BILL ANALYSIS
SENATE JUDICIARY COMMITTEE
Martha M. Escutia, Chair
2001-2002 Regular Session
SB 1040 S
Senator Machado B
As Amended April 18, 2001
Hearing Date: April 24, 2001 1
Health and Safety Code 0
GWW:sr 4
0
SUBJECT
Health Care Plan Arbitration Clauses
DESCRIPTION
This bill would require the following in any health care
plan using binding arbitration to resolve a patient
dispute:
The health plan arbitration program may not include
damage limitations that differ from the damages available
in court.
The plan must permit patients to be represented by
counsel, to file a written brief, and make a closing
argument.
The plan must use the same statute of limitations periods
as a court case.
The plan must expressly incorporate the arbitration
discovery provisions of Code of Civil Procedure Section
1283.05 into the agreement.
The bill would require plans using mandatory arbitration
that:
The claimant shall not be required to pay any
administrative or arbitrator's fees, except for a filing
fee not exceeding the superior court filing fee.
The plan must also use binding arbitration to settle any
dispute with an enrollee or subscriber.
Any plan arbitration agreement containing any terms in
conflict with this bill would be void and unenforceable.
(more)
SB 1040 (Machado)
Page 2
The bill would allow a court to vacate the arbitration
award in a health care service plan arbitration if the
award, on its face, evidences a manifest disregard of the
law and thereby results in a substantial injustice.
Lastly, this bill would declare the Legislature's intent
that the enactment of this bill, applicable only to health
plan arbitrations, shall not be construed as any intent to
(1) limit a court's power to find a term limiting damages
in other arbitration agreements to be void and
unenforceable or to find an agreement with that term to be
void and unenforceable in its entirety; and (2) to affect
in any manner any pending matter before the California
Supreme Court.
BACKGROUND
In its December 2000 Report, Arbitration in California
Health Care Systems, the California Research Bureau reports
that 80 percent of Californians enrolled in a health plan
are required by the plans to use binding arbitration as the
means of resolving patient disputes.
Other findings of the report are:
Binding arbitration agreements are a distinctive feature
of HMO plans. A RAND study found that 90% of responding
hospitals and physicians did not require binding
arbitration as a condition of providing services.
A conservative estimate is that 300 health plan
arbitrations occur annually. The number is believed to
be low because of underreporting of arbitrations by the
plans.
Many arbitration cases are dismissed through summary
judgment. For Kaiser, the summary judgment rate was 12%.
(Before the recent reform of Kaiser's arbitration
system, the summary judgment rate was 27%.) For
comparison, only 0.6% of all civil complaints in court
were dismissed by summary judgment.
Arbitration is expensive. A typical health care
arbitration costs around $4,500. Most plans require an
equal sharing of costs. Lawyers seldom take arbitration
cases on a contingency basis.
Repeated use of the same arbitrator favors the health
plans. In the reported cases involving a patient award
of more than $1 million, none of the arbitrators had a
SB 1040 (Machado)
Page 3
second reported case. In contrast, eight repeat
arbitrators who did five or more cases each decided 30%
of the Kaiser claims studied in 1999. Six of the eight
repeat arbitrators favored ruled in Kaiser's favor in 80%
of the cases.
California does not have established professional
standards or licensing requirements for private
arbitrators. (A pending measure, SB 475 (Escutia) would
require private arbitrators to comply with ethical
guidelines to be adopted by the Judicial Council,
effective July 1, 2002.)
CHANGES TO EXISTING LAW
1. Existing law provides that trial by jury is an inviolate
right and shall be secured to all. (Cal. Const. Article
1, Sec. 16.)
Existing law, Code of Civil Procedure Section 1281,
provides that a contract containing a predispute
arbitration clause is valid and enforceable, except upon
such grounds as exist for the revocation of any contract.
For this purpose, caselaw, Armendariz v. Foundation
Health Psychcare Services, Inc. (2000) 24 Cal.4th 83,
holds that arbitration agreements are neither favored nor
disfavored, but simply placed on equal footing with other
contracts.
Existing law authorizes the court to refuse to enforce a
contract, or provision thereof, if the court finds the
contract to have been unconscionable when made (Civil
Code section 1670.5). In Armendariz, the Court held that
a mandatory arbitration agreement which contained
unconscionable provisions was unenforceable in its
entirety.
