On July 10, the Consumer Financial Protection Bureau issued a final rule to ban certain players in the consumer financial industry from using mandatory arbitration agreements unless the agreement also advises that the consumer may still file or participate as a class member in a class action in court. Dodd-Frank created the CFPB and authorized it to issue rules to limit or condition the use of arbitration agreements if the agency finds that doing so “is in the public interest and for the protection of consumers.”
It took five years, but in March 2015, the CFPB issued its study of arbitration provisions. Now, in 2017, the CFPB has concluded that limiting the use of arbitration agreements would protect consumers by increasing compliance, deterring violations and improving consumers’ ability to obtain redress or relief.
While the debate over mandatory arbitration has heated up in the wake of the CFPB action, it is unlikely that this rule will ever come to fruition. Congress is likely to invoke the Congressional Review Act, which permits a majority of each house to repeal regulations, with presidential approval. Congressional authorization is then required before any agency can promulgate a substantially similar rule. In addition, the CFPB itself is under attack, from the legislative and the judicial branch. The House has passed a bill that would drastically curtail the CFPB. In addition, the D.C. Court of Appeals has declared the CFPB structure to be unconstitutional. While that decision is now on further appeal, the agency’s future is far from certain. Finally, commentators have predicted that even if the rule is not repealed, it will be subject to numerous court challenges, potentially all the way to the United States Supreme Court, which has consistently held that such provisions are enforceable, and stricken state laws that attempt to discriminate against arbitration.
Whatever the fate of the rule, the resulting discussion has renewed debate around mandatory arbitration. Such provisions are prevalent in both consumer and commercial contracts, and not just in the financial services arena. Check your agreement with your cable, internet and cell phone provider, as well as many warranties. The typical provision precludes participation in any type of aggregate or class action, sometimes in both the courts and arbitration. As a result, consumers must bring individual arbitrations to redress any grievances, although many agreements also allow small claims court proceedings.
Consumer groups have derided the use of arbitration provisions that exclude class actions in form agreements as unfair and coercive. The issue has come to the U.S. Supreme Court on several occasions, and the court has declined to invalidate such provisions, even where state law purported to prohibit enforcement. The Supreme Court has upheld these waivers in consumer agreements with communications providers and in agreements between merchants and credit card companies. In January, the Supreme Court agreed to hear a case involving class action waivers in employment agreements, which are argued to violate the National Labor Relations Act.
So, why is mandatory arbitration so controversial?
An interesting starting point is the results of the CFPB study, which found that the overwhelming majority of consumers who were surveyed were unaware of whether they had agreed to arbitration. Significantly, however, those same consumers said that the presence of an arbitration agreement would play little or no role in their selection of a credit provider.
One of the CFPB’s most significant conclusions was that while the effectiveness of arbitration as a means of resolving consumer disputes has long been contested, individual arbitration is not more or less fair or efficient than leaving disputes to the courts. At best, a comparison of the relative fairness and efficiency of arbitration and individual litigation was inconclusive. As a result, the agency decided not to completely ban the use of pre-dispute arbitration agreements in consumer finance contracts.
The benefits of arbitration are generally known and include: expediency (arbitrations are faster); cost-efficiency (parties can represent themselves or even retain a non-lawyer); streamlined processes and limited discovery, which further reduce expense; parties can select their arbitrators; relaxation of the rules of evidence; and flexibility. The American Arbitration Association administers most consumer arbitration agreements, and has earned a reputation for expeditious and efficient management of proceedings. Consumers can and have obtained substantial individual awards, including recovery of their filing fees and attorneys’ fees. Notably, the proceedings are confidential, and there is a very limited scope of appeal, either of which can be an advantage (or disadvantage) for either side.
Focused on consumers’ interests, the CFPB did not analyze the costs of defending class actions, including those that are dismissed, and the impact on the cost of credit. But the CFPB did conclude that class actions are more effective in securing relief for consumers and deterring illegal and potentially illegal conduct; restricting consumers to pursuing claims only on an individual basis, whether in the courts or in arbitration, is “insufficient.”
These conclusions were highly controversial. First, the analysis of benefits to consumers from class actions reveals that limited numbers of consumers benefit from the large number of class actions that target the financial industry: only 12 percent of putative class actions filings that were studied resulted in settlements or judgments and individuals received, on average, only $32 per person in those settlements (less than the average arbitration award). In many instances, consumers received only in-kind relief, such as discount coupons.
And more than half of the cases filed as class actions ended in a settlement for the named plaintiff only or a withdrawal of the case. Even where cases settle, few consumers benefit: the average participation rate in settlements requiring claims was only 21 percent of those entitled to relief, or a paltry 4 percent on a weighted basis. Undeniably, the overwhelming majority of consumers receive no monetary benefit from these class actions. However, even where many cases filed as class actions do not result in a monetary recovery, the CFPB concluded that class litigation can result in widespread changes in policies and practices, which is at least as important as monetary relief.
So, why do the courts uphold these waivers? Because Congress, in the Federal Arbitration Act, articulated a liberal policy favoring arbitration. The Supreme Court has been singularly unimpressed with the argument that the amount at issue in most individual consumer cases is so small that class action waivers effectively preclude vindication of rights. This year, watch for the battleground over the CFPB’s rule to shift to Congress, which is likely to invoke the CRA, and the courts, where the CFPB’s future independence is uncertain.
Carolyn Nussbaum is a partner in the Commercial Litigation group and Nixon Peabody LLP.
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