A Supreme Court ruling this week could make it tougher and costlier for card issuers and other consumer lenders to pursue claims against delinquent borrowers.
Lenders often go through state courts to compel borrowers to make good on their debts, but when borrowers try to dispute the loans, lenders can invoke clauses in their contracts that say such disputes must be handled through arbitration.
When seeking to compel arbitration, lenders often switch to federal courts, which are sometimes seen as a friendlier forum. But as a result of the high court's decision Monday, lenders now must ask the state courts to move the disputes to arbitration.
The court ruled 5 to 4 that a federal court lacked the authority to push a dispute between Discover Financial Services and a cardholder into arbitration. The majority, led by Justice Ruth Bader Ginsburg, said the core case, brought by Discover, was made under state law, even though federal law preempted the customer's counterclaims.
Legal experts said Tuesday that the practical outcome of the decision is unclear, since federal law requires both federal and state courts to enforce arbitration agreements.
"Up until now credit card companies have apparently thought, just based on their practice and pushing this case, that it was better for them to be fighting in federal court," said Daniel Ortiz, a professor at the University of Virginia School of Law who served as one of Betty Vaden's lawyers in her dispute with Discover. "We'll have to see whether they're right about that. That may vary from state to state."
Still, Ortiz said that "by sort of changing the equilibrium," the decision "may encourage some debtors who feel they've been unfairly treated to push back."
Oliver Ireland, a partner with Morrison & Foerster LLP, which filed an amicus brief in support of Discover on behalf of the American Bankers Association, the Financial Services Roundtable and other trade groups, said, "One of the reasons you have federal remedies for federal statutes is you're going to get a more consistent enforcement of the federal law." Since state laws on arbitration are "uneven," he said, "You're not going to have the same level of comfort that you would have if you're in federal court."
Jean Sternlight, a professor at the William S. Boyd School of Law at the University of Nevada, Las Vegas, said corporate and consumer attorneys alike generally believe that "federal courts these days tend to be more likely to be supportive of arbitration, especially mandatory arbitration, than some state courts."
"It's true that there have been some state courts that have been particularly reluctant to enforce mandatory arbitration agreements," she said. "And it's true that some federal courts have been more willing to enforce mandatory arbitration agreements."
But she said the picture is not clear cut. Federal and state courts in California have been reluctant to put cases into arbitration where "they thought the arbitration agreement was unconscionable," for example, Sternlight said.
Also, "as we're now going to gradually see some transition in the makeup of the federal courts with the new president, I suspect that in a number of years this may not play out in the same way, and it could even play out in the opposite way."
Sternlight called the ruling a "split-the-difference decision," since arbitration can still be sought in federal courts when the underlying issue in a state court case is a federal one — for instance, if borrowers initiate a suit alleging usurious interest rates or deceptive practices.
In the Discover case the consumer only raised a federal issue in her cross-suit against the company, which alleged the lender's finance charges, interest and late fees violated state law. The underlying claim by Discover that the consumer owed about $11,000 was made under state law.
Ortiz said that typically, when trying to collect debt, "the lender has gone to state court, filed an action and … basically hopes there's no pushback from the consumer. And then if there's any pushback from the consumer, they would try to go to federal court to force arbitration."
Though "state courts might treat the motions to compel arbitration a little bit differently" — because of different procedural timetables and requirements, for example — "substantively they're all bound by the Federal Arbitration Act and they're all supposed to enforce arbitration agreements."
Laurence Hutt, a partner at Arnold & Porter LLP, said: "There are those intangibles to be sure — the difference between the two systems, and the difference between judges within the same system. Some judges, some courts are more likely to compel arbitration, some are more" reluctant to. But "the governing law, regardless of which forum you go to, is at least supposed to be the Federal Arbitration Act. In theory you should be getting the same decision regardless of which forum you went to." Hutt emphasized that the decision does not address "the enforceability, substantively, of an arbitration clause, or a class-action waiver."
The Supreme Court had previously held that a determination of whether the substantive dispute in a case was a matter of federal law — and thus that a federal court would have the power to order arbitration in a case brought in state court — depended on the complaint and not the counterclaims. But the Fourth Circuit in Richmond, Va., had concluded that preemption of Vaden's counterclaims was "paramount," the Supreme Court said.
