What You Need to Know about CFPB’s Proposal to Ban Mandatory Arbitration Clauses in Financial Contracts

Arbitration AgreementOn May 5, 2016, the Consumer Financial Protection Bureau (the “CFPB”) published in the Federal Register its 376-page proposed rule to limit the use of mandatory arbitration clauses in certain financial contracts. The proposal focuses on contract provisions that bar consumers from filing or participating in class action lawsuits in the event of a dispute, thereby limiting consumers’ recourse to arbitration (the “Proposed Rule”). The Proposed Rule, if passed, would allow consumers to bring class action lawsuits against banks and other financial service providers—even if the parties have an existing agreement to waive their right to a trial.[i]  The Proposed Rule mark the CFPB’s latest effort in moving away from the general preference for enforcing arbitration agreements as a matter of freedom of contract between the consumers and companies, a principle that was long established by the Federal Arbitration Act of 1925 and the Supreme Court’s landmark decision in AT&T Mobility v. Concepcion.[ii] The CFPB has already previously banned the use of arbitration clauses in mortgage loan contracts.

The limitations set forth in the Proposed Rules are twofold: first, financial services providers may not use a pre-dispute arbitration agreement to dismiss or stay class actions. This limitation must also be clearly stated in the arbitration clause.[iii] Second, the Proposed Rule requires financial institutions to report records and correspondence concerning the arbitration proceedings to the CFPB, such as the claims raised, the awards received, as well as certain correspondence exchanged with the arbitration administrations. The Proposed Rule’s 90-day comment period closes on August 22, 2016.

The Proposed Rule applies to several categories of financial services providers, including loan brokers, lease and finance auto brokers, banks, credit-card companies, financial data processors, debt collectors, and certain merchants and retailers.[iv] Note that the ban only applies to financial contract with respect to the financial products and services specifically enumerated in the Propose Rule, which include student loans, debt relief services, credit card and charge card transactions, certain auto and title loans, payday and installment loans, debt settlement and foreclosure rescue services, and credit counseling.[v] Companies that also provide other financial services not enumerated in the Proposed Rules—such as providing business credits—may continue to use the arbitration clauses to bar class action suits with respect to those services.[vi]

The Proposed Rule came as a result of a 3-year long research conducted by the CFPB on the use of pre-dispute arbitration agreements “in connection with the offering or providing of consumer financial products or services.” As stated by the CFPB director, Richard Cordray, the CFPB has determined that “many banks and financial companies avoid accountability by putting arbitration clauses in their contracts that block groups of their customers from suing them.”[vii] Among other things, the research – according to the CFPB – indicates that consumers are generally reluctant to bring individual lawsuits against financial companies to recover losses less than $1,000, and even fewer consumers are willing to engage in arbitrations. By permitting class actions (or having several person(s) sue on behalf of a larger group of people who would otherwise not elect to files a complaint in court), the CFPB hopes to provide those consumers an effective tool to challenge financial companies through aggregated claims so as to eliminate the barriers to judicial relief that may arise in consumer finance contexts, which often involve small-dollar individual claims.

Opponents of the Proposed Rule have raised concerns that the ban might end up hurting rather than helping the consumers. Their chief argument is that a proliferation of class actions will only help plaintiffs’ lawyers and not consumers, and that the costs incurred by financial institutions to defend against litigations and to submit arbitration information will get passed on to consumers in the form of higher service fees. They have also noted that the CFPB ignores the benefits and opportunities from online dispute resolution, and that the Proposed Rule will force market participants to eliminate the use of consumer arbitration processes altogether.

The CFPB is now in the midst of collecting public comments and has already received an abundance of feedback from both consumer advocates and industry advocates. Dorsey will continue to monitor the development of the Proposed Rule and provide update. In the meantime, it is advisable for banks and financial institutions to start thinking about the strategic and other benefits from submitting public comment and which of their existing service contracts may be subject to the new requirements, so that they are ready to make the necessary alteration and supplementation when the rules are in effect.

Endnotes:

[i] Provided that the agreement falls within the Rules’ applicability date.

[ii] 131 S. Ct. 1740 (2011)

[iii] The financial providers may comply with this requirement by amending the language in their arbitration agreements to include the following language proposed by the CFPB: “We agree that neither we nor anyone else who later becomes a party to this pre-dispute arbitration agreement will use it to stop you from being part of a class action case in court. You may file a class action in court or you may be a member of a class action even if you do not file it.” Or they may provide consumers a separate notice.

[iv] The proposed rules specifically exclude a number of service providers, including broker-dealers subject to the regulations of the Securities and Exchange Commission, including those promulgated by the Financial Industry Regulatory Authority; State and Federal government agencies; financial service providers with fewer than 25 customers in the current year and the preceding calendar year; and merchants, retailers, and seller of nonfinancial goods or services.

[v] The Rule would apply to pre-dispute agreements for products listed in Section 1040.3(a) “to the extent they are consumer financial products or services as defined by 12 U.S.C. 5481(5).”

[vi] The CFPB’s proposed language is as follows: “We are providing you with more than on product or service, only some of which are covered by the Arbitration Agreements Rule issued by the Consumer Financial Protection Bureau. We agree that neither we nor anyone else will use this agreement to stop you being [from] being part of a class action case in court. You may file a class action in court or you may be a member of a class action even if you do not file it. This provision applies only to class action claims concerning products or services covered by that Rule.”

[vii] Press Release, Consumer Financial Protection Bureau, CFPB Proposes Prohibiting Mandatory Arbitration Clauses that Deny Groups of Consumers their Day in Court, available at http://www.consumerfinance.gov/about-us/newsroom/consumer-financial-protection-bureau-proposes-prohibiting-mandatory-arbitration-clauses-deny-groups-consumers-their-day-court/.

J.H. Jennifer Lee

Jenny represents large and regional banks, card issuers, mortgage bankers or mortgage insurance companies, online lenders, Fin Tech firms, private equity firms with consumer-facing specialty finance strategies, or any “covered person” delineated in the Bureau’s statute, title X of the Dodd-Frank Act. As a lawyer who worked inside the Consumer Financial Protection Bureau (Bureau) Office of Enforcement for several years beginning with the Bureau’s founding, Jenny possesses unique experience that she draws upon to provide clients with defense strategies for enforcement by or litigation with the Bureau....

Michelle Ng

An attorney in Dorsey’s U.S.-China group, Michelle’s practice focuses on banking regulatory and compliance matters involving the bank secrecy act and related anti-money laundering regulations.

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