The Beginning of the End of Arbitration Clauses in Consumer Finance Contracts?
Are contractual arbitration clauses harmful to consumers of financial products and services? The Consumer Financial Protection Bureau (the “CFPB”) appears to think so. On March 10, 2015, the CFPB released its 2015 Arbitration Study (the “CFPB Study”), which concludes that pre-dispute arbitration clauses in consumer finance contracts adversely affect consumers. Then, on October 7, 2015, the CFPB released its Outline of Proposals Under Consideration and Alternatives Considered (the “Proposed Rules”), which proposes, among other things, prohibiting arbitration clauses that bar the consumer from participating in class action litigation. The CFPB Study and the Proposed Rules signal that, at least with respect to consumer finance contracts, future rule-making could impose substantial restrictions on the use of certain types of arbitration clauses.
Under the Federal Arbitration Act (“FAA”), contractual arbitration clauses, including in consumer contracts, generally are “valid, irrevocable, and enforceable.” See 9 U.S.C. § 2. The U.S. Supreme Court has held that this provision of the FAA reflects “both a liberal federal policy favoring arbitration . . . and the fundamental principle that arbitration is a matter of contract.” See AT&T Mobility LLC v. Concepcion, 131 S.Ct. 1740, 1745 (2010). “In line with these principles, courts must place arbitration agreements on an equal footing with other contracts . . . and enforce them according to their terms.” Id.
However, the Dodd-Frank Act of 2010 contains a provision entitled “Authority to Restrict Mandatory Pre-Dispute Arbitration.” See Dodd-Frank Act § 1028. This provision calls upon the CFPB to conduct a study regarding the use of arbitration clauses in consumer finance contracts. This provision further empowers the CFPB to “prohibit or impose conditions or limitations on the use of” such arbitration agreements if, based on the study, the CFPB “finds that such a prohibition or imposition of conditions or limitations is in the public interest and for the protection of consumers.” See id.
What Is the CFPB Study?
The CFPB Study was the result of nearly three years of analysis of empirical evidence, including consumer contracts and court data. In particular, the CFPB:
• Reviewed nearly 850 consumer-finance agreements to examine the prevalence of arbitration clauses and their terms;
• Reviewed more than 1,800 consumer finance arbitration disputes filed over a period of three years and more than 3,400 individual federal court lawsuits;
• Examined 42,000 credit card cases filed in selected small claims court in 2012;
• Assembled and analyzed a set of roughly 420 consumer financial class action settlements in federal courts over a period of five years and over 1,100 state and federal public enforcement actions in the consumer finance area; and
• Conducted a national survey of 1,000 consumers with credit cards concerning their knowledge and understanding of arbitration and other dispute resolution mechanisms.
What did the CFPB Study Conclude?
The CFPB Study reached numerous conclusions, the most important of which are that:
• Tens of millions of consumers use consumer financial products or services subject to pre-dispute arbitration clauses;
• Nearly all arbitration clauses studied included class action waivers provisions;
• 75% of consumers surveyed were unaware if their credit card contracts contain arbitration clauses;
• Arbitration clauses can act as a barrier to class actions;
• Arbitrators were much more likely to provide some form of relief to companies than to individual consumers, and companies were granted greater monetary awards as a percentage of what they claimed than were individual consumers; and
• There is no evidence that the lack of an arbitration clause results in increased prices or reduced access to credit for consumers.
More important than the empirical conclusions of the CFPB Study are its implied policy-related conclusions, namely, that pre-dispute arbitration clauses disadvantage consumers of financial products and services, and that class actions are a more effective method for consumers to vindicate their rights and obtain relief against consumer finance companies. As discussed below, it is not clear that these are valid conclusions to draw from the data the CFPB Study analyzed; however, that may not prevent the CFPB from enacting new regulations restricting the use of arbitration clauses in consumer finance contracts.
Critical Reaction to the CFPB Study
The CFPB Study – or at least its conclusions – is not without its detractors. For example, on July 13, 2015, the American Bankers Association, the Consumer Bankers Association, and The Financial Services Roundtable submitted a comment letter to the CFPB in response to the CFPB Study (the “Industry Group Letter”). The Letter argues that the empirical evidence analyzed by the CFPB Study in fact supports the view that arbitration has “significant, demonstrable benefits over litigation in general and class action litigation in particular,” and that the Dodd-Frank Act would therefore not allow rulemaking that prohibits pre-dispute arbitration clauses. Interestingly, the Industry Group Letter also notes that “[c]ustomers who prevail in an individual arbitration recover monetary benefits that, on average, are approximately 166 times greater than the sums received by the average class member in a class action settlement.” Finally, the Industry Group Letter requests that the CFPB elicit public comment on the CFPB Study so that all interested stakeholders will have an opportunity to express their views.
