On July 10, 2017, the Consumer Financial Protection Bureau (CFPB) released its long-awaited and controversial final rule on arbitration agreements in contracts for financial products and services. The rule, which takes effect 60 days after its release and requires compliance with its terms 180 days after that, prohibits certain financial services companies from relying on arbitration clauses to block class action lawsuits. It will effectively open up the gates to more class action lawsuits relating to consumer financial products such as credit cards and checking accounts, and will have a significant impact on the financial services industry.
This alert includes a brief history of how the rule developed, a summary of its key provisions, concerns about the rule expressed by the financial industry, potential challenges to the rule, as well as ways Stinson Leonard Street can help your company be prepared for the rule's implementation.
History and Overview
In the Dodd-Frank Act of 2010, Congress mandated that the CFPB conduct a study on consumer finance companies' implementation of arbitration clauses. If the study identified areas where rulemaking could serve the interest of consumers, Dodd-Frank authorized the CFPB to issue regulations restricting or prohibiting the use of arbitration agreements. The CFPB released an arbitration study in March 2015, which concluded that the widespread use of arbitration agreements in the financial industry has kept consumers from seeking meaningful relief for legal violations.
After releasing the study, the CFPB issued the initial proposed rule on May 3, 2016 and requested public comments on the proposal. Despite taking a year to consider the voluminous comments before issuing the final rule, it does not differ significantly from the proposed rule.
The final rule applies to providers of certain consumer financial products and services in the core consumer financial markets of lending money, storing money, and moving or exchanging money. It contains the following substantive limitations on the use of pre-dispute arbitration clauses by covered providers of consumer financial products and services:
- Prohibits providers from relying in any way on a pre-dispute arbitration agreement to block a class action lawsuit related to a covered financial product or service. This includes seeking a stay or dismissal of a claim or action, unless and until the court has ruled that the case may not proceed as a class action.
- Requires that pre-dispute arbitration agreements for a covered product or service contain the following provision explaining that the agreements cannot be invoked in class proceedings: "We agree that neither we nor anyone else will rely on this agreement to stop you from being part of a class action case in court. You may file a class action in court or you may be a member of a class action filed by someone else."
- Mandates the submission of certain arbitration records to the CFPB when an arbitration claim is filed with respect to a consumer that entered any pre-dispute arbitration agreement after the compliance date.
Note that the rule does not preclude covered entities from entering into arbitration agreements altogether, or from invoking such agreements to compel arbitration in order to resolve individual disputes. In addition, the rule only applies to arbitration agreements entered into after the rule's compliance date, which is 180 days after the effective date.
In addition to the potential legal challenges to the rule described below, there has been widespread criticism of the rule from an industry perspective. The following are some of the concerns that have been expressed:
- Industry representatives generally argue that pre-dispute arbitration represents a better, more cost-effective means of resolving disputes that serves consumers well.
- There has not been an empirical analysis conducted on consumer financial arbitration agreements and whether they serve the consumer's interest.
- The scope of the rule is broad, and could reach almost any business providing consumer financial products and services. Among those affected are banks, credit unions, credit card issuers, small-dollar or payday lenders, installment open-end lenders, entities that arrange for consumer loans, loan servicers, debt settlement firms, providers of consumer credit reports and scores, debt collectors, debt buyers and certain payment processors.
- The rule may disproportionately impact smaller banks and other small businesses, which are less capable of handling large litigation expenses. The rule could also impact small entities' ability to obtain insurance coverage for class action litigation defense costs, which is already expensive to maintain. Note, however, that the rule does exclude very small entities – those that provide financial products and services to 25 or fewer consumers per year – from application of the rule.
- The rule requires certain arbitral records be submitted to the CFPB and made public, including the initial arbitration claim, which could contain a number of allegations about the company that could be false. The fact that the bureau will publish some of the information on its website undermines the idea of arbitration, which is that it's a confidential process. Publication of this information could also lead to additional lawsuits by plaintiffs' attorneys.
Congress may take action under the Congressional Review Act to override the CFPB’s rule. It only takes a simple majority of Congress to override the rule, but the vote must occur within 60 legislative days of the final rule. If Congress overrides the rule, the CFPB will be prohibited from enacting a similar rule until Congress expressly provides the CFPB with authority to do so. Some Congressional Republicans have already signaled their intent to take action under the Congressional Review Act to override the rule.
Legal challenges to final rule
It is likely that there will be litigation challenging the CFPB’s actions. Although there are numerous possible grounds for challenging the CFPB’s final rule, the most likely will be based on whether the CFPB acted within the scope of its authority given to it by the Dodd-Frank Act in proposing and ultimately finalizing this rule. Specifically, while the Dodd-Frank Act authorizes the CFPB to issue regulations that "may prohibit or impose conditions or limitations on the use of" arbitration agreements, it only permits that action if the CFPB finds "that such a prohibition or imposition of conditions or limitations is in the public interest and for the protection of consumers." Further, Dodd-Frank expressly requires that the CFPB conduct a study of the use of arbitration agreements between providers and consumers, and that any findings made by the CFPB to support a proposed rule concerning arbitration agreements "shall be consistent with the study conducted."
In March 2015, the CFPB released a report on a study it conducted to evaluate the impact of arbitration provisions on consumers. The CFPB has relied on that study in justifying the proposals outlined in the current arbitration rule. However, despite the CFPB’s reliance on that study to justify its current rulemaking efforts, the study has been widely criticized as having relied on insufficient data, and ignoring certain information that would lead to conclusions at odds with the CFPB’s final rule.
In addition, there are other unanswered legal questions concerning how the final rule comports with the numerous U.S. Supreme Court cases that uphold class action waivers in arbitration agreements. Further, the United States Court of Appeals for the D.C. Circuit recently heard oral arguments in PHH Corporation, et al. v. The Consumer Financial Protection Bureau, in which one of the issues on appeal relates to the constitutionality of the CFPB's structure. If the full D.C. Circuit affirms the earlier panel decision that held the bureau’s structure to be unconstitutional, serious questions remain about the validity of any action taken by the CFPB up to that point, including enacting this rule.
Your First Steps Toward Compliance
Assuming Congress does not override the rule, the financial industry must be prepared for the rule’s implementation. To do so, institutions should begin an initial review of their consumer finance contracts to understand which contracts may be affected by the rule.
If a contract is subject to the rule, institutions need to consider options including: (i) preserving pre-dispute arbitration provisions on an individual basis, but eliminating class action waivers in those agreements, or (ii) maintaining the class action waiver and forgoing arbitration (assuming that such class action waivers are enforceable in the jurisdiction where the institution does business); or (iii) drafting a clause that complies with the rule, but contains a class action waiver that is enforceable if the rule is later enjoined or otherwise invalidated. Institutions should take care to ensure that only contracts that are subject to the rule are identified and changed – the rule does not apply to every contract that an institution may have.
Bottom line: If implemented, the final rule will have a significant impact on consumer finance agreements and will lead to additional consumer class actions against financial institutions. As such, financial institutions need to take steps now to begin to evaluate and mitigate their risks associated with this rule.