may still choose arbitration. The waiver of joint or class proceedings falls with the arbitration clause.
Federal courts have also generally held that a viable harassment allegation exempts the entire case rather than a single count, which means a hostile work environment claim can drag retaliation, discrimination and wage counts into court with it.
Two federal appeals courts, known as circuits, have now adopted that whole-case reading. The Sixth Circuit held in Bruce v. Adams and Reese, LLP on February 25, 2026, that a viable harassment claim bars arbitration of the employee’s entire case, and the Second Circuit reached the same holding in Diaz-Roa v. Hermes Law on September 30, 2026.
Timing is the live battleground. The statute applies to disputes that arise, or claims that accrue, on or after the enactment date of March 3, 2022, regardless of when the agreement was signed.
The circuits have started drawing that line. The Sixth Circuit treated an accrued claim and an arisen dispute as separate questions in Memmer v. United Wholesale Mortgage, LLC in 2025, and the Ninth Circuit reached its first interpretation in Combs v. Netflix, Inc. on July 8, 2026, holding that conduct and a termination predating March 3, 2022 left the employee inside her arbitration agreement.
The table below shows which claims a predispute clause can reach and what to write in the agreement for each. Two of its rows cover charges filed with the Equal Employment Opportunity Commission (EEOC) and the National Labor Relations Board, called the labor board in this guide.
| Claim type | Can a predispute clause require arbitration | What to write in the agreement |
|---|---|---|
| Sexual assault or sexual harassment | No, if the claimant elects to go to court | Say so explicitly rather than leaving a stale clause on file |
| Discrimination charge filed with the EEOC | The charge itself cannot be blocked | Carve out administrative agency filings by name |
| Unfair labor practice charge at the labor board | The charge itself cannot be blocked | Carve it out; overbroad wording alone has been found unlawful |
| Wage and hour claims, individually | Yes, in most states and most roles | Name the statutes, keep the limitations period untouched |
| Wage and hour claims, as a class or collective | Yes, a waiver of joint proceedings is enforceable | Pair it with a severability clause that survives partial invalidity |
| Workers’ compensation and unemployment | No, these run through state systems | Carve out both, or the whole clause starts to look overreaching |
Two more carve-outs belong in every draft: one for workers’ compensation and unemployment claims, which run through state systems, and one for agency charges.
Administrative charges survive the agreement: the EEOC has stated that an arbitration agreement does not preclude an individual’s right to file a charge and have the case investigated, and that the agency remains fully available to employees regardless.
The labor board reaches the same result from a different direction. Following the Supreme Court’s decision on class waivers, the Board has still held that an agreement broad enough that an employee could reasonably read it as barring a charge with the Board is unlawful on that ground alone. Language, not intent, is what gets judged.
Class and Collective Action Waivers
Class and collective action waivers inside arbitration agreements are enforceable, and for most small employers they are the strongest argument in favor of having one. In Epic Systems Corp. v. Lewis, decided in 2018, the Supreme Court held that agreements requiring individualized arbitration must be enforced as written and that federal labor law does not displace that command.
That enforceability matters because of which claim is most likely to end a small business. A single discrimination suit is expensive. A wage and hour collective action covering every hourly employee for three years is a different order of magnitude, and misclassification cases in particular expand from one person to a whole job title without any new facts.
The labor board’s treatment of workplace rules has swung with its composition more than once, so treat the outer edges as unsettled rather than resolved.
What has stayed constant since the Epic decision is narrower and easier to comply with: keep the waiver individual, keep the agency carve-out explicit, and do not word the clause so broadly that it reads as a gag on employees talking to each other or to a government agency.
State Laws That Limit What You Can Require
Several states passed outright bans on requiring arbitration as a condition of employment, and federal courts have mostly held those bans preempted, meaning the federal statute overrides them. California is the case to know. Assembly Bill 51 made it unlawful, with criminal exposure attached, to condition employment on an arbitration agreement.
On February 15, 2023 the Ninth Circuit held in Chamber of Commerce v. Bonta that the Federal Arbitration Act preempts that law. The court’s reasoning is that a state may not place a special burden on the formation of arbitration agreements specifically, because that treats arbitration worse than other contracts.
Other states passed similar restrictions. New York’s civil practice rule barring arbitration of discrimination claims and New Jersey’s comparable provision have met the same fate in most federal decisions.
