Earlier last week, a group of consumer advocate organizations filed a Petition for Rulemaking with the CFPB that would prohibit the use of pre-dispute arbitration clauses in consumer contracts in favor of arbitration clauses that would permit consumers to choose between arbitration and litigation only after a dispute has arisen. There are numerous compelling reasons why the CFPB should not engage in such rulemaking.

First, the petition is clearly attempting to make an end-run around the CFPB’s prior arbitration rulemaking that would have prohibited class action waivers in consumer arbitration agreements.

The previous rule was overridden by Congress in 2017 under the Congressional Review Act (CRA). Under the CRA, as the petition acknowledges, an agency may not issue a later rule in “substantially the same form” as the one that was overturned (absent a new statute authorizing such action). Although the petition asserts that the CRA “poses no barrier” to the proposed rulemaking, that is wishful thinking. At its core, the petition embodies an ill-disguised policy preference for class action litigation over individual arbitration (even though, as we have observed on numerous occasions, the data contained in the CFPB’s own study show that individual arbitration is faster, less expensive and more beneficial financially to consumers than class action litigation). Petitioners make no effort to hide this, emphasizing early in the petition that:

Forced arbitration clauses require private arbitration of disputes, often on an individual basis, because most of these clauses also bar individuals from joining with others in class actions or class arbitration …. [T]he widely used prohibitions on aggregated or class claims in arbitration clauses eliminate the possible adjudication of systemic and widespread violations of the law. When consumers suffer small but serious injuries, banding together in a joint or collective action is often the only practical, cost-effective path for consumers to seek and obtain corporate accountability. Without the ability to go to court and band together, consumers harmed by corporate wrongdoing are deterred from asserting claims against financial institutions because it is costly, risky, and impractical to pursue their claims alone in arbitration.

Thus, despite their protestations to the contrary, a very strong argument could be made that petitioners’ proposed rulemaking would be barred by the CRA because it is “substantially the same” as the earlier CFPB rule barring the use of class action waivers that Congress vetoed.

The CFPB’s 2015 empirical study of consumer arbitration clauses was predicated upon Section 1028(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which instructed the CFPB to study “the use of agreements providing for arbitration of any future dispute . . . in connection with the offering or providing of consumer financial products or services,” and to provide a report to Congress on the same topic. (Emphasis added). The arbitration study, and the later final arbitration rule on which it was predicated, was all about the use of pre-dispute arbitration clauses in consumer contracts. And, the CFPB expressly viewed the “pre-dispute” nature of arbitration clauses as being inextricably intertwined with the class action waivers often found in such clauses. As stated in the study:

As noted, use of pre-dispute arbitration provisions in agreements governing consumer financial products and services has become a contentious legal and policy issue. An important development in this controversy occurred in 2011, when in AT&T Mobility LLC v. Concepcion, a divided Supreme Court held that the Federal Arbitration Act of 1925 (“FAA”) preempted state law that would have prohibited the enforcement of a consumer arbitration clause with a “no-class” provision.

Likewise, the CFPB’s final arbitration rule stated at the outset:

[The final rule prohibits providers from using a pre-dispute arbitration agreement to block consumer class actions in court and requires most providers to insert language into their arbitration agreements reflecting this limitation. This final rule is based on the Bureau’s findings – which are consistent with the Study – that pre-dispute arbitration agreements are being widely used to prevent consumers from seeking relief from legal violations on a class basis ….

The rule that petitioners propose would allow plaintiffs’ class action attorneys to reject arbitration on behalf of a putative class or certified class. That is really what petitioners envision when they argue that “[i]t is generally only after a dispute arises that consumers have access to counsel to help them make informed decisions about where and how to bring their claims.” (Emphasis added). Those attorneys have a strong economic incentive to reject arbitration so that they can receive exorbitant attorneys’ fees to the detriment of consumers and companies. (Recall that the CFPB’s earlier arbitration study found that consumers who received cash payments in class action settlements got a paltry $32.35 on average after waiting for up to two years, while their lawyers recovered a staggering $424,495,451). Class actions only make economic sense to counsel for the class.

In light of the foregoing, how can petitioners contend (or pretend) that there is no substantial overlap between the CFPB’s prior vetoed rule which amputated “pre-dispute” consumer arbitration clauses by prohibiting the use of class action waivers and the proposed rule that would prohibit the use of such clauses altogether (along with the class action waivers contained therein). Make no mistake, the real target here is the elimination of class action waivers, which benefits only plaintiffs’ class action lawyers. At heart, the proposed rule is substantially the same as the earlier vetoed rule and thus would be precluded by the CRA.

It should also be noted that petitioners are asking the CFPB to do what it already rejected when it issued its previous final arbitration rule. The CFPB refused to prohibit the use of pre-dispute arbitration clauses that did not contain class action waivers (“the final rule requires providers that use pre-dispute arbitration agreements to submit certain records relating to arbitral and court proceedings to the Bureau”). Thus, the CFPB a short while ago considered, then rejected, the idea of banning pre-dispute arbitration provisions altogether.

