California Senate Bill No. 940, which became effective January 1, 2025, places significant restrictions on arbitration provisions affecting California consumers. Under the law, consumers may void contractual provisions that require them to arbitrate certain claims outside of California and may seek attorney’s fees for doing so. Despite the apparent sweeping impact of this new law, it may be subject to federal preemption under the Federal Arbitration Act (FAA).
California SB 940 was passed by the California State Legislature on August 28, 2024 and was signed into law of September 29, 2024. It has since been codified in relevant part as California Civil Code § 1799.208.
The law applies to all consumer arbitration agreements “entered into, modified, or extended on or after January 1, 2025.” Under this law, “[a] seller shall not require a consumer to agree to a provision that would … [r]equire the consumer to arbitrate outside of California a claim arising in California” or “[r]equire the consumer to arbitrate a controversy arising in California under the substantive law of a state other than California.” The law allows consumers to void contractual provisions that violate these requirements, and instead allows them to litigate or arbitrate their claims in California, under California law. The statute also permits an award of attorney’s fees for consumers who enforce their rights under it.
Despite the law’s potential implications for consumer arbitration agreements, it may face challenges of its own. Section 2 of the FAA makes arbitration agreements “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” The Supreme Court has interpreted that language strictly. For example, in the 2017 case Viking River Cruises, Inc. v. Moriana, the Court held that “[a] court may invalidate an arbitration agreement based on generally applicable contract defenses like fraud or unconscionability, but not on legal rules that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.” The Court has been clear that “the FAA ‘preempts any state rule discriminating on its face against arbitration.’”
California Civil Code § 1799.208, which, again, prohibits “[r]equir[ing] the consumer to arbitrate outside of California a claim arising in California” and “[r]equir[ing] the consumer to arbitrate a controversy arising in California under the substantive law of a state other than California,” appears to be a rule that “appl[ies] only to arbitration or that derive[s] [its] meaning from the fact that an agreement to arbitrate is at issue.” Thus, under Supreme Court precedent, this new law may be subject to federal preemption on its face.
Notably, the California legislature was aware of this problem and initially seems to have tried to address it. Specifically, the original bill prohibited requiring a consumer to “adjudicate” outside of California, with “adjudication” defined to mean both arbitration and litigation, which commentary at the time suggested was done to avoid this preemption issue. But a June 12, 2024, amendment changed the bill to be a prohibition on arbitration only. Later, an August 20, 2024 Senate Committee bill analysis dismissed the risk of federal preemption, citing a California state appellate court decision assessing a similarly structured provision of the California Labor Code. However, that case, Zhang v. Superior Court of Los Angeles County, dealt with Section 925 of the Labor Code, which applies to both arbitration and litigation. California Civil Code § 1799.208, in contrast, only applies to arbitration agreements. Thus, the reasoning from Zhang on which the California legislature relied is unlikely to apply.
No court has yet weighed in on whether this law is subject to federal preemption, and only time will tell how this issue will ultimately be resolved. In the meantime, businesses that enter into arbitration agreements with California consumers should be mindful of the risks posed by Section 1799.208 and its implications for consumer-facing arbitration agreements. Care should be taken in drafting, revising, or extending such agreements to avoid the potential risks posed by this new law.
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