The U.S. Court of Appeals for the Fourth Circuit held that a creditor’s arbitration agreement contained unenforceable choice of law provisions rendering the entire agreement unenforceable.

Accordingly, the Fourth Circuit affirmed the trial court’s order denying the creditor’s motion to compel arbitration.

A copy of the opinion in James Dillon v. BMO Harris Bank, N.A. is available at: Link to Opinion.

The borrower applied for and received a “payday loan” through the lender’s website. The lender was wholly owned by a Native American tribe.

To complete the loan transaction, the borrower was required to sign an agreement containing a choice of law provision stating that tribal law would apply, and that “no other state or federal law or regulation shall apply.” The agreement further provided that any dispute would be resolved by arbitration in accordance with tribal law.

The borrower subsequently filed a putative class action complaint alleging that the lender and other tribal payday lenders had issued unlawful loans. However, instead of directly suing the lender, the borrower sued the financial institutions that facilitated the payday lending transactions over the ACH Network, including the defendant bank.

In the trial court, the bank sought to compel arbitration under the agreement. Relying on the Fourth Circuit’s ruling in Hayes v. Delbert Services Corp., 811 F.3d 666 (4th Cir. 2016), the trial court concluded that the agreement was unenforceable, and denied the bank’s motion to compel arbitration.

On appeal, the bank argued that the agreement did not implicate the prospective waiver doctrine, and should be enforced because the borrower failed to show that the choice of law provision would actually deprive him of any federal remedies. Moreover, the bank argued that any ambiguities that may arise in application of the choice of law provision should be resolved by the arbitrator in the first instance.

The borrower argued that the prospective waiver issue was ripe for review because there was no uncertainty regarding the effect of the choice of law provision as that provision effects an unambiguous and categorical waiver of federal statutory rights. Therefore, the borrower argued that the choice of law provision was unenforceable under the Hayes decision.

Initially, you may recall that arbitration agreements are “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2. However, arbitration agreements that operate “as a prospective waiver of a party’s right to pursue statutory remedies” are not enforceable because they are in violation of public policy.

Under the “prospective waiver” doctrine, courts will not enforce an arbitration agreement if doing so would prevent a litigant from vindicating federal substantive statutory rights.

In siding with the borrower, the Fourth Circuit noted that the agreement contained many of the same choice of law provisions it held were unenforceable in Hayes. In fact, the Court noted that the language related to the agreement to arbitrate was identical apart from the name of the designated tribe.

Thus, the Fourth Circuit held that “the above provisions in [this agreement] are not distinguishable in substance from the related provisions in the [agreement] that we held unenforceable in Hayes.”

Further, the Court held that “[t]he arbitration agreement in this case implicitly accomplishes what the [agreement in the Hayes case] explicitly stated, namely, that the arbitrator shall not allow for the application of any law other than tribal law.” Thus, “[j]ust as we did in Hayes, we interpret these terms in the arbitration agreement as an unambiguous attempt to apply tribal law to the exclusion of federal and state law.”

The bank next argued in the alternative that the Court could “effectively sever the choice of law provisions from the arbitration agreement, and accept [the bank’s] concession to the application of federal substantive law in arbitration notwithstanding the unambiguous choice of tribal law in the arbitration agreement.”

The Fourth Circuit disagreed, noting that the bank “seeks to rewrite the unenforceable foreign choice of law provision in order to save the remainder of the arbitration agreement.” However, “[b]ecause these choice of law provisions were essential to the purpose of the arbitration agreement, [the bank’s] consent to application of federal law would defeat the purpose of the arbitration agreement in its entirety.”

Accordingly, the Fourth Circuit held that the entire arbitration agreement was unenforceable, and affirmed the ruling of the trial court.