Arbitration Agreements

June 20, 2012

Providers of consumer financial products or services who rely on the enforceability of arbitration agreements should closely follow the CFPB’s statements and guidance on this topic over the next year.

The Issue: Many contracts for consumer financial products or services contain arbitration agreements. These agreements generally oblige the provider and the consumer to arbitrate most, or all, disputes that arise out of their contractual relationship. While seemingly offering reciprocal rights to providers and consumers, such arbitration agreements are perceived in some quarters to advantage the providers of products or services at the expense of the consumers by making it less likely that certain small-dollar disputes will be presented. For instance, many arbitration clauses in use in the financial services sector bar class-based claims, depriving consumers of the potential leverage afforded by aggregating claims in litigation.

The Federal Arbitration Act (FAA), which governs the use and enforcement of arbitration agreements in interstate commerce, strongly favors enforcement of such agreements according to their terms. This federal policy has been underscored by recent Supreme Court decisions. In Stolt-Nielsen S.A. v. AnimalFeeds International, 130 S. Ct. 1758 (2010) (available here), for instance, the Court held that an arbitration panel’s “imposi[tion] [of] class arbitration on parties whose arbitration clauses are ‘silent’ on that issue” was inconsistent with the FAA, thus making it difficult for consumers to commence class-based arbitrations absent a textual basis for concluding that the contracting parties contemplated class proceedings. And in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011) (available here), the Court held that state laws or “unconscionability” doctrines that are applied exclusively to invalidate class action waivers[1] in arbitration agreements were preempted by the FAA.

The 2010 enactment of the Dodd-Frank legislation signaled Congress’s reconsideration of this strong federal policy favoring enforcement of arbitration agreements in interstate commerce. In Section 1028 of the Act, Congress gave the Consumer Financial Protection Bureau (CFPB) power to regulate arbitration agreements in the consumer finance realm. Section §1028(a)[2] requires the CFPB to study the use of arbitration clauses in consumer financial services arrangements and provide a report to Congress. Section 1028(b),[3] in turn, gives the CFPB authority to, “by regulation[,] prohibit or impose conditions or limitations on the use of” arbitration agreements entered into between consumers and providers of financial products of services. If the CFPB decides to write regulations, it will likely do so after submitting its report to Congress, though the legislation does not require the CFPB to wait. Importantly, any regulation issued by the CFPB will apply only prospectively to contracts entered into after the regulation’s effective date.[4]

On April 27, the CFPB set in motion the process leading to the study mandated by §1028(a)[5] by seeking input on the precise questions that should be examined by the agency, and on the methodology and sources of data that should be tapped. The questions on which the CFPB seeks comments provide potential insights into how the agency will exercise its regulatory province over financial services arbitration agreements under Section 1028(b). The topics identified in CFPB’s notice include the following:

  • Prevalence of use in contracts for consumer financial products or services: The CFPB states that, “at a minimum,” it will study how frequently contracts incorporate arbitration clauses. Related to this inquiry, the CFPB asks: How should it solicit data when investigating this question? Should the agency focus on particular markets, like credit card markets? Should they measure the prevalence of particular arbitration terms? Are there existing studies on this topic?
  • The arbitration claims process: The CFPB asks if it should investigate what happens when claims are arbitrated. It solicits comments on whether it would be appropriate to ask the following questions: How frequently do consumers arbitrate disputes? How efficient is the process in terms of cost and time? Is the process satisfactory? Should it distinguish between claims that start in arbitration, as opposed to those that a defendant moves to arbitration by invoking the arbitration clause? How should it solicit data and/or which studies should it rely on when answering the above questions? Do financial services entities ever bring arbitration claims against a consumer, and if so should it ask the above questions for those proceedings as well?
  • The effect of arbitration clauses on consumer and provider behavior: The CFPB notes that some believe the existence of an arbitration clause affects (a) the rate at which a consumer will formally dispute a provider’s actions, (b) the price of financial services or products, (c) whether providers comply with consumer financial protection laws, (d) the consumer’s awareness of potential legal claims and how such claims may be resolved and (e) the development, interpretation and application of relevant laws. The CFPB asks if the agency should investigate these alleged effects, or any other effects proposed. The CFPB also asks how it should solicit data, and which studies it should review when conducting this analysis. Finally, the agency asks whether its analysis should be limited to particular product markets, or to particular arbitration agreement terms.

Implication: The agency was not required to solicit public input on the contours of the research required by Section 1028(a), but its recent solicitation of such input provides insights into the philosophy that will guide the agency’s ultimate exercise of its power. The CFPB appears interested in understanding the effects of arbitration provisions that make it difficult to bring claims―for example, by constraining the aggregation of claims in class proceedings, or by making the presentation of even individual claims less likely.[6] The agency’s conclusions on these inquiries could lead to prohibitions on the use of clauses requiring mandatory resort to arbitral remedies in certain contexts, new restrictions on the use of arbitration language that purports to constrain class-based claims, and the imposition of express, objective criteria for judging whether “adhesive” arbitration clauses provide fair and balanced processes and may be enforced. Financial services market participants whose business models include reliance on mandatory arbitration should pay close attention to the CFPB’s ongoing research in this area.

[1] The Court took aim at unconscionability standards that apply discretely to class action waivers, as opposed to more general standards applicable to contracts of all kinds. AT&T Mobility LLC v. Concepcion, 131 S. Ct. at 1746 ("[The Federal Arbitration Act] permits agreements to arbitrate to be invalidated by 'generally applicable contract defenses, such as fraud, duress, or unconscionability,' but not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.”) (citations omitted). A recent case in California federal court cited this distinction holding an arbitration clause unconscionable under general state-law standards. Trompeter v. Ally Fin., Inc., C 12-00392 CW, 2012 WL 1980894 (N.D. Cal. June 1, 2012).

Ally's reading of Concepcion is overbroad . . . Concepcion does not preclude this Court's finding that the arbitration agreement in the present case is unconscionable because the finding does not undermine the fundamental attributes of arbitration as an alternative form of dispute resolution that is neutral, speedy, economical and informal. The Court's review of the arbitration agreement applies the generally applicable contract principle of unconscionability and, thus, does not offend the FAA's policy objective favoring arbitration.

[2] 12 U.S.C. § 5518(a).
[3] 12 U.S.C. § 5518(b).
[4] 12 U.S.C. § 5518(c).

EFFECTIVE DATE.—Notwithstanding any other provision of law, any regulation prescribed by the Bureau under subsection (b) shall apply, consistent with the terms of the regulation, to any agreement between a consumer and a covered person entered into after the end of the 180-day period beginning on the effective date of the regulation, as established by the Bureau.

[5] 77 FR 25148 (Apr. 27, 2012), available here.
[6] 77 FR 25148, 25150 (Apr. 27, 2012), available here (“[A]cademics and other parties have claimed that the existence of pre-dispute arbitration agreements may impact [t]he incidence and nature of consumer claims against covered persons.”)