Where states have real power is at the back end, policing how the arbitration runs. That is where a California employer feels the difference most. In the table below, CCP means California’s Code of Civil Procedure, CPLR means New York’s Civil Practice Law and Rules, and SB means Senate Bill.
| State measure | What it does | Where it stands |
|---|---|---|
| California AB 51 (Labor Code 432.6) | Bans conditioning employment on an arbitration agreement | Preempted by the federal statute, Ninth Circuit, February 2023 |
| New York CPLR 7515 | Voids predispute arbitration of discrimination claims | Generally held preempted in federal court; state decisions have split |
| New Jersey anti-arbitration provision | Voids waivers of rights and remedies under the state discrimination law | Largely enjoined as preempted |
| California CCP 1281.97 and 1281.98 | Employer that misses the fee deadline is in material breach and loses arbitration | In force; the state supreme court allowed relief for non-willful lateness in August 2025 |
| California SB 365 (CCP 1294) | No automatic stay of the court case while the employer appeals a denied motion to compel | In force since January 2024; preemption still contested |
| Federal arbitration statute, section 1 | Excludes transportation workers by what they do, not who employs them | Confirmed by the Supreme Court in 2022, 2024, and 2026 |
The fee deadline rule is the one that surprises people. Under the California statutes, an employer that fails to pay arbitration fees within thirty days of the due date is in material breach, waives the right to compel arbitration, and can be liable for the employee’s fees.
In Hohenshelt v. Superior Court, decided August 11, 2025, the California Supreme Court held that section 1281.98 survives federal preemption when read to allow relief for lateness that is not willful, fraudulent, or grossly negligent. Missing an invoice is a genuine way to lose the forum you paid to build.
State rules differ this much, so if you employ people in more than one state, check the rules where each employee actually sits rather than where the company is registered.
Who Pays, and Why It Is Not Automatically Cheaper
When you impose arbitration as a condition of employment, you pay for the forum. That single rule undoes most of the cost argument people make for these agreements, and it is not optional: it comes from the case law on unenforceable cost shifting and from the administrators’ own rules.
The California Supreme Court set the marker in Armendariz v. Foundation Health Psychcare Services, holding that an employer imposing mandatory arbitration must bear the costs unique to arbitration, because an employee cannot be required to pay expenses they would never have faced in court. Other states get to comparable places through ordinary unconscionability analysis.
The administrators built the same principle into their fee schedules. Under the American Arbitration Association’s employment rules, the employee’s exposure is limited to a capped administrative filing fee while the company pays the arbitrator’s compensation, travel, the hearing facility and a case management fee.
The other major administrator, JAMS, takes the same approach. Under the JAMS minimum standards of procedural fairness for employment cases, an employee subject to a required arbitration clause pays a single $400 filing fee and the company covers every other fee and expense.
| Cost item | Federal court | Employer-imposed arbitration |
|---|---|---|
| Who pays to open the case | Plaintiff pays the filing fee: $350 statutory plus a $55 administrative fee | Employer pays most of the administrative fee; employee’s share is capped |
| Who pays the decision maker | Nobody, the judge and jury are publicly funded | Employer pays the arbitrator by the hour or the day |
| Discovery | Full civil discovery, the largest single cost driver | Usually limited by rule, which is the real saving |
| Appeal | Ordinary appellate review of legal error | Very narrow vacatur grounds, so a bad award tends to stand |
| Publicity | Filings and judgments are public record | Private, subject to state disclosure rules for administrators |
| Group exposure | Class and collective actions available | Waivable, but mass individual filings shift the fee risk back |
Be honest about the trade. Arbitration can shorten the schedule, compress discovery, keep the dispute out of public filings, and remove the tail risk of a jury award nobody can predict.
A Cornell study of employer-promulgated arbitrations, published in the Journal of Empirical Legal Studies in 2011, found employees prevailed in 21.4 percent of decided cases with a median award of $36,500. The federal court comparison set beside it, from Eisenberg and Hill, shows a 36.4 percent win rate and a $176,426 median. Both medians are stated in 2005 dollars.
Those numbers are the reason employers like arbitration and the reason critics call it forced. Read them carefully, though: they compare decided cases, and most disputes in either forum settle long before anyone reaches an award.
What arbitration does not do is remove the cost of defending a case. Your counsel still prepares, still takes depositions, still argues. The arbitrator’s bill is added on top of that, at professional rates. A public court supplies that time once the plaintiff has paid the statutory fee and the $55 administrative fee the judiciary sets.
For a business with one dispute every few years, the forum bill can exceed anything the compressed schedule saved. That is the number almost nobody runs before signing off on the clause, and it is the one that decides whether the agreement was worth having.
