## Facts

- Mary Nelson, a former employee, sued American Apparel, Inc. and executives for wrongful termination and related employment claims.
- On the eve of trial, the parties announced a settlement that included (1) American Apparel paying Nelson $1.3 million and (2) Nelson dismissing the lawsuit.
- The settlement also required the parties to conduct an expedited “final and binding” arbitration before an arbitrator selected and paid by American Apparel on a stipulated record, with a prearranged award in American Apparel’s favor.
- The agreement permitted American Apparel to issue a press release publicizing the supposed arbitration “victory,” and included confidentiality and a separate arbitration clause covering disputes arising from the settlement.
- Nelson signed a request to dismiss the underlying action with prejudice, but her attorney later refused to participate in the staged arbitration.
- American Apparel claimed Nelson and/or her counsel breached the settlement (failure to participate; confidentiality violations) and asserted it was excused from paying the $1.3 million.
- American Apparel petitioned to compel arbitration of the settlement-performance dispute; the trial court denied the petition, citing enforceability and public-policy concerns, and American Apparel appealed.

## Issues

1. Whether a court or an arbitrator decides threshold enforceability and legality challenges to an arbitration clause contained in a settlement agreement.
2. Whether an arbitration clause is enforceable when it is intertwined with a settlement structure calling for a prearranged “sham” arbitration and a potentially misleading public announcement.
3. Whether the employer could withhold settlement payment based on alleged breaches tied to the questioned arbitral scheme while simultaneously demanding arbitration under the same settlement.

## Decision

- The Court of Appeal affirmed the order denying the petition to compel arbitration.
- The court held that the trial court properly decided gateway enforceability questions rather than sending those questions to an arbitrator.
- On the record presented, the arbitration clause could not be enforced because it was tied to, and could not be cleanly separated from, a settlement arrangement premised on a fictitious, preordained arbitral award and related publicity.

## Legal Principles

- Courts decide threshold questions concerning the validity and enforceability of an agreement to arbitrate; an arbitrator’s authority depends on a valid arbitration agreement.
- An agreement structured to generate a fabricated adjudicative outcome and enable misleading public claims can be treated as contrary to public policy and thus unenforceable.
- Severability does not require enforcement of an arbitration clause when the clause is embedded in, and dependent on, the challenged mechanism and alleged illegality is directed at the integrity of the arbitral process itself.
- A party cannot rely on disputed, potentially unenforceable settlement provisions both to justify nonperformance (such as withholding payment) and to compel arbitration of the resulting dispute.

## Conclusion

The appellate court affirmed denial of American Apparel’s motion to compel arbitration because the enforceability of the settlement’s arbitral arrangement presented gateway questions for the court, and the arbitration clause was inseparable from a settlement design calling for a prearranged, misleading “sham” arbitration and related publicity.


Nelson v. Am. Apparel, Inc., No. B205024, 2008 WL 4713262 (Cal. Ct. App. Oct. 28, 2008)