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Why The CFPB Thinks Arbitration Is Bad

There are few issues in the world that are quietly controversial, as muteness is not, generally speaking, a feature of conflict, particularly when the disputes are about money and consumer rights.

Arbitration — a legally binding method of dispute resolution that happens outside a courtroom — is less formal, faster and generally less expensive than a court case.

Defenders of the practice note that arbitration has been a necessary and useful tool in preventing defendants’ and plaintiffs’ attorneys from waging lengthy and staggeringly expensive wars of attrition in court by using the intricacies of the American legal system as their battleground. American consumers and businesses were the ultimate losers in those cases, and arbitration fans note that the practice — combined with state-level reforms — brought litigation costs down from their late twentieth century peak, when they represented 2 percent of American GDP.

Opponents of the practice note that while arbitration can be used judiciously, it has been adopted as a favored tactic of service providers (cable companies), financial services firms (credit card companies) and debt collectors (particularly expired debt collectors) to skirt consumer protection laws and insulate themselves from class action lawsuits. Moreover, they note, consumers are not being given a chance to opt out of arbitration agreements even if they want to.

Which is why it has become extremely controversial over the course of 2015, having recently gotten some high-profile attention from both the U.S. Supreme Court and the Consumer Financial Protection Bureau, and seems likely to get more when 2015 becomes 2016.

The why of it all is complicated.

Arbitration Does A Good Thing By Short-Circuiting Predatory Lawsuits

Arbitration exists and has risen sharply in popularity over the last decade or so for a very good reason: It is much, much more efficient than a traditional lawsuit.

Instead of being presided over by judges, matters are heard by arbitrators (or a panel of them, depending on the specific nature of the dispute). Class actions are disallowed, as are summary judgments, meaning both sides are, more or less, offered an opportunity to present their full case without having to withstand motions of dismissal.

Arbitration is also a much shorter process. In extremely complicated situations, it can go on for about 14 months, but that is unusual. Litigation can, and often does, take years.

It is also considered consumer-friendly. The theory of that case is that it would never be in any individual’s interest to wage a court battle over a small dollar amount since the cost of the case would very quickly outstrip whatever dollar amount was in question. The prior legal remedy — the class action lawsuit that clumps a large batch of consumers with small dollar grievances into one big ticket supergroup — was rife with horrible abuses. The real winners in those cases were the class action lawyers; few plaintiffs ever walked away with piles of dough.

By disallowing the class action suits that offer attorneys perverse incentives and creating a space where individual defendants can quickly and relatively cheaply settle disputes, arbitration is as close to an everyone wins as possible and deserves to be preserved.

Except that…

Arbitration Does A Bad Thing By Empowering Crooked Debt Collectors

As is their custom, The Wall Street Journal and The New York Times spent mid-December playing the journalistic version of dueling banjos over arbitration and its relative merits and flaws. And while WSJ presented the story of how arbitration was instrumental in saving the system from the predations of litigation-happy liability lawyers, NYT presented the dark tale about how arbitration is an increasingly popular go-to tool in the arsenal of predatory debt collectors, who use it to protect their ability to leverage illegal practices against vulnerable consumers.

Consumers like retired Baltimore electrician Clifford Cain, Jr., who found he had lost a legal action that he didn’t know he had to a debt collector — specifically, Midland Funding, a unit of the Encore Capital Group. Cain was one of a number of Maryland residents who the company sued in a debt collection case — a crop of mass suits that a later review showed contained many cases of consumers who simply owed no money or who owed debts that were long expired and therefore no longer legally collectable. In any event, Midland is not legally licensed to collect debts in Maryland.

However, when Cain and several other consumers who contended they’d been wrongfully swept up in Midland’s mass collection attempt collectively sued in a class action case, their case was dismissed, as all parties had agreed (as part of the terms of whatever loans had purportedly landed in collections as debt collectors buy loan contracts and thus the terms that come with them) to settle such disputes through arbitration and class actions are not legally allowed in arbitration matters.

