They Dun Them Wrong
Danny Chou.
Photo by Melissa Barnes
When he began using mandatory arbitration clauses in credit card agreements about 20 years ago, Philadelphia attorney Alan S. Kaplinsky likely never imagined where it would lead.
Now a senior partner at Ballard Spahr Andrews & Ingersoll, Kaplinsky sought to keep a client—a company that financed large TV satellite dishes—out of rural state courts when consumers disputed fees.
The customers “alleged that they didn’t realize they were getting a credit card, and when they got a statement showing that they were paying interest it shocked them,” he recalls.
The claims were rarely dismissed on summary judgment, and, Kaplinsky says, “if you went to trial in a remote county in Alabama, you would end up in front of a jury that was bound to sock it to you.” Most of the cases were settled for “staggering amounts of money.”
When a client asked Kaplinsky how to get around that, he thought about the Federal Arbitration Act, the 1925 legislation that eased the process of arbitration for resolving disputes between businesses.
Even by the 1980s, the statute was rarely used in consumer disputes. Since then, mandatory arbitration clauses have become practically automatic in credit card agreements—along with employment and securities contracts, and just about every other standard form agreement.
Arbitration clauses appear in 69 percent of contracts in the financial services industry—the highest rate across businesses, according to a 2004 study by researchers from the RAND Institute for Civil Justice and Stanford Law School.
The upshot for the credit card industry is that companies increasingly use the process to go after cardholders they claim have been delinquent. In so doing, the companies have turned arbitration businesses into debt collection services, critics say.
From January 2003 through March 2007, one arbitration company, the Minneapolis-based National Arbitration Forum, handled 34,000 arbitrations in California, of which only 118 were initiated by consumers, according to a September 2007 report by Public Citizen, a consumer advocacy group based in Washington, D.C.
Consumers in California, the only state that requires the disclosure of arbitration results, lost 94 percent of the time in credit disputes the NAF handled, according to the report, “The Arbitration Trap: How Credit Card Companies Ensnare Consumers.”
A DEBTOR VICTORY
But concern over mandatory arbitration is growing—in Congress and in state and federal courts.
Last year, Sen. Russ Feingold, D-Wis., and Rep. Hank Johnson, D-Ga., offered the Arbitration Fairness Act, which aims to eliminate mandatory arbitration in consumer and employment contracts.
Meanwhile, a federal appeals court handed a significant victory to cardholders in April when it reversed a lower court and allowed an antitrust suit to proceed against several major card companies. The plaintiffs claim that banks conspired to place mandatory arbitration agreements in all credit card applications while denying accounts to consumers who balked.
The New York City-based 2nd U.S. Circuit Court of Appeals revived the claim April 25, holding in Ross v. Bank of America that the banks’ alleged actions could have deprived consumers of a meaningful choice in credit card services. Other defendants include Capital One Bank, JPMorgan Chase and Citibank.
On March 24, the San Francisco city attorney’s office filed People v. National Arbitration Forum in California state court.
The NAF violated California’s unfair business practices statute, the complaint says, because while purporting to provide neutral services, NAF arbitrators heavily favor debt collection clients, and the organization frequently ends relationships with arbitrators seen as friendly to consumers.
The complaint also accuses the forum of operating an “arbitration mill” in its paper arbitrations, in which parties submit arguments in writing without personal appearances. According to the complaint, the NAF pays arbitrators by the number of hearings, giving arbitrators incentive to decide the matters quickly, with little review.
Danny Yeh Chou of the San Francisco attorney’s office says the complaint was inspired by the Public Citizen report. “In law there’s no such thing as a sure thing, but that comes pretty close to being a sure thing,” says Chou, who heads the complex and special litigation section. “We’re not saying that some consumers don’t owe the money, or that banks shouldn’t make a profit, but we are saying that consumers should have a fair shake.”
According to an NAF representative, arbitrators must apply substantive law when issuing awards, including in situations where consumers have not responded. The organization has more than 1,600 arbitrators and neutrals, all of whom are licensed lawyers, according to the representative, who declined further comment while the claims were being litigated.
However, critics of arbitration say consumers don’t understand the process and often don’t realize they’re in arbitration when they receive debt collection notices. Nor do many customers know that under the Federal Arbitration Act, parties that want to challenge an award must do so within 90 days.
“The vast majority of people who get one of these notices don’t know what it is, and they think it’s junk mail,” says F. Paul Bland Jr., a staff lawyer at Public Justice, a D.C.-based public interest group. “We get a couple of calls every day from people who feel they are having unfair debt collection. There’s a huge number of cases.”
If a consumer doesn’t respond to an arbitration notice, Bland says, the NAF enters a full award, without researching the credit card company’s claim.
“In court if you get a default the judge will find liability, but the court will make [the credit card company] prove damages” and attorney fees, he says.
Meanwhile, supporters of mandatory arbitration say consumers rarely have a defense, which is why credit card companies and debt collection agencies win almost all arbitrations.
“Statistically, I have found in favor of the credit cards 99 percent of the time,” says University of Montana law professor Scott J. Burnham, an NAF arbitrator. “But I don’t think it’s because I’m biased. It’s because they have a simple case factually.” Consumers almost always admit that they owe the money in question, Burnham says. “As soon as they say that,” he says, “the case is virtually over.”
Sloppy legal work is common among attorneys representing debt collection and credit card companies, Burnham says.
For instance, most of the credit companies are incorporated in Delaware, which allows a reasonable attorney fee of up to 15 percent. In the filings, he adds, lawyers often misstate that rule to automatically be 15 percent and don’t make a showing of work.
Debtors rarely challenge that, Burnham says, but he takes it upon himself to disallow it. He also sees carelessness with arbitration fees.
“The arbitration clause in the credit card agreement says that fees for arbitration can’t exceed the cost of litigating the case in court,” Burnham says. “So again, it seems to me [that lawyers] have an obligation to prove to me how much it would cost to defend this in Montana. But they don’t do that.”
CHAMBER WRITES BACK
The U.S. Chamber of Commerce’s Institute for Legal Reform responded to the Public Citizen report in April with its own, “Arbitration—A Good Deal for Consumers: A Response to Public Citizen.” The report, which disputes the Public Citizen findings with arbitration studies, cites a 2005 Ernst & Young survey of consumer lending participants that found 69 percent of respondents were either “satisfied” or “very satisfied” with the arbitration process. The report criticizes the Public Citizen study for focusing only on one arbitration business, the National Arbitration Forum, and ignoring others, such as the American Arbitration Association and JAMS.
Ultimately, it could be lawyers who benefit the most from the arbitrations.
“If the consumer is not going to pay the arbitration award, you have to take them to court anyway,” says Chicago attorney Robert G. Markoff, president of the National Association of Retail Collection Attorneys and a partner at Baker, Miller, Markoff & Krasny. “If you just filed in court, most of the time the consumer who owes money either doesn’t show up or enters into an agreement.”
Philadelphia attorney Kaplinsky says, “I think it’s a question of cost,” mentioning a credit card client that tried debt collection arbitration and eventually decided the process did not save money.
“The collection costs were just as high if not higher than going through court,” Kaplinsky says.
