WASHINGTON - A federal appeals court ruled Tuesday that borrowers who sign loan contracts requiring arbitration of disputes may not file class actions later against lenders for violating consumer protection laws.
The case, Johnson v. West Suburban Bank; Tele-Cash Inc.; and County Bank of Rehoboth Beach, Del., arose last year when a borrower claimed that, though his contract barred him from suing as an individual, it did not prevent him from joining a class action filed under the Truth-in-Lending Act and the Electronic Fund Transfer Act.
The borrower, Terry Johnson, said the lenders failed to disclose the interest rate on his loan and committed other violations.
In overturning a lower court ruling that had allowed the suit to proceed, the U.S. Court of Appeals for the Third Circuit in Philadelphia wrote: "Because neither the TILA nor the EFTA explicitly precludes the selection of arbitration instead of litigation, a party who agrees to arbitrate but then asserts that his or her statutory claim cannot be vindicated in an arbitral forum, faces a heavy burden. That burden has not been met here."
In recent years banks and other lenders have tried to reduce legal costs by steering disputes with borrowers into arbitration, which is usually faster and cheaper than litigation. The result has been a flurry of lawsuits challenging the enforceability of arbitration clauses, the sections of loan contracts in which both parties agree to forgo lawsuits.
"This is a heavily litigated issue throughout the country," said Alan S. Kaplinsky, senior partner in charge of the banking practice of the Philadelphia law firm Ballard Spahr Andrews & Ingersoll. "We are involved in a dozen similar cases right now."
Mr. Kaplinsky, who filed a friend-of-the-court brief on behalf of the American Bankers Association in the Johnson case, said the appellate court's decision was good news for banks dealing with the issue in other jurisdictions. "I would think that it is likely to be very persuasive in circuits where the other cases are pending."
The issue has also caught the attention of the Supreme Court, which will hear Green Tree Financial Corp. v. Randolph on Oct. 3. In Green Tree, another appeals court ruled an arbitration clause was unenforceable, because it hid the potential costs of arbitration from the borrower.
However, another element of the Green Tree case not mentioned in the ruling more closely mirrors the Johnson case. Specifically, it addresses a borrower's right to appeal a court order compelling him/her to comply with an arbitration clause.
Some observers predicted that the high court will address both elements of the Green Tree case, and that activity in other arbitration-related cases may slow pending the decision.
Trade groups heralded the decision as one more step toward establishing the validity of arbitration clauses in loan contracts.
"Trial lawyers are attacking it from every angle they can think of, and we beat back the attacks one by one," said Michael F. Crotty, the American Bankers Association's deputy general counsel for litigation. "Collectively, when we win these cases, it creates an almost irrebuttable presumption of the enforceability of these contracts."
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