Insights

Arbitration—used by creditors to keep disputes out of court and avoid class actions, but increasingly viewed by consumer advocates and state and federal lawmakers as overly protective of businesses at the expense of consumer rights—has faced numerous attacks over the last few years to curtail its use. This year has been no different with initiatives at both the state and federal level to restrict or limit its use by creditors.

On the state level, Arizona, Maine, and Minnesota enacted laws this spring dealing with arbitration. Maine legislators took steps to eliminate arbitration, while Arizona and Minnesota made lesser changes to their arbitration laws. On the federal level, spring also saw the nation’s top court issue a ruling that held that parties to an agreement could not force each other to arbitrate their claims if they have not agreed in advance to do so. Perhaps most significantly, Sen. Christopher Dodd’s (D-Conn.) controversial Wall Street reform bill also takes aim at arbitration, proposing to provide the new Bureau of Consumer Financial Protection (“Bureau”) with the authority to limit or to forbid mandatory predispute arbitration.

Maine made the most radical changes to its arbitration laws. Maine’s governor signed H.P. 875 into law on March 31. The law – styled as “An Act to Provide Protections for Consumers Subject to Mandatory Arbitration Clauses” – prohibits predispute mandatory arbitration claims in consumer contracts dealing with the purchase or acquisition of goods and services for personal, family, or household purposes. Although H.P. 875 does not include insurance contracts – and apparently allows the use of arbitration in employment agreements – the law provides that “[a] consumer arbitration agreement not allowed under federal law is void and unenforceable.” As a result, to the extent that a creditor cannot rely on the Federal Arbitration Act (“FAA”), arbitration agreements will soon become unenforceable in Maine. State Rep. Sean Flaherty, formerly a Washington, D.C.-based community organizer, told Basis Points that he introduced the bill because businesses have abused consumers with expansive use of arbitration clauses. “They’re contracts of adhesion,” he said. Flaherty points to the automotive industry as a perfect example of an industry that has pushed the boundaries of arbitration into the realm of the unfair. Maine’s law becomes effective on July 21, 2010.

Meanwhile, Arizona and Minnesota also amended their state laws regarding arbitration, albeit in a less restrictive way. The Arizona Legislature adopted House Bill 2430, which codifies the Revised Uniform Arbitration Act (“RUAA”) adopted by the National Conference of Commissioners on Uniform State Laws (“NCCUSL”). The RUAA defines the terms relevant to an arbitration proceeding and dictates the necessary steps to provide and to receive notice of arbitration. Like the Maine law, the Arizona measure does not apply to an arbitration agreement between an employer and employee or to insurance contracts. The Arizona measure expressly does not apply to federally-chartered entities, and designates an official agreement to arbitrate a controversy as valid, enforceable, and irrevocable except as prescribed by law or in equity for the revocation of a contract. The bill leaves it to a court to decide if an agreement to arbitrate exists or a controversy is subject to arbitration, while the arbitrator must decide whether a contract that contains a valid agreement to arbitrate is enforceable. The RUAA applies only to agreements to arbitrate made on or after January 1, 2011, or agreements made before that date if the parties agree. To date, 13 states have adopted the RUAA, with another five states considering adoption of the RUAA. In the Midwest, Minnesota made minor changes to its arbitration laws on April 22. With the enactment of H.F. 1692, the Land of 10,000 Lakes adopted the RUAA and amended its existing arbitration laws. The Minnesota law goes into effect on Aug. 1, 2011.

The nation’s top court also grappled with the issue in April. On April 27, the United States Supreme Court issued a major arbitration opinion that concluded that the parties to an agreement cannot be compelled to engage in class-wide arbitration unless they have agreed to do so. In Stolt-Nielsen S. A. v. AnimalFeeds Int’l Corp., the high court held that imposing class arbitration on parties who did not agree to authorize class arbitration violates the Federal Arbitration Act. The parties in Stolt-Nielsen agreed that their commercial contract was “silent” on the class arbitration issue. The Court, in a decision authored by Justice Samuel Alito, noted that the arbitrators’ proper task at that point was to identify the rule of law that should govern in that circumstance. Instead, the panel wrongly based its decision on post-Green Tree Financial Corp. v. Bazzle arbitral decisions without mentioning whether those decisions were based on a rule derived from the FAA or on other law. Rather than inquiring whether those bodies of law contains a “default rule” that permits an arbitration clause to allow class arbitration absent express consent, the arbitrators’ panel proceeded as if it had a common-law court’s authority to develop what it viewed as the best rule for such a situation.

Finding no reason to depart from its perception of a post- Bazzle consensus among arbitrators that class arbitration was beneficial in numerous settings, the panel in Stolt-Nielsen simply imposed its own conception of sound policy and permitted class arbitration. The panel’s few references to intent do not show that the panel did anything other than impose its own policy preference, and the panel imposed class arbitration despite the parties’ stipulation that they had reached “no agreement” on that issue. The panel’s conclusion was “fundamentally at war” with the foundational FAA principle that arbitration is a matter of consent. The Stolt-Nielsen court thus answered the question left open in Bazzle regarding arbitration agreements that are silent on class-wide arbitration, holding that a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.

In Congress, Section 1028 of Sen. Dodd’s Wall Street Reform bill, S.3217, orders the Bureau of Consumer Financial Protection – the proposed new regulatory authority for the financial services industry – to conduct a study and to provide a report to Congress on arbitration in connection with the offering or provision of consumer financial products and services. Dodd’s bill also gives the Bureau the authority to prohibit or to impose limitations on arbitration if limitations or an outright ban on mandatory predispute arbitration would protect consumers. It’s likely that the final financial regulatory reform bill will give the Bureau the power to ban arbitration – and it’s just as likely that the Bureau will exercise that power.

So, while it appears that arbitration is on its last legs, creditors should still write arbitration clauses in their contracts so that disputes fall under the FAA. In order for the FAA to apply, the transaction must affect interstate commerce—and consumer finance transactions almost always affect interstate commerce. The arbitration agreement should specifically invoke and reference the parties’ acknowledgment and acceptance of the FAA as the choice of law to resolve any disputes between the parties. Further, creditors should ensure that their arbitration agreements include class action waivers. Stolt-Neilsen held that a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so. Including a class action waiver agreement in an arbitration clause clearly demonstrates the parties’ intent not to submit to class-wide arbitration. The arbitration clause should contain a provision that the arbitration clause remains valid if a provision other than the class action waiver is declared invalid. If the class action waiver is declared invalid, the arbitration provision should have a “blow-up” provision that invalidates the entire arbitration clause.

Stayed tuned to the arbitration weather channel to see where the tornado touches down.

Nicole Frush Munro and Catherine M. Brennan are partners in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Nikki at 410-865-5430 or by e-mail at nmunro@hudco.com and Cathy at 410-865-5405 or by email at cbrennan@hudco.com.