Cain told NYT he was unable to afford going through the arbitration process with the well-capitalized legal department and was thus forced to accept a $4,500 debt that he has no recollection of owning and has seen no proof of to this day.

“I can’t for the life of me understand how this is allowed to happen,” Cain told NYT.

And, according to NYT, Cain’s story is not all that unique, as debt collectors have become fairly audacious in their embrace of this particular tactic in an attempt to collect debts. Even when they are suing to collect debts that are nonexistent or expired, they often win, largely by default, since a limited effort is made to make the defendant aware of the forthcoming court action.

Those practices could be stamped out by a big and expensive class action, as nothing says “stop pursuing illegal debt collection” like a cripplingly expensive verdict care of the vengeful civil court system. However, because an increasing number of contracts for telecom services, utilities, credit cards and bank accounts come preloaded with arbitration clauses, such collective actions are, more or less, impossible for most consumers.

Put succinctly, once consumers click “I agree” on the terms of service they didn’t bother to read, they essentially agree that no matter how illegal things go from there on out, they are not going to sue collectively but instead walk the solo road of arbitration.

So Why Don’t Consumers Just Go To Arbitration?

The strange and under-addressed question in this whole mess is one about the arbitration process itself and why so few consumers seem to avail themselves of it. NYT noted that once class actions have been dismissed and consumers are referred back to individual arbitration, almost none of them go, which has given businesses free reign to engage in practices like wage theft, discrimination and predatory lending because they essentially have contracted with customers or employees to never see the inside of a courtroom.

“This is among the most profound shifts in our legal history,” William G. Young, a federal judge in Boston who was appointed by President Ronald Reagan, told NYT in an interview. “Ominously, business has a good chance of opting out of the legal system altogether and misbehaving without reproach.”

And while that is very alarming-sounding, it doesn’t really explain why consumers who have putatively been wronged almost never pursue arbitration. According to NYT research, between 2010 and 2014, only 505 consumers went to arbitration over a dispute of $2,500 or less.

Perhaps it’s as one federal judge so astutely noted: “Only a lunatic or a fanatic sues for $30.”

Or perhaps it is as self-described lunatic-fanatic Todd Cowen learned by spending $25,000 in an arbitration grudge match over a $125 late fee: Arbitration may be cheaper than a full blown court case, but it is not free.

Or perhaps it is because they are merely unlikely to succeed. NYT data also indicates that roughly two-thirds of consumers contesting credit card fraud, fees or costly loans received no monetary awards in arbitration.

It does seem worth noting, however, that NYT offers no independent verification of that two-thirds figure, whereas WSJ offers two studies that would seem to contradict that finding.

The first, a 2009 study by the Searle Civil Justice Institute at the Northwestern University School of Law, found that consumers stood a better chance of winning in arbitration cases than they did in court (after controlling for other variables in case characteristics). Searle further found there was “no statistical difference in the amount they were awarded as a percentage of the amount sought,” between consumers who received awards through arbitration or the courts.

The second piece of independent study on arbitration comes from a 2014 survey by the Kaiser Foundation Health Plan that found that mandatory arbitration clauses in its health plans have not lead to wide dissatisfaction and instead found that 90 percent that had gone through arbitration found the process to be at least as good as the court system.

WSJ leaves it unclear how much the process of arbitration varies between health care and financial services; it is, of course, entirely possible that a process that works just great in one vertical is a tool of destruction in another.

For example, collateralized debt obligations (CDOs) were an existent, if obscure, part of the investing landscape for 18 years and were largely harmless when they were used to group institutional debt or diversified packages of consumer loans. Once they mutated into bundles of subprime mortgage loans in the early 2000s, they destroyed the entire global economy in less than a decade.

WSJ’s overall point, however, is well-taken. Arbitration may have its issues, but the independent studies indicate that it serves consumers as well, if not better, than the court systems, whose expensive issues are well-known.

