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Resurrection of an old but timely proposal: voluntary arbitration of employment discharges.


More than 10 years have passed since the controversial idea that small business should voluntarily arbitrate employee discipline and discharge cases was first proposed (Fenton & Timmins, 1982). The proposal was primarily a response to some experts' (e.g., Summers, 1980) interest in encouraging the passage of federal legislation to protect all employees against discharges without cause. Today, the proposal has even more relevance. Crippling damage awards from employment-related litigation have grown to enormous proportions over the last decade. It has been reported that in California three out of four plaintiffs win wrongful termination suits and recover an average verdict of $1.5 million (Dertouzos, Holland & Ebener, 1991). This article reviews the need for arbitrating employee discharge cases and concludes that businesses, particularly small businesses, should adopt this strategy.

The At-Will Doctrine Revisited

Unlike public sector employees, whose individual employment rights are protected by constitutional due process, the "just cause" shield, and, in some cases, the just cause provisions of labor agreements, most of the private sector workforce has no similar protections against loss of employment through discharge. The root cause is the age old doctrine of employment-at-will. In its most basic form, the doctrine states that the employer can terminate a subordinate who is not under contract for good cause, bad cause, or no cause (Pane v. Western & A.R.R.). The quid pro quo in the courts' view is that the employee has the right to quit his employment-at-will at any time with or without notice (Blades, 1967). Thus, the parties are looked upon by the courts as equals in their respective powers.

The reality, however, is that the powers of the parties, employer and employee, are anything but equal. From the employee's perspective, the power is more theoretical than real, since the employee's fear of losing a job far outweighs an employer's fear of losing an employee (Vickory, 1992). Employment has significant meaning to the employee, and his ability to find alternative equal employment, particularly today, cannot be assumed. Further, the propensity of employers to abuse their power to discharge has been well chronicled (see e.g., Aaron, 1976; Himburger, 1989; Peck, 1979; Stieber, 1980).

Exceptions to the Doctrine

Erosion of the at-will rule has come in the form of federal legislation and through the courts. Federal legislation including the National Labor Relations Act,(1) the Civil Rights Act,2 and the Americans With Disabilities Act(3) prohibits employers from discharging workers covered by such legislation.

Courts have modified the at-will rule in three areas: public policy exceptions, breach of an express or implied contract, and breach of the covenant of good faith and fair dealing. According to the Bureau of National Affairs (1991), the public policy exception has been adopted by courts of law in 43 states, the breach of express or implied contract theory is accepted in 34 jurisdictions, and the exception based on the covenant of good faith and fair dealing is followed in 13 states.

The most common limitation to the at-will doctrine is the public policy exception (Holley & Wolters, 1987). In short, this exception recognizes that employers cannot discharge employees for exercising statutory rights, i.e., obeying a law or following recognized public policy. Therefore, for example, where employers discharge employees for testifying under oath in any forum,(4) or because they missed work to sit on a jury,(5) or for refusing to violate a professional code of ethics that was legisla-lively endorsed,(6) a suit alleging the public policy exception to the at-will rule may be triggered.

In addition to these public policy examples are so-called "whistle blowing" actions. Whistle blowing is the act of an employee who discloses improper employer practices or policies typically forbidden by statutory legislation. More than 20 federal and 34 states' statutes offer whistle blower protection (Dworkin & Callahan, 1991). Prevention of retaliatory discipline including discharge is the primary aim of such legislation (Harless v. First National Bank).

Probably the most controversial exception to the at-will rule is the implied contract exception, which is premised on the notion of an implied promise on the part of employer to employee. Verbal "promises" including pre-employment statements like "if you work hard you'll be here forever," have been interpreted as guarantees of indefinite employment. Similar statements in handbooks and policy manuals have been enforced as contracts. For example, where an employer uses language which implies that employees will be released from employment "for just cause only," the at-will doctrine is in effect negated. Courts look upon such language as implied contracts and enforce them in favor of employees (Thompson v. St. Regis Paper Co.).

The last exception and the one receiving the least acceptance from courts is called the good faith and fair dealing exception. Basically, this exception says that neither employer nor employee will interfere with one another's rights to receive the benefits of a mutual agreement - implied or in fact. The case of Fortune v. National Cash Register Co. exemplifies the argument of this exception. A commission salesperson for the firm landed a five million dollar order, and due to the size of the order the company had second thoughts about paying the commission and decided instead to terminate his employment. The employee argued that the firing was done in bad faith and violated an implied (unwritten) covenant of an indefinite hire employment contract. The jury agreed as did the Appellate Court that reviewed the jury's finding.

