California Passes Strict Statute To Curtail Arbitration Clause

California, with the signature of Governor Jerry Brown, has officially passed a law that will make it easier for consumers to sue banks alleged to have created fraudulent accounts in their names.

The legislation was inspired by the ongoing soap opera that is Wells Fargo.

The new legislation specifically prohibits banks from requiring disputes over fraudulent accounts to be sent to private binding arbitration instead of being heard in a court. This law overrides banks’ tendency to insert arbitration clauses into consumer contracts at sign up — which then work to prevent class actions suits and court cases in the event of things going horribly wrong.

While arbitration clauses have their defenders, they are harder to defend in the case of Wells Fargo — which admitted that it had wronged consumers as a group by creating millions of checking, savings, credit card and other accounts without customers’ knowledge or permission. But — thanks to the magic of the arbitration clause — Wells Fargo was able to shield itself from lawsuits filed over the bogus accounts, even though customers had never agreed to open them.

Wells Fargo Chief Executive Timothy Sloan was sharply questioned about the bank’s position on arbitration during a Tuesday hearing held by the U.S. Senate Banking Committee.

During his post-scandal update, Sloan testified that the bank was no longer taking the position that its arbitration clause prevents customers from suing the bank. Senator Chris Van Hollen countered that there is at least one lawsuit currently open where that is exactly its position.

Whether the new California law will stick remains another question entirely — the U.S. Supreme Court has issued opinions in the past saying that states cannot make rules that disfavor arbitration and that state courts must honor arbitration agreements.

“It clearly won’t stand up,” Alan Kaplinsky, a Philadelphia attorney, noted. “Really, there’s no doubt at all that the state law would be preempted.”

Rep. Brad Sherman (D-Sherman Oaks) and Sen. Sherrod Brown (D-Ohio) have introduced matching House and Senate bills that would change federal law and prohibit the application of arbitration clauses to fraudulently opened bank and credit card accounts.

But in a Republican-controlled House and Senate, that provision is unlikely to move forward.