But fair or not, cheap or not, consumers aren’t using it, and that is widely considered to be a problem, since it is the only recourse in the event that things go south that most contracts one signs these days offer.

High-Profile Cheerleaders And Jeerleaders (And An Uncertain Future)

In fairness, an argument between the writers at The Wall Street Journal and The New York Times does already count as a pretty high-profile jeer and cheerleading session, especially for an issue that almost no one outside of a few legal niches knows very much about.

But in this rare and unusual case, NYT and WSJ editorial staffs are actually their squads’ respective junior varsity players.

The bigger name headlining the “yay” side of arbitration is the U.S. Supreme Court, which has found in favor of arbitration three times in three years, all on the basis of the 1925 Federal Arbitration Act. In all three cases, the court upheld a corporations’ right to make arbitration part of their standard contracts and struck down plaintiffs’ ability to sidestep arbitration agreements to form classes for the purposes of legal suits.

“Requiring the availability of classwide arbitration,” Justice Scalia wrote for the majority in AT&T Mobility v. Concepcion “interferes with fundamental attributes of arbitration.”

The main purpose of the Federal Arbitration Act, he wrote, “is to ensure the enforcement of arbitration agreements according to their terms.”

The court upheld a similar decision in 2013’s American Express v. Italian Colors Restaurant and again about two weeks ago in DirecTV v. Imburgia.

However, the court’s support of arbitration is based on the supremacy of federal law over state law. Federal law can be changed — and very well might be if the CFPB gets its way.

“Consumers should not be asked to sign away their legal rights when they open a bank account or credit card,” said CFPB Director Richard Cordray earlier this year. “Companies are using the arbitration clause as a free pass to sidestep the courts and avoid accountability for wrongdoing. The proposals under consideration would ban arbitration clauses that block group lawsuits so that consumers can take companies to court to seek the relief they deserve.”

The CFPB is empowered under the provisions of the Dodd-Frank Act to regulate the use of arbitration clauses in consumer financial products if it found, based upon study, that doing so would protect consumers and serve the public interest and if any proposed rule included findings consistent with study results. Arbitration in home mortgage agreements is outright prohibited under Dodd-Frank.

It seems the consumer watchdog group is now looking to move forward with such rule changes that would ban financial service companies (like credit cards and banks, for example) from inserting mandatory arbitration clauses in their terms of use contracts and has done the study to make it possible.

According to study results released in March 2015, arbitration clauses restrict consumers’ relief for disputes with financial service providers by allowing companies to block group lawsuits.

The study also found that over 75 percent of consumers surveyed were completely unsure as to whether or not they were subject to an arbitration clause in their contract and that less than 7 percent of those consumers covered by arbitration clauses realized that the clauses restricted their ability to sue in court.

The CFPB proposals would specifically ban firms under their jurisdiction from inserting arbitration clauses that prevent the formation of class action lawsuits.

The consumer watchdog did note that it did not seek to ban all arbitration but instead was looking to force said clauses to explicitly state that they do not apply to cases filed as class actions unless and until the class certification is denied by the court or at such time as the case is dismissed by a court.

The new rule would also require that firms that use arbitration clauses for individual disputes must submit all arbitration claims filed and awards issued to the CFPB. The bureau reports that the purpose of this is to allow it to better monitor consumer finance arbitrations to ensure that the process is fair for consumers.

The bureau also might publish claims and awards on its website so the public can monitor them.

Sounds great, doesn’t it?

Stay tuned. It’s about to get interesting — and certainly so if you are an attorney that specializes in class action lawsuits.

The CFPB’s proposal, if successful, can only mean a whole new wave of unintended consequences for consumers in the form of higher fees on the services of said companies, who will no longer be able to stave off the wave of class action lawsuits that will come their way. Settlements that, by the way, don’t end up in the pockets of consumers but rather the lawyers who try and settle cases for their benefit.

And isn’t that just the kind of protection consumers are looking for?

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