Small Businesses' Vulnerability

Over the past decade, the courts have become increasingly receptive to ex-employee wrongful discharge claims under these exceptions to the at-will employment doctrine (Geylein, 1989). At the same time, employees have become increasingly aware of the availability of the court system and are not the least bit reluctant to use it. Also, many attorneys are now willing to take cases on a contingency fee basis, so there is effectively no cost or risk to the plaintiff. One author describes the result of this new consciousness as "flooding state courts with at-will complaints" (Gradwohl, 1988). Moreover, in three out of four cases, judgments have gone in favor of ex-employee plaintiffs. In many instances, the firm is liable not only for make-whole damages but also for punitive damages. It is routine to see courts awarding hundreds of thousands of dollars in damages, and some judgments have exceeded one million dollars. Such judgments have been appropriately labeled "crippling" and "catastrophic" to the firm (Lambert, 1992).

Unfavorable judgments are of even more concern to small businesses that generally lack the financial strength to absorb them and can easily be driven out of existence by the loss of a single case. Furthermore, most small businesses do not have attorneys on staff, so whenever a case is brought they must hire legal representation on the open market, adding another cost to the burden. In addition, liability insurance coverage to cover the downside risk of employment-related litigation is difficult to obtain. When available, the coverage is expensive and growing more so as at-will litigation increases and juries find in favor of plaintiffs.

Another major development in this area is the mounting interest in federal and state legislation compelling employers to be bound by a "just cause" standard (or equivalent language) in discharge disputes and having such disputes proceed to an administrative (quasi court) hearing or to arbitration (Howlett, 1980; Summers, 1980; St. Antoine, 1988). Montana has a comprehensive statute in place,(7) and other state legislatures including Massachusetts, Delaware, Wisconsin, and Hawaii are actively debating the issue. Recently, the National Conference of Commissioners on Uniform State Laws approved and recommended for all states the enactment of the Model Employment Termination Act (META) (IERM, 1991). This Act proposes that, for covered employees, termination would be prohibited without "good cause." Enforcement will be through arbitration, with appropriate state agencies appointing the third party. Remedies called for in the proposal include make-whole measures such as back pay, seniority, benefits, reinstatement, and attorney's fees for a prevailing party. Other compensatory and punitive damages would not be allowed. The costs for these proposed procedures would be borne partly by the states but mostly by employers, with some cost being borne by employees.

These proposed state or federal laws should be a cause of some concern particularly for small businesses. The principle objection, from a small business point of view, is the addition of one more statute and possibly more bureaucracy with its costs and burdens. Second, such laws would further reduce small business' freedom to act. Third, the costs of the proposed process would ultimately be borne mostly by business in the form of either outright payments or increased taxes.

The Alternative - Voluntary Rights Arbitration

Arbitration is a quasi-judicial process voluntarily initiated by two parties. The parties, as part of their agreement, desire a dispute to be heard and decided by an expert, objective third party whose decision will be both final and binding. As a system of dispute resolution, it is considered to be the "elder" of all methods (Elkouri & Elkouri, 1991).

Arbitration has many advantages for both parties of the employment relationship.

* The employer would be seen as recognizing the importance of being fair and equitable to his employees by adopting a "due process" tool.

* Arbitration has an exceptional track record of effectiveness in unionized environments. Compared with courts of law, arbitration is less formal, less costly, and less time consuming. It does not require the parties to be represented by attorneys, it typically does not employ rules of evidence or procedure, and appellate review is very limited.

* Typical arbitration pacts with employees contain some very important provisions: an agreement whereby employee rights to sue over discrimination and discharge issues are waived; an agreement that the arbitration result is final and binding on all parties; and damage provisions limiting the arbitrator's awards to make-whole remedies with no consideration for punitive damages.

In 1991, the U.S. Supreme Court, in the case of Gilmer v. Interstate Johnson Lane Corporation, reinforced the strength of private arbitration pacts by upholding the finality of arbitrators' decisions under such agreements in a securities law context. Experts believe that holding applies to employment agreements as well (Lambert, 1992; Hayford, 1993).

The community of labor arbitrators has recognized the needs of the nonunion employee sector and is ready to help. Dr. Anthony V. Sinicropi, John F. Murray Professor of Industrial Relations at the University of Iowa and President of the National Academy of (labor) Arbitrators (1991-92), stated in his presidential address at the Academy's 45th annual meeting that the Academy "as an institution should adopt a significantly broader role with respect to the arbitration of employment disputes including those arising outside the context of collective bargaining" (Sinicropi, 1992).