Existing case law , Armendariz v. Foundation Health
Psychcare Services, Inc., supra, held that that statutory
employment rights may be subject to mandatory arbitration
"if the arbitration permits an employee to vindicate his
or her statutory rights. As explained, ? the arbitration
must meet certain minimum requirements, including
neutrality of the arbitrator, the provision of adequate
discovery, a written decision that will permit a limited
form of judicial review, and limitations on the costs of
SB 1040 (Machado)
Page 4
arbitrations." Id., at pp. 90-91.
This bill would prohibit any health care service plan
contract using mandatory or voluntary binding arbitration
to resolve disputes with subscribers and enrollees, from:
(1) imposing limits on the awardable arbitration
damages that differ from that awardable in a court or
jury trial;
(2) prohibiting attorney representation for the
claimant;
(3) prohibiting the claimant from filing a written
brief or making a closing argument; and
(4) using different statute of limitations for the
filing of an arbitration than a court claim.
In addition, the contract must expressly incorporate the
provisions of Code of Civil Procedure Section 1283.05
which sets forth the rules for discovery in arbitration.
This bill would also require, for plans using mandatory
arbitration to settle enrollee disputes, that (1) the
claimant shall not be required to pay any administrative
or neutral arbitrator's fees, except for a filing fee not
exceeding the superior court filing fee; and (2) the plan
must also use binding arbitration to settle any dispute
with an enrollee or subscriber.
This bill would provide that arbitration agreement in a
health care plan that contains any terms that are
inconsistent with the provisions of this bill would be
void and unenforceable
2. Existing law requires a court to vacate a private
arbitration award if the court finds that the award was
procured by corruption, fraud or other undue means; or if
the rights of the party were substantially prejudiced by
the arbitrator's misconduct or refusal to postpone the
hearing for good cause or to hear evidence material to
the controversy. (CCP Sec. 1286.2.) Under existing case
law , Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1, a
private arbitrator's award cannot be judicially corrected
even when the error [of fact or law] appears on the face
of the award and manifest injustice will occur as a
result of the uncorrected award.
SB 1040 (Machado)
Page 5
This bill would allow a court to vacate an arbitration
award if the court finds that the award, on its face,
evidences a manifest disregard of the law and thereby
results in substantial injustice.
COMMENT
1. Prior legislation: SB 1934 (Polanco)
This bill is a significant expansion of SB 1934 (Polanco)
which this committee approved last year on a 6 - 1 vote,
with two abstentions. In the Assembly, the bill was
significantly expanded to include other provisions,
including the right of any party to vacate an arbitration
award if the award, on its face, evidences a manifest
disregard of the law and thereby results in substantial
injustice. This proposal was very controversial, see
Comment 4, below, as were the other provisions. The bill
failed passage in the Assembly Judiciary Committee
SB 1040 is a reintroduction of the expanded bill rejected
by the Assembly Judiciary Committee. It has been
expanded even further to add provisions, say proponents,
"suggested by Armendariz."
2. Stated need for bill
The sponsor, the Kaiser Permanente Medical Care Program,
asserts that
SB 1040 is intended to assure due process protections for
consumers in health plan arbitrations. Kaiser is aware
of at least one health plan which prohibited the award of
punitive damages in arbitrations to resolve disputes
arising from the health care service plan. This bill
would ban such a limitation.
Following Armendariz, the bill would also require any
binding arbitration clause to expressly allow specified
discovery in the arbitration and would provide for a
limited right of appeal.
In addition, SB 1040 would also bar the use of specified
provisions in the arbitration agreement, with the goal of
ensuring that health plan enrollees' rights are
protected. For instance, the Armendariz case identified
SB 1040 (Machado)
Page 6
several possible clauses in mandatory arbitration
agreements that may be improper or unconscionable. SB
1040 would prohibit clauses imposing binding arbitration
only for patient disputes and clauses requiring the
claimant to share in the costs of the arbitration in a
health care service plan contract that uses mandatory
arbitration.
Left unsaid, but obviously important, is that the removal
of improper or unconscionable provisions would make the
remainder of the arbitration agreement less subject to
challenge and being found unenforceable. (In Armendariz,
the Court refused to sever the unconscionable provisions
and found the entire agreement to be unenforceable.)
