Mandatory arbitration clauses have been billed as a panacea for ending "frivolous" litigation against banks and reducing lenders' legal costs. Public-interest advocates have always viewed arbitration as a threat to consumers' rights. Now, developments suggest that arbitration clauses may not be in the industry's best interest either.
Boosters of arbitration clauses have contended that they can be used to prohibit participation in class actions. This month a federal court in Washington State joined seven other state and federal courts in holding that such bans are unconscionable and thus unenforceable. In August, South Carolina became the third state to permit classwide arbitrations.
Most banks have drafted "one-way" arbitration clauses, which require that claims by the consumer be arbitrated, while allowing the lender access to judicial foreclosure proceedings. Last month the Pennsylvania Superior Court followed California's lead in questioning this practice. Specifically, the court remanded a case to the trial court for determination of whether "business realities" demanded a one-way clause. This puts the lender in the awkward posture of producing evidence on arbitration's disadvantages in order to validate its clause.
Many lenders use two-way clauses to avoid this pitfall. But the two-way clause has its own drawback: The borrower may invoke the arbitration clause in a debt-collection proceeding, which means added hurdles and costs for banks pursuing deadbeats.
The usual gridlock in Congress has stymied efforts to exempt consumers from the Federal Arbitration Act. But state legislatures are using their limited authority to scale back the unfairness of mandatory arbitration. New Mexico has passed the Fair Bargain Act, which sidesteps federal preemption and bans unfair terms in consumer contracts. California just enacted a package of arbitration bills, including broad sunshine provisions.
The biggest benefit that arbitration provided lenders was the cost barrier it put in front of consumers. The high filing fees and hourly arbitrator charges traditionally required to initiate an arbitration used to scare off most claims. This year, however, all three of the major arbitration providers announced new fee structures that shift the lion's share of arbitration costs to businesses.
This is expected to let many more claims proceed; however, many consumers' attorneys continue to challenge the legality of arbitration clauses, often by conducting discovery into arbitration providers' inner workings.
Banks that use arbitration clauses are playing with fire. The fact of the matter is that nobody has a greater interest in maintaining a strong public judicial system than lenders. Ultimately, it is only through the courts that creditors can enforce debts. If arbitration clauses lock average citizens out of our courts and make them the private domain of corporations, taxpayer support for subsidizing the courts will disappear. The federal courts' diversity jurisdiction has been on the bubble for years, with the federal judiciary on record favoring its abolition. This could be the first subsidy to go - ironic, since the federal courts were created to ensure the ability of out-of-state creditors to collect debts.
It's been fashionable of late to bash juries, and to suggest that "rash" and "anti-business" laypersons be replaced with dispassionate, expert arbitrators. Arbitrators may be experts, but they lack the most important trait of jurors: legitimacy. Americans are willing to accept the judgment of 12 randomly-selected peers, even when it goes against them. But consumers feel violated by arbitration tribunals they perceive as stacked decks. Consumers who lose in arbitration are more likely to pursue complaints with regulators, set up "grudge" sites on the Internet, speak to the media, and even mount protest demonstrations in front of businesses.
In the end, the arbitration craze will probably prove to be a short-lived fad.