Dwight SchruteSales3 people
Darryl PhilbinWarehouse1 person
Kelly KapoorCustomer Service1 personWhat Makes an Agreement Unenforceable
Agreements almost never fail on the core promise to arbitrate. They fail on the extras somebody added to gain an edge: a damage cap, a shortened deadline, a discovery limit, a one-way obligation, a fee-splitting clause. Courts apply ordinary contract defenses through the saving clause in the federal statute, and unconscionability is the one that does the work.
Unconscionability generally has two halves. Procedural unconscionability looks at how the agreement was formed: a take-it-or-leave-it document handed to an applicant with no chance to negotiate supplies some of it almost by definition.
Substantive unconscionability looks at whether the terms themselves are unreasonably one-sided. Most courts require both, on a sliding scale, so a fair set of terms usually survives even a rushed signing.
One drafting point does more than the rest: include a real severability clause. It says the rest of the agreement survives if a court strikes one term, so decide in advance what you want to happen then.
Courts handle an unconscionable term in two ways. Some sever the offending provision and enforce the rest. Others hold that a document permeated with unconscionable terms cannot be saved by editing, and refuse to enforce any of it. Piling on aggressive terms increases the chance you lose the entire agreement rather than the term.
Rolling One Out Without Breaking It
How you present the agreement matters as much as what it says, because the procedural half of the unconscionability test looks at formation. Bury it inside the handbook as one clause among fifty and you invite an argument that nobody knew they were waiving a jury trial.
Practically, the agreement should ride in the same packet as the rest of the signed paperwork. Presenting it alone, weeks after the start date, makes it look like an afterthought and gives the other side an argument that nobody treated it as a term of the job.
The offer letter and the confidentiality agreement go out together, and if you do not already have the latter, an NDA template is the fastest way to get a defensible one in place.
Storage is the unglamorous half of the work. A signed arbitration agreement you cannot produce is not an agreement, and countersigned records scattered across email are how employers lose motions they should have won. Keeping the whole signed file in one system, with dates and versions, is what HR document management is for. If you are rolling one out now, open a register on day one rather than reconstructing it later:
| A | B | C | D | E | F | G | H | I | J | K | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| 1 | Employee | Job title | State where the work is performed | Role moves goods on an interstate journey, even an in-state leg (Y/N/Unsure) | Agreement version | Date presented | Days given to review | Date signed | How it was signed | Where the signed copy is stored | Notes |
| 2 | |||||||||||
| 3 | |||||||||||
| 4 | |||||||||||
| 5 | |||||||||||
| 6 | |||||||||||
| 7 | Note | One row per person, including anyone who declined or never returned it, because a gap you cannot explain is worse than a no | |||||||||
| 8 | Note | The transportation column is a flag for counsel, not a conclusion. The test is what the person does, not what industry you are in | |||||||||
| 9 | Note | Store the signed copy with the offer letter and the confidentiality agreement, not in an inbox |
When a Small Employer Should Skip It
Skip it when the exposure you actually face is a handful of individual disputes with salaried staff. In that shape, arbitration buys privacy and speed while adding a per-case forum bill and an outcome you cannot appeal, and the trade rarely comes out ahead.
Consider it seriously when you employ a large hourly workforce, when overtime and meal-break exposure is genuine, or when a single misclassification theory could apply to an entire job title at once. That is the scenario the waiver was built for, and no other tool addresses it as directly.
Whatever you decide, remember what actually reduces claims. Clear workplace policies and documented performance conversations prevent more disputes than any clause resolves, because most employment claims start as a disagreement about what the rules were.
A termination process somebody thought about beforehand does the same work at the other end of the relationship, because separation is where a manageable disagreement usually turns into a filed claim. When a separation is contested anyway, a properly drafted severance agreement with a valid release closes the matter far more cheaply than either forum.
Your next step is one question: which specific claim is this agreement meant to protect you from? If you can name one, such as a collective wage claim across an hourly team, draft the agreement carefully and present it as a standalone document. If you cannot, leave the clause out.
Frequently Asked Questions
Are mandatory arbitration agreements legal for employers?
Yes. The Federal Arbitration Act makes a written agreement to arbitrate valid, irrevocable and enforceable, and the Supreme Court has repeatedly applied that rule to employment agreements signed as a condition of getting or keeping a job. Two federal limits matter. Section 1 of the statute excludes transportation workers, defined by what the worker does rather than by the employer’s industry, so distribution drivers and cargo loaders can fall outside it. And the Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act lets a person alleging sexual assault or sexual harassment refuse arbitration even though they signed. Beyond that, ordinary state contract defenses still apply, which is where most agreements actually fail: one-sided terms, cost shifting, damage caps, and shortened deadlines.
