Read the fine print in your financial contracts—whether they are credit card agreements, loan terms, or otherwise—and the odds are overwhelming you will discover an arbitration requirement.
Those ubiquitous contractual clauses limit, if not outright remove, the ability to sue or take part in a class-action lawsuit when there is a dispute. Instead, in a forum of the firm’s choosing, with a hand-picked mediator, aggrieved customers are offered an arbitration hearing to resolve matters.
Thoughts on this practice provide a dividing line between consumer advocates and businesses. Consumer advocates rail against what they perceive as an unfair limitation on a customer’s ability to solve problems, seek restitution, and set a precedent that spares others from a similar complaint. Firms, however, see arbitration as fair, fast, effective for all involved, not to mention a cheaper alternative to the court system.
Count the Consumer Financial Protection Bureau in the camp of critics. On May 5, it released a proposed rule seeking to prohibit the widespread use of mandatory arbitration clauses. The proposal fulfils a mandate of the Dodd-Frank Act and draws heavily upon a March 2015 study of resolution practices. That CFPB research found that very few consumers ever bring—or even think about bringing—individual actions against financial service providers either in court or in arbitration. The conclusion: Class actions provide a more effective means for consumers to challenge problematic practices.
“Signing up for a credit card or opening a bank account can often mean signing away your right to take the company to court if things go wrong,” CFPB Director Richard Cordray said, announcing the proposal at an event in Albuquerque, New Mexico.
The hundreds of millions of mandatory arbitration clauses in consumer contracts typically state that either the company or the consumer can require that disputes between them be resolved by privately appointed arbitrators, except for cases brought in small claims court. They also typically bar consumers from bringing group claims through the arbitration process.
The proposed rules would apply to most consumer financial products and services the CFPB oversees, including those related to lending money, storing money, and moving or exchanging funds. Congress has already prohibited arbitration agreements in the residential mortgage market.
The rule would prohibit providers from using a pre-dispute arbitration agreement to block consumer class actions in court and would require providers to insert language into their arbitration agreements reflecting this limitation. It would also require providers that use pre-dispute arbitration agreements to submit certain records relating to arbitral proceedings to the CFPB, which intends to use the information it collects to monitor proceedings and determine whether there are developments that raise consumer protection concerns and warrant further action. The Bureau intends to publish these materials on its website in some form, with appropriate redactions or aggregation as warranted, to provide greater transparency into industry practices.
Consistent with the Dodd-Frank Act mandate, the proposed rule would apply only to agreements entered into after the end of the 180-day period beginning on the regulation’s effective date. The CFPB is proposing an effective date of 30 days after a final rule is published in the Federal Register.
“Let’s call it what it is. If this legislation becomes final, most companies will simply abandon arbitration altogether because the cost/benefit analysis of using arbitration will shift dramatically. I was sincerely hoping this day would never come because it really is a sad one for consumers.”
Alan Kaplinsky, Partner, Ballard Spahr
The proposal would permit providers of general-purpose, reloadable prepaid cards to continue selling packages that contain non-compliant arbitration agreements, if they give consumers a compliant agreement as soon as consumers register their cards and the providers comply with the proposed rule’s requirement not to use an arbitration agreement to block a class action.
Immediate reaction to the rule was typical of the battle lines drawn since the CFPB first began looking into the issue. On one side is Paul Bland, executive director of the advocacy group Public Justice. “Banks, payday lenders, and others have completely been able to break the law with impunity, and their customers really couldn’t do anything about it,” he says.
“Almost no consumers in America are going to individual arbitration—it is a rounding error, it is a speck,” Bland adds. “It is just not happening. The market has spoken. They built it and no one came.” The rule, however, “changes everything” and the “wild, wild west is over.”
“Banks are going to have to follow the consumer protection laws or they are going to have to face their consumers in court, not a corporate-controlled, secret tribunal where the consumers are divided and atomized and everyone is by themselves and alone,” he says. “It is no longer the ‘Hunger Games.’ Now, you are going to be back in the court system.
The “single most important thing the Bureau can do is level the playing field for consumers,” says Deepak Gupta, a principal at the firm Gupta Wessler, a self-described “national appellate and constitutional litigation boutique.”
