United States: CFPB Proposals Would Restrict Use Of Arbitration Clauses In Consumer Financial Services Contracts

In May 2016, the federal Consumer Financial Protection Bureau (CFPB) proposed, and requested public comments on, a new rule intended to limit the use of mandatory pre-dispute arbitration clauses in agreements governing a wide range of consumer financial products and services. These include but are not limited to many products and services that involve lending money, holding deposits, and transferring funds, which may be offered to consumers by banks, credit unions, various other types of lenders, and other firms involved in the financial services industry. A mandatory "pre-dispute" arbitration clause is an agreement between a financial services provider and a consumer requiring that any future disputes which may arise between the parties be resolved through established arbitration procedures (the costs of which are typically borne largely or solely by the provider) rather than by litigating in the court system.

The proposed rule does not cover residential mortgage or home equity line of credit agreements, because Congress earlier banned the use of mandatory pre-dispute arbitration clauses in those types of contracts, effective June 1, 2013. Nor would the rule affect the use of arbitration provisions in any non-consumer agreements, such as those governing loans to, or deposit accounts of, business customers. Instead, it applies only to agreements that govern products or services used primarily for personal, family or household purposes by individuals or representatives acting on behalf of individuals.

For years, many financial services companies have included these types of provisions in various consumer contracts. While the CFPB's proposal would not outright ban such clauses in the types of contracts covered by the rule, it would prohibit the use of so-called "class action waiver" provisions that prevent consumers from participating in class action lawsuits. If the rule is finalized in a form similar to its current state, the result would be that arbitration could no longer be made mandatory, and agreements would have to expressly state that consumers may join in class actions.

There has been much speculation within the industry and in the financial services media that this could actually mean the end of consumer arbitration clauses entirely, or at least lead to a drastic reduction in their use. The fear is that the floodgates would be opened to a wave of expensive and time-consuming litigation, and that defending those claims would cause companies to allocate extensive funds and resources, some of which are currently devoted to their arbitration programs.

Compounding the issue for financial services providers is that, under the proposed rule, companies also would be required to submit certain records to the CFPB concerning arbitrations of disputes with consumers (redacted to remove names and other personal information of individuals), which would lead to increased compliance burdens and costs. The industry is also concerned these reporting requirements could provide fuel both for stepped-up enforcement actions by the agency and (assuming the CFPB makes the data publicly available on its website as it is considering doing, and as it is already doing with consumer complaints) additional litigation by plaintiffs' attorneys.

The traditional industry defense of mandatory arbitration is that it provides a more economical and expeditious method for resolving disputes than does litigation, resulting in lower costs to consumers for products and services. If, as many industry observers expect, litigation and compliance costs were to increase significantly as a result of the CFPB's proposal, those costs ultimately would almost certainly be passed along to customers. The counter-argument is the position taken by consumer advocates, and at least implicitly if not overtly by the CFPB itself, to the effect that the playing field needs to be made more level between relatively powerless individuals and often very large companies viewed as imposing "take it or leave it" provisions such as mandatory arbitration on consumers denying them their day in court.

The CFPB reached this point after conducting an extensive study of pre-dispute arbitration clauses mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Dodd-Frank also authorized the CFPB to restrict or prohibit the use of arbitration agreements if, consistent with the findings of its study, it determined that would be in the public interest and would better protect consumers. However, many within the affected industries have asserted that the study was flawed and did not provide an adequate basis for the CFPB's proposals. That theory will likely be a cornerstone for what could well be a legal challenge by one or more industry groups once the final rule is published.

It is worth noting that some financial services providers have sought to find a middle ground by utilizing "opt-out" provisions, whereby consumers may avoid the effects of a mandatory arbitration clause by notifying the company that they reject it. The CFPB analysis in the proposed rule considered such provisions, but the agency concluded they were largely ineffective and that many consumers were not even aware there were arbitration clauses in their contracts at all (which serves as a reminder that any arbitration clause should always be made conspicuous within the agreement – for example, by use of all caps or bold type). The CFPB's skepticism can be viewed as rendering the usefulness of such opt-out provisions in doubt going forward, to the extent vestiges of arbitration clauses may remain after the rule is finalized.

It is important to remember that the rule in its current form is merely a proposal, and that the CFPB has invited comments from any interested parties (businesses and consumers alike), which must be submitted on or before August 22, 2016. Among other things, the agency is specifically soliciting comments on alternative approaches to accomplish the same goals, and on a possible exemption from the rule for certain small entities. The proposed rule, with all of the CFPB's analysis (which is very lengthy), is available at https://www.federalregister.gov/articles/2016/05/24/2016-10961/arbitration-agreements.

The final rule will become effective for arbitration agreements entered into beginning 211 days after the rule's publication (likely meaning the latter part of 2017, if not later), unless that date is further delayed by a court challenge or by CFPB action. Some observers have interpreted this delayed compliance date as clearly grandfathering mandatory arbitration clauses in existing agreements, as well as any agreements entered into in the future but prior to the compliance date. Some companies which do not currently have class action waivers in their agreements may be considering adding them before compliance becomes mandatory, an approach that would seem to be within the "letter of the law" but which might run the risk of putting a provider on the CFPB's radar as circumventing the spirit of the (for now, just proposed) rule.

There is also some debate about exactly when an agreement should be deemed "entered into" to determine whether it falls before or after the mandatory compliance date -- for example, in the case of existing contracts that a provider becomes a party to through a merger or acquisition, or in the case of agreements modified after the compliance date to add or amend arbitration provisions. Because the term "entered into" is used but never defined in Dodd-Frank, the CFPB is specifically soliciting comments to assist it in clarifying that issue in the final rule.

Our advice in the short term to our financial services business clients, and to any individual clients of the firm who may have an interest in this topic, is to determine whether they wish to submit comments on the proposal, and if so, to send them to the CFPB by the August 22 deadline. In the case of potentially affected businesses, this should include (1) doing an internal inventory of all existing online and hard copy consumer agreements to determine what types of arbitration provisions, if any, they presently contain, and (2) giving consideration to the potential financial and other effects on the business should the rule be adopted substantially as proposed.

In the longer term, there should be adequate time after the final rule is published and before compliance becomes mandatory to determine what changes may be necessary or desirable in any affected agreements, or whether the business wishes to eliminate the use of mandatory pre-dispute arbitration clauses entirely. Poyner Spruill would be glad to assist any of its existing or prospective clients in making these determinations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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