Can an employer require arbitration of sexual harassment claims?
No, not through an agreement signed before the dispute existed. The Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act, signed March 3, 2022, lets the person making the allegation decide whether to stay in arbitration or go to court. If they choose court, neither the predispute arbitration clause nor a predispute waiver of joint action can be enforced against them in that case. Only the claimant holds that option, so an employee who prefers arbitration can still use it. Two federal appeals courts, the Sixth and Second Circuits, have applied the exemption to the entire lawsuit rather than just the harassment count, so one viable harassment allegation can bring discrimination, retaliation and wage claims into court alongside it. The law reaches any dispute that arises, or claim that accrues, on or after March 3, 2022, no matter when the employee signed.
Is arbitration cheaper for the employer than a lawsuit?
Often not, and treating arbitration as the cheaper route is behind more poor decisions than anything else on this topic. When an employer requires the forum, both major administrators put its cost on the company. The employee pays only a capped administrative filing fee, while the employer covers the arbitrator’s pay, the case management fee, expenses and the hearing room, and arbitrators bill by the hour or the day at professional rates. A federal district court charges the plaintiff a few hundred dollars to file and provides the judge at no cost to either side. Arbitration can save time, discovery volume and the risk of a runaway jury verdict. It does not reduce what your lawyers charge to defend the case, and it adds a forum bill that a court case never carries.
Can employees still file with the EEOC if they signed an arbitration agreement?
Yes, always. Signing an arbitration agreement does not take away an employee’s ability to file a discrimination charge with the EEOC, and it does not stop the agency from investigating that charge or from seeking relief for the person in its own lawsuit. When the agency rescinded its older policy statement opposing mandatory arbitration, it explained that court decisions now make clear it stays available to employees to assert their rights and to investigate in the public interest, whatever arbitration agreement they signed. The National Labor Relations Board follows a related principle: a clause that an employee could reasonably read as forbidding a charge to the Board has been found unlawful. For that reason, write an explicit carve-out for filings with administrative agencies.
Are class action waivers in arbitration agreements enforceable?
Yes. The Supreme Court decided in Epic Systems Corp. v. Lewis that an agreement to arbitrate individually, with a waiver of class and collective proceedings, must be enforced as written, and that the National Labor Relations Act gives no basis for setting the Federal Arbitration Act aside. For a small employer this is the main attraction, since a wage and hour collective action is the claim most likely to outgrow what the business can absorb. A newer problem works the other way. Plaintiff firms now file large batches of individual demands under one clause, and each demand carries its own forum fee for the employer. Administrators have responded with batching procedures and staged fee schedules, but the exposure has not gone away.
Did California ban mandatory arbitration agreements?
It tried, but the ban cannot be enforced. Assembly Bill 51 made it unlawful, and in some situations a crime, to require an applicant or employee to accept arbitration as a condition of getting or keeping a job. In Chamber of Commerce v. Bonta, decided February 15, 2023, the Ninth Circuit ruled that the Federal Arbitration Act overrides the ban, because a state may not treat arbitration agreements worse than other contracts when they are formed. New York and New Jersey passed similar restrictions, and federal courts have mostly reached the same result. California still regulates arbitration after the agreement is signed, through strict deadlines for paying arbitration fees, close unconscionability review, and no automatic pause of the court case while an employer appeals a denied motion to compel.
What has to be in an enforceable arbitration agreement?
Six elements do most of the work. A neutral arbitrator chosen through a process both sides accept. Mutual obligation, so the company arbitrates its claims too. Discovery adequate to prove a statutory claim. No costs unique to arbitration charged to the employee, which in practice means the company pays the arbitrator. A written award with enough reasoning to permit the limited review the statute allows. And every remedy the underlying statute provides, with no damage caps, no shortened limitations period, and no interference with fee shifting. Add an explicit carve-out for administrative agency charges and for workers’ compensation and unemployment claims. Agreements fail on the extras that someone added to gain an edge, not on the core promise to arbitrate.
Should a small business use a mandatory arbitration agreement?
It depends on the claim you are actually worried about. If your exposure is a wage and hour collective action across an hourly workforce, an individual arbitration requirement with a class waiver is the strongest tool available, and that alone persuades many employers. If your exposure is one-off disputes with salaried staff, arbitration mostly buys privacy and speed at the price of a forum bill and a nearly unappealable outcome. Two facts should temper the decision either way. Sexual assault and sexual harassment claims can be pulled back into court at the claimant’s election, and mass filings turn the fee structure against you. A clean handbook, documented performance management and disciplined termination practice prevent more claims than any clause resolves.
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