On May 5, the Consumer Financial Protection Bureau (CFPB) released its long-awaited proposed rule (Proposed Rule) on the use of arbitration clauses by consumer financial services companies in their customer contracts that restrict a customer’s ability to file or join a class action lawsuit. The Proposed Rule will be open for comment for 90 days after the date it is published in the Federal Register.

Section 1028(a) of the Dodd-Frank Act required the CFPB to study the use of the mandatory arbitration clauses in consumer financial markets. The CFPB released its study early last year and later introduced an outline of proposed restrictions on mandatory arbitration. The study’s results and the outline left little doubt that the CFPB intended to act aggressively to limit the use of arbitration clauses with class action waivers in financial consumer agreements, and in that respect, the Proposed Rule does not disappoint.

The Proposed Rule would enact the following:

  • Prohibit providers of “covered consumer financial products and services,” such as credit cards, deposit accounts, other consumer loans, and automobile loans from using an agreement with a consumer that provides for arbitration of any future dispute between the parties and bars the consumer from filing or participating in a class action. Excluded are transactions subject to FINRA arbitration.
  • Require providers that participate in predispute arbitration to submit certain records to the CFPB (including the arbitrator’s judgment or award) so the CFPB can monitor arbitration proceedings and determine if further rulemaking is required.

The Proposed Rule would apply prospectively to agreements entered into 211 days after the final rules’ publication in the Federal Register.

The general ban on the use of mandatory arbitration as the sole remedy for most disputes arising under consumer financial product or services contracts is not unexpected. The CFPB touts the Proposed Rule as providing “a day in court for consumers,” having a “deterrent effect” on companies that fail to comply with the law out of concern of being subject to a class action, and having “increased transparency” through the mandatory submission of arbitration records to the CFPB. The CFPB has been openly and highly critical of mandatory arbitration clauses. In the news release accompanying the Proposed Rule, the CFPB calls mandatory arbitration clauses “contract gotcha[s]” through which “companies can sidestep the legal system, avoid accountability, and continue to pursue profitable practices that may violate the law and harm countless consumers.”

If (or perhaps more accurately, when) the Proposed Rule is finalized, it will almost assuredly result in significantly increased litigation and compliance costs for financial institutions and other providers of consumer financial products and services, and at least some of those costs will most likely be passed on to consumers. It has already been hailed as a victory by plaintiff class action lawyers, who predict a vast rise in class action filings. Significantly, however, although the Proposed Rule will eliminate the restriction on class action lawsuits that currently is standard in these customer agreements, nothing in them changes class certification standards. If certification is denied, individual matters may be sent to arbitration.

Fortunately for providers of consumer financial products and services, since the time that arbitration clauses were first introduced as part of consumer agreements, there have been a number of important legal changes that help providers weed out meritless class actions, including, among others, the Class Action Fairness Act (which allows most large class actions to be litigated in federal court), heightened pleading requirements at the outset of the case, and various cases interpreting Rule 23 of the Federal Rules of Civil Procedure. In turn, it will be incumbent on financial institutions and other providers to leverage these tools in mounting a vigorous defense to the anticipated wave of class action defenses.

In addition, the Proposed Rule does not affect the requirement that state attorneys general be notified of proposed class action settlements and have an opportunity to intervene in the settlement under the Class Action Fairness Act before any proposed class action settlement is finally approved. Thus, there will be a watchdog to ensure that settlements really do benefit consumers and not merely contingent fee plaintiffs’ lawyers.

We expect a good deal of industry input to emerge on the scope of “covered consumer financial products and services” as well as the type of information required to be submitted to the CFPB. Regardless of how these discussions play out, however, any final rule almost certainly will contain a broad prohibition on the use of mandatory arbitration clauses in consumer financial product and services agreements.