Second, the petition mischaracterizes pre-dispute arbitration clauses as being “forced”—a word that appears 94 times in the 18-page petition. The CFPB is well aware that the days when consumer contracts were individually negotiated “are long past” (to quote the U.S. Supreme Court) and, more importantly, non-negotiated contracts are not inherently offensive. On the contrary, non-negotiated contracts can benefit both consumers and customers. As observed in the American Law Institute’s (ALI) recently approved Restatement of the Law, Consumer Contracts: “There are many benefits to standard-form contracting …. The efficiencies of mass production and mass distribution of products and services would be hindered if the terms of each transaction with each consumer had to be individually negotiated. These market efficiencies can benefit all market participants ….” The Reporters Notes to the Restatement likewise state: “[T]he use of standardization in the production of contract terms is, like standardization in the production of goods and services, a source of potential benefits to consumers and businesses alike. Standardization supports efficient production and distribution, resulting in lower prices and lower transaction costs, and the introduction of new forms of products and services.” The Restatement culminated an 11-year project by ALI to address how contractual terms are adopted, modified and enforced in contracts between business and consumers. It reflects the collective input of hundreds of professors, consumer advocates, industry lawyers and other interested persons who carefully considered what rules should apply to consumer contracts.

Third, as we have pointed out before there is nothing “new” about petitioners’ proposal. It is just the latest spin on the decades-old argument by consumer advocates that arbitration agreements should only be entered into after a dispute has occurred, not before, because consumers are not fully cognizant of their rights until then. Yet the FAA itself contemplates the use of pre-dispute arbitration clauses. Section 2 of the FAA provides: “A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction … shall be valid, irrevocable, and enforceable ….” Notably, although the CFPB has statutory authority with respect to pre-dispute arbitration clauses, it does not have such authority with respect to post-dispute arbitration clauses.

In any event, the proponents of post-dispute arbitration agreements have never made a convincing case, and the same is true of the petition. Limiting consumer arbitration to post-dispute controversies would severely curtail consumer arbitration because once a dispute has arisen, one side or the other, or both, inevitably use the in terrorem “threat” of expensive and prolonged litigation as a negotiating tool. That tactic is eliminated if the parties have agreed to arbitrate the dispute prior to the dispute arising. Thus, although post-dispute arbitration is a theory that may sound superficially appealing, it fails in real life. An empirical study by researchers at the University of California at Berkeley concluded that the “overriding problem” with post-dispute arbitration is that “it is extremely rare for both the plaintiff’s and defense’s attorneys in a case to select arbitration after the dispute has arisen” and, accordingly, both businesses and individuals “are hurt by a post dispute system.” David Sherwyn, “Because It Takes Two: Why Post-Dispute Voluntary Arbitration Programs Will Fail to Fix the Problems Associated with Employment Discrimination Law Adjudication,” 24 Berkeley Journal of Employment and Labor Law 1, 7, 68 (2003). By contrast, “[p]re-dispute arbitration agreements ensure that both parties are on the ‘same page’ regardless of the particulars of any subsequent dispute.” Victor E. Schwartz and Christopher E. Appel, “Setting the Record Straight About the Benefits of Pre-Dispute Arbitration,” 34 Legal Backgrounder No. 7, Washington Legal Foundation (June 7, 2019).

Fourth, the petition is premature. The CFPB should defer doing anything with respect to the petition unless and until it finalizes its proposed rule that would create a registry of non-banks that use arbitration provisions and it has been in use for a while. Until that is done, the CFPB simply does not have the data it needs about the prevalence of consumer arbitration. Petitioners put the cart before the horse when they argue that “it is necessary for the Bureau to proceed a step further to adequately address the issue that a registry alone cannot wholly resolve” when the registry system itself has not even been finally approved or implemented. In addition, it would trammel on Congressional power for the CFPB to undertake the proposed rulemaking while Congress is considering bills that would ban consumer arbitration altogether.

Moreover, the petition has been filed at a most inappropriate time when the Supreme Court is poised to consider whether the CFPB has been unconstitutionally funded. The Fifth Circuit had already reached the conclusion that the CFPB was and is unconstitutionally funded. If the Supreme Court reaches the same conclusion, it might very well invalidate all regulations previously issued by the CFPB and preclude the proposing of new regulations, unless and until Congress cures the constitutional deficiency.

Finally, we respectfully suggest that the CFPB (and the consumer advocacy groups that sponsored the proposal) would be better served by devoting their time and resources to educating the public about the many benefits that arbitration has to offer. That would go a long way to achieving what the petition purports to strive for—i.e., “competitive markets where [consumers] can make informed and meaningful choices about the products they use and the terms of service they are bound to.” Petitioners rely heavily on studies that purport to show that consumers are not aware of and do not understand the meaning or consequences of pre-dispute arbitration clauses. We have written about those studies before and found them to be deeply flawed. We concluded then, and again conclude now, that education, not regulation, is the key to improving consumers’ financial literacy.

We will keep you updated on events as they develop.

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