While most of the financial services world has been buzzing about the coming payday lending regulations expected shortly from the Consumer Finance Protection Bureau, it seems another set of new rules may be about to quietly jump the line.
Recent reports indicate that the CFPB will announce a new rule governing arbitration clauses in consumer lending contracts at a field hearing on the subject scheduled in Albuquerque, New Mexico, later this week.
Arbitration — a legally binding method of dispute resolution that happens outside a courtroom — is, as PYMNTS has reported in the past, something of a strange topic in financial services in that it is very controversial but in an extremely low-key kind of way.
Fans of arbitration in general note that it is a highly useful tool in stopping frivolous and expensive lawsuits. As of the late 20th century, litigation costs in the United States had literally climbed to the level of 2 percent of GDP – and plaintiffs’ attorneys developed a rather pronounced reputation for leveraging the threat of a very expensive trip through the legal system to get settlements for non-infractions since it was cheaper to pay than fight. The only winner in that scenario are scammers and lawyers. Arbitration, according to its staunchest defenders, played a critical role in ending the era of the “hot coffee” lawsuit by short circuiting expensive cases in favor of mediator-led resolutions.
On the other side of the issue — the side the CFPB is largely expected to come down on — are those who point out that arbitration may be a fine tool in some cases, but not all. They further note that the persistent use of arbitration clauses in contracts for almost every conceivable financial product or consumer service is a problem because that list includes most contracts for credit cards, checking and deposit accounts, prepaid cards, money transfer services, auto loans, small dollar or payday loans, student loans, cable service and mobile services. The only major financial service one won’t find on this list is mortgage loans, because it is illegal to put an arbitration clause into a mortgage loan.
The issue, though not quite as famously contentious as payday lending, does tend to draw out raised feelings when it comes up, as it has periodically for the last several years since a regulatory focus on the use of arbitration clauses has been part of the CFPB’s mandate since Day 1, since the firm is required by Dodd Frank to:
“Conduct a study of, and provide a report to Congress concerning, the use of agreements providing for arbitration of any future dispute between covered persons and consumers in connection with the offering or providing of consumer financial products or services.”
The study has been written and presented to Congress and the people. And now it is time for the rule. What can we expect?
A Lot More Class Action Suits (And A Lot More Oversight)
Among the main complaints about arbitrations as a consumer protection issue is that class action lawsuits are not possible within an arbitration framework. In short, 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.
And there have certainly been documented abuses of that, particularly among a spectacularly shady subset of debt collectors who specialize in creating legal headaches for consumers with expired debt.
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.
Midland made several creative attempts to collect the debt in Maryland, starting with the fact that it is not licensed to collect debt there at all. Cain was one of a number of Marylanders swept up in a crop of mass suits that a later review showed contained many cases of consumers who owed no money or who owed debts that were long expired.
When Cain and several other consumers contended they’d been wrongfully swept up in Midland’s mass collection and sued as a class, their case was dismissed. Why? All parties had agreed at some point to an arbitration clause in whatever contract has gone into collections, and class action lawsuits are not legally allowed in arbitration matters.
Cases like that are why the CFPB is considered likely to make a rule prohibiting the application of arbitration agreements as to class actions.
The CFPB’s study, “shows that … aggregated actions – typically class action litigation – have provided significant benefits to consumers, through cash settlements and other benefits made available to them and from agreements by companies to stop harmful behavior. Class litigation may also benefit consumers through the deterrent impact of those settlement agreements on other companies’ conduct.”
The new rule is also considered to likely require all arbitration disputes between consumers and firms be submitted to the CFPB for review — with the possibility that disputes and awards will be published on the Bureau’s website.
Concerns Bubble As The Rule Drop Nears
While consumer watchdog groups have generally lauded an overhaul of arbitration rules in consumer contracts, the move has its critics, who note that consumers may not be quite as widely benefited by this as they might appear to be on first glance.
Arbitration is inarguably subject to abuse — the problem is so is the civil tort system, particularly around class actions lawsuits. There is a reason arbitration came into fashion.
Moreover as lenders, issuers and service providers now face the possibility of large — and in some cases very expensive — lawsuits, they have to build risk into their models. Those costs, some have noted, will likely be passed onto customers and accountholders.
Alternately, service providers and underwriters could also tighten their requirements for contracting more tightly around credit in the hopes of selecting a customer base they end up in a protracted struggle with.
The problem with arbitration is really just the latest chapter in the ongoing problem of protecting consumers from actors who are truly out to cheat them, while not punishing all the good actors and making it harder and more expensive for everyone to transact.
And, as with most of these issues, there aren’t any easy answers.
But the CFPB will officially offer its first round of solutions this week, and take public comments on it in real-time at a field hearing.
We’ll keep you updated on this story as it develops.