The CFPB Study has also been the subject of criticism from academic commentators. For example, in August of 2015, two law professors published a paper that was highly critical of the methodology and conclusions of the CFPB Study (the “Critique”). The Critique concludes that the CFPB’s own findings in fact support the position that arbitration is a simple and inexpensive process through which consumers can achieve good results even when not represented by counsel. The Critique further argues that the CFPB Study does not provide a basis for imposing “new restrictions or prohibitions on mandatory arbitration clauses in consumer contracts.” The Critique goes on to fault the CFPB Study for, among other things: (1) neglecting to consider if most consumer disputes are resolved without litigation or arbitration through internal dispute resolution processes; (2) failing to assess the merits of the consumer class actions that ended in the class action settlements discussed in the CFPB Study; and (3) misapplying data regarding class action payouts.
On a more general level, one might also question the scientific validity of the CFPB Study. While it purports to be a comprehensive empirical analysis of the available data regarding consumer finance disputes, and is presented as a quasi-scientific study, the CFPB Study arguably fails the most basic tests of the scientific method. For example, it was not peer-reviewed, and the results have not been independently replicated by any person or entity other than the CFPB. In light of recent scandals involving purportedly “empirical” studies in the social sciences, a certain degree of skepticism regarding the rigor and objectivity of social science studies such as the CFPB Study seems warranted.
A further weakness of the CFPB Study is that it appears to lack any analysis of programs where consumers voluntarily choose to arbitrate disputes with companies after a dispute has arisen. For instance, for many years the New York City Small Claims Court has operated a highly successful arbitration program in which the parties voluntarily agree to arbitrate in order to avoid the time-consuming process of traditional litigation and trial. One would think any analysis of the benefits, or lack thereof, to consumers of arbitration would need to explain why many consumers voluntarily choose arbitration over court.
The CFPB’s Proposed Rules
As discussed above, Section 1028(b) of the Dodd-Frank Act permits the CFPB to issue regulations regarding the use of arbitration clauses in consumer finance contracts. Accordingly, on October 7, 2015, the CFPB announced its Proposed Rules, which include a discussion of both the CFPB’s proposed new rules and the alternatives the CFPB considered. The good news for consumer finance institutions is that the CFPB “is not proposing for consideration a ban on all pre-dispute arbitration agreements or other conditions or limitations on the use of such agreements at this time.” However, the Proposed Rules involve two limited proposals that would regulate such consumer arbitration clauses.
First, the CFPB proposes to “prohibit the application of pre-dispute arbitration agreements to class litigation in court” unless class certification is denied or the class claims are dismissed. In support of this proposed rule, the CFPB claims that “consumers and the broader consumer finance market will benefit by allowing consumers to pursue relief for violations of law through class proceedings against providers of covered consumer financial products or services without the impediment of arbitration agreements.”
Second, the CFPB is considering a proposal “that would require companies that use arbitration agreements with consumers for certain types of consumer financial products or services to submit claims filed and awards issued in any arbitration proceedings to the [CFPB].” According to the CFPB, this proposed regulation would facilitate future CFPB studies and public monitoring of consumer finance arbitrations.
Like the CFPB Study upon which they are purportedly based, the Proposed Rules are likely to be the object of considerable criticism. First, the CFPB Study purported to analyze the costs and benefits of arbitration, but did not include any meaningful study of the costs and benefits of class actions. The Proposed Rules, however, call for a ban on class action waivers on the basis that class action suits are more beneficial to consumers than arbitration. Support for this conclusion does not appear anywhere in the CFPB Study; indeed, the class action process is frequently criticized as detrimental to consumers. Relatedly, it is unclear whether this proposed regulation is consistent with the language or intent of Section 1028 of the Dodd-Frank Act. After all, Section 1028 says nothing about class action litigation, yet class action litigation is the main focus of the CFPB’s proposed regulation.
Furthermore, it is possible that the industry will raise a constitutional challenge to the authority of the CFPB to issue the regulation. Specifically, where existing statutory law (i.e., the FAA) provides that contractual arbitration clauses are enforceable, was it appropriate for Congress to delegate to an administrative agency (the CFPB) the authority to effectively create new exceptions to such a statute by means of regulation?
Conclusion and Recommendations
In light of the CFPB’s proposed rule prohibiting the use of class action waivers in arbitration agreements, stakeholders, such as consumer finance service providers, may wish to consider a two-pronged strategy for risk mitigation.
First, stakeholders should continue engaging with industry groups and the CFPB in an attempt to educate the CFPB on the benefits of arbitration. In that regard, the Industry Group Letter urges the CFPB to solicit public comment on the CFPB Study, and the CFPB has received similar requests from lawmakers. Indeed, as part of its rulemaking process, the CFPB is obliged to consider feedback from affected small business owners as well as seek public comment on the proposed rule. Stakeholders who wish to submit comments to the CFPB regarding the CFPB Study, the Proposed Rules, or the benefits of arbitration are advised to consult with counsel regarding the most effective manner of engaging with the CFPB.
Second, if the proposed regulation is ultimately adopted by the CFPB, consumer finance institutions will need to consider whether and how to adapt their policies while the inevitable questions as to the validity of the regulation play themselves out in court. An important threshold question will be whether a consumer finance company should promptly revise its standard arbitration clause to conform to the conditions and limitations set forth in the regulation, or, alternatively, whether the company should continue using a broad arbitration clause until any challenges to the validity of the regulation have been fully determined.
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