While Armendariz concerned the arbitration of statutory
employment rights under the Fair Housing and Employment
Act, its reasoning could be applied to other mandatory
arbitration settings in which a statutory right is being
adjudicated. Thus, proponents of mandatory arbitration
agreements are making pro-active changes in an attempt to
buttress these agreements.
3. Opposition to "reforms" of mandatory arbitration clauses
The Consumer Attorneys of California (CAOC) argues that
"forced, binding arbitration is inherently unfair" and
that problems associated with forced arbitrations cannot
be addressed by adjustments to the process that are
geared more towards protecting the arbitration clause
from attack, than towards protecting the rights of
claimants. As evidence of the sponsor's motivation, CAOC
points out that SB 1040 fails to expressly adopt two key
requirements also suggested by Armendariz, that a neutral
arbitrator must be used and the requirement for a written
decision that will permit a limited form of judicial
review.
With or without those additional provisions, CAOC
contends that SB 1040 would perpetuate a fundamentally
unfair and flawed system of forced arbitration. CAOC
asserts that the focus of any change to the arbitration
process should be to make the system voluntary. As the
Court stated in Armendariz, "[a]rbitration is favored in
this state as a voluntary means of resolving disputes,
SB 1040 (Machado)
Page 7
and this voluntariness has been its bedrock
justification." (Id., at p. 115.)
The Foundation for Taxpayer and Consumer Rights also
opposes SB 1040. It contends that the bill's main
purpose is to protect mandatory binding arbitration
systems from recent court attacks by offering an
innocuous alternative that simply restates current law,
but calls it reform. For example, Code of Civil
Procedure Section 1282.4 already provides for the right
to be represented by counsel, though this right may also
be waived. Section 1283.05, which this bill
incorporates, provides for only limited rights of
discovery which depend on the arbitrator's permission
(subd. (e)).
Opponents argue that, fundamentally, forced binding
arbitration agreements are nothing more than adhesion
contracts imposing unconscionable terms on consumers who
had to "take-it or leave-it." Courts, including the
California Supreme Court, are refusing to enforce these
adhesion contracts, finding that the unconscionable terms
make the contract in its entirety unenforceable. (Cf.
Armendariz, supra. See, also, McCoy v. Marshack, Shulman
& Hodges (2001) 87 Cal.App. 4th 354. But, see, Pichly v.
Nortech Waste (2001) ___ Cal.App. 4th ____, April 2, 2001
ruling of Third District Court of Appeals severs
unconscionable clause imposing binding arbitration only
on the employee's disputes and enforces the remainder of
the agreement.*)
*(In Shubin v.William Lyon Homes, Inc., decided November
14, 2000, the First District Court of Appeal also severed
an unconscionable provision and ordered enforcement of
the arbitration agreement. The California Supreme Court
denied the petition for review and ordered the case
depublished. (2001 Cal. LEXIS 1552.) No doubt, a
petition of the Pichly case to the Supreme Court will
raise similar questions.)
The Foundation writes: "[s]uch a lack of due process
rights for patients [in HMO arbitrations] caused a
commission of the American Medical Association, American
Arbitration Association and American Bar Association to
conclude in 1998 that patients should only enter into
SB 1040 (Machado)
Page 8
arbitration voluntarily, after a dispute occurs, not as a
condition of having health coverage as an HMO."
Opponents argue that rather than faux reform, mandatory
arbitration agreements should be banned in favor of
voluntary arbitration.
4. New grounds to vacate erroneous award
based on manifest disregard of the law may provide no relief
for consumers, and could advantage the wealthier party
In Moncharsh, the California Supreme Court limited any
review of a private arbitrator's erroneous decision, even
if that error appears on the face of the award and
manifest injustice would result from an uncorrected
award. In contrast, a judicial arbitration judgment,
like a court judgment, is reversible upon a showing of
error. Since Moncharsh, consumer critics of binding
arbitration clauses have contended that consumers forced
into mandatory arbitrations should not lose their
fundamental right to basic justice, and that private
arbitration clauses should not be able to take away
fundamental rights such as the right to basic justice.