In addition to advantages, arbitration has some weaknesses in the eyes of some observers. Arbitration does have dollar costs associated with it. Arbitrators typically charge on a per diem basis for their services plus expenses. If a party desires to be represented by an attorney, charges for legal services on a per diem basis will be charged to the party. If expert witnesses are used, consultation charges will be assessed to the party employing the expert. Finally, if the employer is found to have discharged the employee without proper cause, an award having some dollar value will be issued by the arbitrator. However, such costs compared with those of a lawsuit are generally much lower. In short, arbitration costs are less than those incurred in court cases.

Arbitration does require time - time to prepare for and to conduct. Such time would typically be taken from a manager's or entrepreneur's busy work schedule. The typical hearing could take as little as one hour or as much as several days. Preparation time typically requires eight hours or more depending on how many witnesses you wish to call upon to assist your case at the hearing.

Another oft-cited concern is that the arbitrator will evaluate management's actions using the standard of "cause," also known as "just cause," "proper cause," or "sufficient cause." The simplest definition of these terms is tautological, namely, that the company must show that it had some cause for the discipline (or discharge), and that the cause was just (Dunsford, 1990). This definition, however, begs a question or two. What is proper cause? What is a just one? The problem is that the answers to these questions cover the spectrum from the most conservative to the most liberal interpretation.

Another alleged flaw is that since arbitration is probably more beneficial to the employer than to employees, employees may not be willing to use it unless inducements are offered. Lynch and Redfern (1933) suggest that in the case of new hires, the offer of employment may be sufficient inducement. With respect to existing employees, however, salary or other benefit increases may be necessary to gain acceptance of the process as well as to establish that the agreement is not an unenforceable "contract of adhesion."

Conclusions and Recommendations

Today, employers, notably those with small businesses, are vulnerable to liability from court judgments addressing wrongful discharge claims. Another source of vulnerability arises from the possibility of statutory legislation designed to protect all so-called "at-will" employees against unjust discharges. To effectively address these areas of risk, the time has come for business, particularly small business, to take the initiative and act voluntarily on the matter, thereby defusing the issue. The proposal to voluntarily arbitrate all at-will employee discharges, first advanced over a decade ago, was a good policy proposal then and is an even better one today. Adopting this employment-related strategy makes good, practical business sense.


1. 49 Stat. (1935), as amended; 29 U.S.C. 151-69 (1988).

2. Pub. L. No. 102 (1991); 42 U.S.C. 2000 (e) et seq.

3. 42 U.S.C. 12101 (1990).

4. Petermann v. Teamster Local 396, 344 P2d 25, 1 IER Cases 5 (Call, Ct. App.).

5. Nees v. Hocks, 272 Or. 210, 536 P. 2d 512 (1974) (en banc).

6. Suchodolski v. Michigan Consolidated Gas Co., 316 NW 2d 710, 115 LRRM 4449 (Mich. Sup. Ct. 1982).

7. MONTANA CODE ANN. 39-2-901 1987).


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Lambert, Wade. (1992), "Employee Pacts to Arbitrate Sought by Firms," Wall Street Journal, October 22, B-1 & 14.

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Payne v. Western A.R.R., 81 Tenn. 507, 519-20 (1884).

Peck, Cornelius, (1979), "Unjust Discharges from Employment: A Necessary Change in the Law," Ohio State Law Journal 40, 1-49.

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St. Antoine, Theodore J. (1988), "A Seed Germinates: Unjust Discharge Reform Heads Toward Full Flower," Nebraska Law Review 67, (1 & 2), 56-81.

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Summers, Clyde. (1980), "Protecting All Employees Against Unjust Dismissal," Harvard Business Review 58 (1), 134-140.

Thompson v. St. Regis Paper Co., 102 Wash 2d 219, 685 P. 2d 1081 (1984).

Vickory, Frank. (1992), "The Erosion of the Employment-At-Will Doctrine and the Statute of Frauds: Time to Amend the Statute," American Business Law Journal 30, 97-122.

Dr. Fenton, Acting Dean and Forrest S. Williams Professor of Entrepreneurship and Human Resource Management, has 15 years of experience in private industry, including eight as an entrepreneur, and has published widely in academic and professional journals. Dr. Kelley is Professor of Management, Coordinator of the Management Area, and Director of the Small Business Institute at Francis Marion, where he has supervised over 300 small business cases.
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Author:Fenton, James W., Jr.; Kelley, Donald E.
Publication:SAM Advanced Management Journal
Date:Sep 22, 1994
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