Why it matters

The Consumer Financial Protection Bureau (CFPB) has picked its next battle: a proposal to limit the terms of mandatory pre-dispute arbitration agreements in contracts involving consumer financial products or services. Calling such provisions a "free pass" for companies, the Bureau said they allow entities to "sidestep the legal system, avoid big refunds, and continue to pursue profitable practices that may violate the law and harm countless consumers." The proposal would ban clauses that block class arbitrations in contracts for consumer financial products and services, including agreements for credit cards, checking and deposit accounts, and prepaid cards. In addition, the ban would require covered entities that elect to use arbitration agreements for individual claims to maintain records and submit data to the Bureau on claim filings and written awards, possibly for publication on the CFPB website. After the Bureau released a study earlier this year highlighting negative effects of arbitration on consumers, the proposal did not come as a shock to the industry. But that doesn't mean the proposal will face smooth sailing, already facing criticism from industry and the strong likelihood that any rule promulgated by the CFPB will be challenged in court.

Detailed discussion

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 tasked the Consumer Financial Protection Bureau (CFPB) with taking a look at the use of arbitration provisions in consumer financial agreements. In March, the Bureau released the findings from its study.

The Bureau said that most arbitration agreements prohibit group action (such as class actions or collective actions) and that few consumers individually seek relief. More than 75 percent of the consumers surveyed were unaware of whether they were subject to an arbitration clause in a financial product contract, the CFPB said, while less than 7 percent knew the clause restricted their ability to file a lawsuit.

The CFPB's conclusions left little doubt that the Bureau would crack down on arbitration provisions in consumer contracts, and earlier this month the agency announced its intent to ban the use of arbitration clauses to block consumers from suing in groups to obtain relief. Characterizing such clauses as "free passes," the agency said its proposal "would give consumers their day in court and deter companies from wrongdoing." Banning clauses that prohibit group arbitrations likely will have the effect of eliminating arbitration clauses in these agreements entirely, since arbitration awards generally may not be appealed, and companies will not want to risk a non-appealable class award in an arbitration.

In preparation for convening a Small Business Review Panel to gather feedback, the CFPB published an outline of its proposals. The Bureau noted that the proposals would not ban arbitration altogether but "the clauses would have to say explicitly that they do not apply to cases filed as class actions unless and until the class certification is denied by the court or the class claims are dismissed in court."

The proposals would apply to the bulk of the consumer financial products and services overseen by the CFPB, including checking and deposit accounts, credit cards, prepaid cards, money transfer services, certain auto loans, auto title loans, small-dollar or payday loans, private student loans, and installment loans.

Congress and the courts developed class litigation procedures for a reason, the CFPB said, particularly where the harm to an individual consumer might be too small to make the pursuit of litigation practical. Group lawsuits provide consumers with "opportunities to obtain relief they otherwise might not get," the Bureau added.

The proposals will also incentivize companies to comply with the law and serve as a deterrent, the CFPB argued, as arbitration clauses "enable companies to avoid being held accountable for their conduct" and make them "more likely to engage in conduct that could violate consumer protection laws."

Companies that elect to continue using arbitration on an individual consumer basis would be subject to continuing CFPB oversight. Covered entities would need to submit information to the agency about arbitration claims filed and awards issued. "This will allow the Bureau to monitor consumer finance arbitrations to ensure that the process is fair for consumers," the CFPB said, adding that it is also considering publishing the data on its website.

The Bureau noted that it will seek input from the public, industry, consumer groups, and other stakeholders once proposed regulations are issued.

In response, the industry has asserted that consumers in fact receive greater relief in individual arbitration actions, in which the financial institution typically agrees to pay many of the consumer's costs, than in a class action in the courts, the primary beneficiaries of which are plaintiffs' attorneys.

To read the outline of the CFPB's arbitration proposals, click here.