This bill would provide, for health care service plan
arbitrations, that a court may vacate an arbitration
award if the award, on its face, evidences a manifest
disregard of the law and thereby results in substantial
injustice.
a) Similar standard in federal law has not resulted in
a single case being vacated; standard fails to allow
appeals for errors in fact
The proposed standard comes close to adopting the federal
standard of "manifest disregard of the law or completely
irrational." To staff's knowledge, no cases have been
reported in which the standard was used to vacate an
arbitration award. Thus, this limited review may well
provide no relief in cases of error.
CAOC asserts that this provision is very
anti-consumer. In order to allow a claimant to
vindicate his or her rights, the grounds for appeal
must allow meaningful judicial review. SB 1040's
SB 1040 (Machado)
Page 9
proposed standard for vacatur, "manifest disregard of
the law," cannot correct a decision based on erroneous
facts, and its standard is so high, "manifest
disregard," that no federal court has used it to
vacate a single case.
b) Proposal could enable wealthier HMO to appeal
arbitration award in favor of claimant, to leverage a
settlement
Instead of providing even modest fairness to consumers
forced into mandatory arbitration, CAOC asserts that
this provision would give even greater advantages to
the wealthier HMO party. Under SB 1040, the HMO would
be able to appeal an award in favor of the claimant,
thus using the process to further delay resolution of
the dispute. CAOC writes: "?the HMO's ability to
stall means that the patient is further denied
treatment deemed necessary and presents a very real
chance that the HMO will simply wait for the patient
to die, as Kaiser did in the Engalla case."
In defense of this two-way appealability, the sponsor
argues that SB 1040 strikes a balance between keeping
arbitration fast and affordable and providing a remedy
for serious legal error. While the goal of binding
arbitration is a quick and final resolution of the
dispute, the sponsor recognizes, following Armendariz,
that there needs to be a safety valve to ensure that
justice is served in rare cases of gross error by the
arbitrator.
c) Prior consumer reform efforts opposed by sponsor
In 1995 and again in 1997, then-Senator Lockyer
carried proposals to provide relief from an erroneous
arbitration award to consumers forced into binding
arbitration by a pre-dispute clause in the consumer
services contract. Both his SB 692 of 1995 and SB 19
of 1997 sought to allow consumers whose claims were
subject to mandatory arbitration to appeal the award
where a legally erroneous award would result in the
miscarriage of injustice. Those provisions were
opposed by the sponsor and other proponents of this
bill, and were ultimately withdrawn.
SB 1040 (Machado)
Page 10
5. Intent language may undermine Armendariz's application to
other cases
SB 1040 would adopt intent language proposed last year in
SB 1934. However, the passage of time and the Court's
decision in Armendariz make the need for the intent
language and its desirability less than clear. Moreover,
the intent language may be read as implied legislative
intent to limit application of Armendariz to arbitrations
involving statutory employment rights and health care
service plan patient disputes.
Opponents state that the intent language is a Trojan
horse, that the harm it threatens is that the intent
language would create a legal implication that other
(non-health plan) types of binding arbitrations are not
similarly prohibited from provisions limiting a
consumer's available remedies and rights. In addition,
Armendariz noted five minimal features for enforceability
of a mandatory arbitration clause. SB 1040's "savings
language" would only apply to one -- terms limiting
damages - thus making the statement that the Legislature
does not believe the other four requirements should also
be required in other mandatory arbitration settings.
Opponents contend that the intent language would
undermine application of Armendariz to protect consumers
in other mandatory arbitration settings.
IS THIS THE AUTHOR'S INTENT?
6. Other Support argument
Proponents, other health plans, the Civil Justice
Association of California, the California School
Employees Association, the California Chamber of
Commerce, and other business groups, write that the bill
would provide new rights to health plan members in
binding arbitration to settle patient disputes. They
state that SB 1040 would ensure that arbitration
proceedings are conducted in a fair and impartial manner,
and would provide a health plan enrollee with additional
tools in which to settle disputes equitably. They also
state that use of predispute arbitration agreements
lowers costs and that keeping health care costs
SB 1040 (Machado)
Page 11
affordable is good public policy.
The California Association of Health Plans (CAHP) also
adds that arbitration is an effective alternative means
of resolving disputes that has been widely supported by a
broad spectrum of organizations, including the courts.