MANDATORY ARBITRATION AGREEMENTS
The following is a selection from a 2014 study conducted by the Consumer Financial Protection Bureau on mandatory arbitration agreements.
The CFPB looked at American Arbitration Association filings about credit cards, checking accounts, payday loans and prepaid cards between 2010 and 2012. The research indicates that arbitration clauses are commonly used by large banks in credit card and checking account agreements.
Fewer than 1,250 consumer arbitrations about those four products were filed. Many of these concerned debt collection. Consumers filed around 900 of these disputes. Others are filed by companies or submitted by both sides together.
In comparison, in that same three-year time period, over 3,000 cases were filed by consumers in federal court about credit card issues alone. More than 400 of these federal court cases were filed as class actions, whereas CFPB's research found only two class filings in arbitration and neither was about credit cards.
Larger institutions are more likely than community banks or credit unions to include an arbitration clause in consumer contracts for credit cards or checking accounts. While the CFPB estimates that only 7.7 percent of banks use arbitration clauses for their checking accounts, 62 percent of the top 50 banks have arbitration clauses in their checking account contracts.
In credit card contracts, the arbitration clause section of the contract was almost always more complex and written at a higher grade level than the rest of the contract.
Around 9 out of 10 arbitration clauses expressly bar consumers from filing class arbitration.
Source: Consumer Financial Protection Bureau
“The biggest practical problem of forced arbitration [is that it] simply does not do what its proponents say it does in the consumer finance context,” Gupta says. “It does not move smaller dollar claims to a cheaper, faster alternative. Instead, arbitration kills claims. Millions of consumer claims that would otherwise be vindicated through group litigation in the courts and would have resulted in compensation for consumers, industry changing injunctions, and the deterrence of future bad conduct just simply disappear.”
A pro-business take on the rule comes by way of the U.S. Chamber of Commerce. “The CFPB is proposing to give the biggest gift to plaintiffs’ lawyers in a half century—at the expense of the consumers the agency is charged with protecting,” it said in a statement.
The proposed rule will “enrich class-action trial lawyers at the expense of the consumers the Bureau is charged with protecting,” says Travis Norton, executive director for the Chamber’s Center for Capital Markets Competitiveness.
Norton doesn’t buy into the CFPB’s stance that it is not directly banning arbitration. The regulation will have the practical effect of eliminating consumer arbitration and replacing it with class-action litigation, he says, calling it “a back door attack” that will spike legal contingency budgets.
“If companies that currently subsidize arbitration programs for their customers are also forced to reserve millions for class-action defense, many are going to stop funding their arbitration programs,” he says. “No rational company is going to pay more to provide customers less …The Bureau says, ‘Oh, we aren’t touching arbitration; we are just allowing class actions. That doesn’t pass the smell test. A farmer who takes in a fox can’t be surprised when he wakes up one day to find that his chicken coop is empty. The reality is that arbitration will go away and the Bureau knows it.”
“Did the ATM fail to credit your deposit? Was the interest calculated incorrectly this month? These are claims with unique facts that cannot proceed in class-action litigation,” he added. “If not for arbitration, where does that consumer go? These are serious, real world problems.” The Chamber is asking the CFPB to suspend rulemaking until it commits to further research on costs and benefits.
Alan Kaplinsky, a partner with law firm Ballard Spahr who leads its consumer financial services group, agrees that the CFPB is “in reality proposing a de facto ban.”
“Let’s call it what it is,” he says. “If this legislation becomes final, most companies will simply abandon arbitration altogether because the cost/benefit analysis of using arbitration will shift dramatically. I was sincerely hoping this day would never come because it really is a sad one for consumers.”
If customers are not seeking arbitration, education, rather than a prohibition, may be warranted. “The Bureau has this enormous division devoted to consumer education, but it hasn’t spent one penny educating consumers about arbitration,” Kaplinsky says.
Among the concerns firms may have is that, just as the CFPB’s public complaint database is a cause of consternation, the release of complaint resolution data may also prove to be problematic. Quyen Truong—former assistant director and deputy general counsel for the CFPB, now a partner with the law firm Stroock & Stroock & Lavan—would advocate that the Bureau offer an additional cost-benefit analysis “because right now the specific purposes and benefits for the data collection aren’t entirely clear yet,” she says.