Many credit card issuers and subprime mortgage lenders use mandatory arbitration clauses to reduce their exposure to expensive litigation.
But a recent policy change at one of the big three arbitration firms, JAMS, could result in the clauses’ increasing lender risk, industry lawyers said.
JAMS announced Nov. 12 that it would no longer enforce provisions in mandatory arbitration clauses that bar consumers from forming classes in arbitration. Most arbitration clauses allow the consumer to choose between JAMS, the American Arbitration Association, and the National Arbitration Forum.
That could mean lenders — particularly in the mortgage and home equity areas — may face a greater likelihood of class arbitrations, which some lawyers say are even worse for defendants than class-action litigation. And though credit card providers can at least change their terms to exclude JAMS from the list of options, doing so could be politically perilous.
Kirk Jensen, an associate with Womble Carlyle Sandridge & Rice PLLC in Charlotte, predicted that credit card issuers will send a flood of mail to their customers with change-of-terms notices eliminating JAMS as an option for arbitration. He said he is mulling over what he should advise his card-issuing clients to do.
Jay Welsh, a vice president and the general counsel of JAMS, which is based in Irvine, Calif., said, “We felt that it was inappropriate for companies to require that as a condition of arbitration, consumers waive rights to class-action arbitration.”
Womble Carlyle partner Donald Lampe said lenders that used arbitration clauses to protect themselves against lawsuits “now may face significant exposure to class arbitration,” which “they thought they had effectively negated.”
Class arbitrations, Mr. Lampe said, are “widely regarded as much worse for a financial institution than class-action litigation in court because it entails much, if not all, of the financial risks of class-action litigation without many of the procedural protections” of court class actions, which include the right to an appeal.
A mandatory arbitration clause is an agreement between the borrower and the lender that any disputes over the loan will be resolved by an independent arbitrator.
Consumer activists have called the clauses unfair because they limit borrowers’ access to courts and because the arbitration process can be expensive, which weighs in a lender’s favor.
The government-sponsored enterprises Fannie Mae and Freddie Mac have said they will not buy loans with mandatory arbitration policies.
Mr. Welsh said that his firm changed its policy because arbitration should not be a “method whereby one party — in consumer cases normally the company — should get an advantage over the consumer. That’s why we have said, ‘You can’t limit the remedy.’ ”
Mr. Jensen said that as open-end credit providers, card issuers are allowed under the law to change the terms of their cards any time they want because the credit card loan is an “ongoing relationship.” A borrower who does not like the change can simply cut up the card and no longer use it.
However, closed-end lenders, such as home equity and subprime mortgage providers, do not have the luxury of changing their terms, Mr. Jensen said.
“In a closed-end case where the loan was made and the borrower’s only outstanding obligation is to repay the loan, it is difficult if not impossible to go back and take JAMS out of the arbitration agreement,” he said.
Mr. Lampe said that even credit card issuers that change their terms could find themselves in an awkward spot because removing one of the three forum options might undermine the industry’s argument that mandatory arbitration clauses provide borrowers choices in the matter.
Eric Mogilnicki, a partner with Wilmer Cutler Pickering Hale & Dorr LLP in Washington, criticized JAMS’ move.
In an email, he wrote that it was inappropriate for JAMS to “agree to handle such an arbitration and then rewrite the parties’ agreement without the parties’ consent.”
“Rewriting an arbitration provision that precludes class arbitration so that it allows class arbitration is unfair — not only to the parties, but to all of the absent class members,” he wrote.
The absent members “will have their claims resolved through class arbitration even though they have a binding agreement with the lender that this will not happen.”
Mr. Welsh said that JAMS does not have any agreements with lenders or issuers. Though it is an arbitration option on “millions” of financial agreements, it was the lenders, banks, and other financial institutions that chose to give it such status, he said.
Mr. Welsh said that JAMS contends it is a consumer’s minimum right to have access to class-action arbitrations, since they are barred by mandatory arbitration clauses from forming classes in courts.
He said that in each case the individual arbitrator will have the right to determine whether a consumer is eligible for class-action arbitration, meaning that not all consumers will be able to form such classes.