Hearings are much quicker, usually one to three days,
compared to weeks or months in court. Also, because
arbitrations are usually final, enrollees see a prompt
enforceable resolution to their dispute. Lastly, CAHP
and others argue that arbitration is less expensive for
both consumers and health plans.
7. Other concerns raised by opponents
Opponents also assert that SB 1040 fails to address the
many fundamental problems associated with mandatory,
pre-dispute binding arbitration. These other flaws
include:
a) There are no mandated regulatory, ethical or
educational schemes governing arbitrators. Almost
anyone can call herself an arbitrator, regardless of
knowledge of the law or expertise;
b) Unlike a jury, arbitrators rarely reflect the
population mix. The challenge arises from a belief
that claimants, particularly patients challenging a
large institution such as an HMO, deserve the
opportunity to have their cases heard before a jury of
their peers, a jury that more accurately reflects
their community; and
c) There is an inherent bias in a system with repeat
users (like HMOs) who pay the arbitrators' or
administrators' fees and who have access to detailed
track records. This shortcoming was echoed and
verified by the recent Legislative Research Bureau
report. In short, CAOC says, the HMO claim that
arbitration can be a "separate but equal" forum is
wrong.
In addition, opponents say that forced arbitration is
unfair to consumers because it limits their ability to
retain counsel. Since arbitration awards are lower than
court or jury awards, and are not appealable for legal
errors, lawyers generally refuse to take arbitrations on
a contingency basis. With the need to hire a lawyer on a
SB 1040 (Machado)
Page 12
hourly scale, even with the cost limits required by
Armendariz, arbitration is still more costly for
claimants than litigation. Thus, forced arbitration
makes justice unavailable to those who cannot afford it.
Finally, opponents contend that the sponsor's claimed
interest to provide due process protections to injured
claimants is simply not credible. Until the Supreme
Court reined in their arbitration practices in Engalla v.
Kaiser Permanente, (1997) 15 Cal.4th 951, the sponsor's
arbitration system was an illustration of "justice
delayed is justice denied." The average time for the
appointment of a neutral arbitrator was 674 days, and the
average wait for a hearing was 863 days. In that case,
the claimant died awaiting his hearing.
While these abuses have been corrected with the
appointment of an independent administrator to operate
the Kaiser arbitration system, other unfair requirements
on claimants in typical arbitration systems, such as the
requirement to share in the costs of arbitration, have
continued and would likely have continued in the absence
of Armendariz**. As an example, the sponsor's bill last
year to give due process to claimants did not limit the
claimant's responsibility for sharing the costs of health
plan arbitrations. Like Engalla, it took the Supreme
Court of California to rein in the practice. Thus,
opponents conclude, Kaiser's interest in promoting SB
1040 is not to protect the due process rights of its
injured enrollees, but rather to protect their forced
arbitration system from being held unenforceable.
**(It should be noted that Rule 15 of Kaiser's
arbitration system now provides for Kaiser to pay the
neutral arbitrators fees if the claimant agrees to waive
any potential objection arising out of such payment and
signs a waiver of objection form, and if the arbitration
only has a neutral arbitrator or the claimant has waived
the right to a party arbitrator. Absent these
conditions, the fees and expenses of the neutral
arbitrator are assessed to both parties. This
conditional protection from a fee assessment does not
appear to comport with Armendariz, assuming its
applicability to health plan arbitrations.)
SB 1040 (Machado)
Page 13
In defense, it can be said that regardless of the
motivation, SB 1040's prescription of rights for
claimants in health care arbitrations is more than the
law currently requires. Armendariz, on its facts,
applies only when a statutory employment right is subject
to mandatory arbitration and its extension to other
mandatory arbitration settings cannot be automatically
assumed.
8. Opposition from arbitrators' group
The California Dispute Resolution Council (CDRC) believes
that it would create confusion to establish an appeals
standard for health care arbitrations only, and not for
the other cases as well. It suggests that the standard
be enacted as a general rule of appealability.
CDRC also believes a violation of the bill's provisions
should not be punishable as a misdemeanor, as it would
because of its inclusion in the Knox-Keene laws. The
sponsor rejected a similar suggestion to SB 1934, stating
that Kaiser would find it awkward for Kaiser to propose
lesser civil penalties for itself when it violates the
law.
9. No preemption problem
The Federal Arbitration Act ("FAA") applies to "any
contract evidencing a transaction involving commerce"
which contains an arbitration clause. (Title 9 United
States Codes, Section 1.) Section 2 provides that
arbitration provisions "shall be valid, irrevocable, and
enforceable, save upon such grounds as exist at law or in
equity for revocation of any contract."
Section 1281 of the California Arbitration Act contains
similar language. As made clear recently in Armendariz
as well as the United States Supreme Court: "[S]tates may
regulate contracts, including arbitration clauses, under
general contract law principles and they may invalidate
an arbitration clause upon such grounds as exist at law
or in equity for the revocation of any contract.
[Allied-Bruce Terminex Companies, Inc. v. Dobson Inc.
(1995) 115 S.Ct. 834.]
SB 1040 (Machado)
Page 14
10. Conflicting legislation
SB 458 (Escutia), pending hearing by this committee,
would specify that a health care service plan or managed
care entity is liable "in a court of law" for its failure
under SB 21 (Figueroa) of 1999 to provide medically
necessary care and the enrollee suffers substantial harm.
SB 458 will be heard by this Committee within the next
few weeks.
SB 1040 could be used to enable Kaiser and other health
care service plans to compel arbitration of claims under
this statutory right. In this regard, the policies of
the two bills are inconsistent and in conflict.
11. Related pending legislation
SB 475 (Escutia) would require an appointed arbitrator in
non-judicial (private or contractual) arbitrations to
comply with all disclosure and disqualification
requirements established in current law, and would make
it a basis for vacating an arbitration award if the
arbitrator failed to timely disclose a known ground for
disqualification. The bill would also direct the
Judicial Council to adopt ethical guidelines for these
arbitrators by July 1, 2002, and would require these
arbitrators to comply with the adopted ethics standards
on and after that date. SB 475 was approved by this
Committee at its April 17 hearing by a 6 to 1.
12. Prior conflicting legislation
AB 1751 (Kuehl, 2000) would have prohibited a health
care service plan or disability insurer from requiring
that enrollees, subscribers and policyholders agree to
submit to binding arbitration to resolve disputes arising
under the contract or policy. It would also have
provided that any pre-dispute binding arbitration clause
inserted into a health care service contract or
disability insurance contract would be void and
unenforceable, and that any waiver by a subscriber or
enrollee of this prohibition would be deemed involuntary
and contrary to public policy. AB 1751 was heavily
opposed by the sponsor and other health plans. It was
SB 1040 (Machado)
Page 15
held without a vote on the Assembly Inactive File.
AB 1557 (Gallegos, 1998) provided that mandatory
arbitration clauses in health care contracts are valid
only if the enrollee voluntarily and affirmatively agrees
to the provision at the time of enrollment. It also
prohibited plans from requiring enrollees to agree to the
provision as a condition of receiving benefits. AB 1557
was opposed by the health and business groups supporting
this measure. It was held by the Senate Appropriations
Committee.
SB 19 (Lockyer, 1997) would have created a right on
behalf of consumers to appeal a legally erroneous
arbitration award when the consumer had to agree to
submit mandatory arbitration as a condition of entering
into the contract to obtain goods, services, or
employment. The provision was opposed by the Kaiser
Permenente Medical Program, among others, and was
eventually deleted from the bill.
Support: California Association of Health Plans; Health
Net; PacifiCare; California Medical Association;
L.A. County Federation of Labor, AFL-CIO; California
Chamber of Commerce; California Black Chamber of
Commerce; Association of California Life & Health
Insurance Companies; Californians Allied for Patient
Protection; California School Employees Association;
Civil Justice Association of California; California
Healthcare Association; Employers Health Care
Coalition of Los Angeles; Health Insurance
Association of America
Opposition: Congress of California Seniors; The Foundation
for Taxpayer and
Consumer Rights; Consumer Attorneys of California;
California Dispute Resolution Council; California
Nurses Association
HISTORY
Source: Kaiser Permanente Medical Care Program
SB 1040 (Machado)
Page 16
Related Pending Legislation: SB 458 (Escutia) - Pending in
Senate Judiciary
SB 475 (Escutia) - Pending in Senate
Appropriations Committee
Prior Legislation: SB 1934 (Polanco) - Held in Assembly
Judiciary Committee
**************