Foreclosing Mandatory Arbitration:
Understanding the CFPB’s Prohibition
Mandatory Arbitration and
Consumer Credit Agreements
The inclusion of mandatory arbitration
clauses in consumer financial product
agreements is very common. Under the
clauses, all disputes between a consumer and a bank must be settled through
arbitration, without resort to a court
of law. A typical arbitration clause will
include the following language:
Any controversy or claim arising out
of or relating to this contract, or the
breach thereof, shall be settled by arbitration administered by the American Arbitration Association under
its Commercial Arbitration Rules.
The number of arbitrators shall be
three. The place of arbitration shall be
[City], [State]. [State] law shall apply. Judgment on the award rendered
by the arbitrators may be entered in
any count having jurisdiction thereof.
From a bank’s perspective, arbitra-
tion offers several advantages, including
preventing the possibility of class ac-
tion litigation. As noted in the example,
arbitration clauses typically specify
the arbitration institution and the
procedural rules of that institution to
be used in the event of arbitration. Un-
like in a court of law, disputes in most
arbitration procedures must be heard
individually, and separate claims cannot
be consolidated. Class action litigation
against mortgage lenders rose dramati-
cally in the years leading up to and fol-
lowing the recent housing market crash.
Even if a claim is unsuccessful, defend-
ing against such an action can prove
to be costly, both monetarily and to an
institution’s reputation since these cases
often receive public attention.
Arbitration further reduces legal
costs. Under most arbitration pro-
cedural rules the consumer is on the
hook for part, if not all, of the bank’s
attorneys’ fees if the consumer’s claim
fails. While a bank typically is able
to add its attorneys’ fees to a foreclo-
sure action, it is highly unlikely that a
court would award fees to the bank in
the event of a consumer bringing an
unsuccessful claim against the bank.
The arbitration process also is much
quicker. The rules of arbitration make
it easier to prove a case than it would
be to do so in court. They also make it
easier to expedite the discovery process,
which in turn makes it more difficult
for a consumer’s attorney to drag out
the foreclosure process.
Hostility to Arbitration
Before the CFPB’s rule, opposition to
using mandatory arbitration in con-
sumer mortgages was brewing in state
and federal courts for at least a decade
and heated up after the mortgage crash
of 2008. Although the Federal Arbitra-
tion Act generally requires courts to en-
force arbitration agreements according
to their terms, some courts, nonetheless,
have refused to enforce mandatory
arbitration provisions in consumer fi-
nancial products, instead holding them
to be unconscionable (that is, extremely
unfair or one-sided). In fact, some states
already had prohibited such clauses in
mortgage agreements before the CFPB
rule even came down.
Consumer groups and opponents
to mandatory arbitration provisions
argue that such provisions are unfair
to consumers, who must pay their own
filing costs, which are significantly
higher in arbitration than typical court
filing fees, in addition to the bank’s
attorneys’ fees if they lose. Arbitration
also restricts the defenses available to
a consumer fighting a foreclosure action. Moreover, precluding class action
litigation leaves consumers unlikely to
pursue potentially legitimate claims for
regulatory violations since the amount
at stake makes the pursuit of individual
claims financially unfeasible.
In the mortgage arena specifically,
regulators long preferred the court process compared to nonjudicial foreclosure.
They often view arbitration provisions
as taking away consumers’ access to the
court system and forcing consumers
into a system that is unfavorable to their
interests. Some states prohibit any nonjudicial foreclosure.
The CFPB’s Prohibition
The CFPB’s rule amended TILA to
provide that a contract or other agreement for a consumer credit transaction secured by a dwelling (including
HELOCs) cannot include terms that
require arbitration or any other nonju-
IN JANUARY 2013, the Consumer Financial Protection Bureau (CFPB) issued its final rule amending the Truth in Lending Act (TILA). Among other things, the rule, which took effect in June 2013, prohibits mandatory arbitration clauses in residential mortgage loans or home equity lines of
credit (HELOCs). Mandatory arbitration clauses are commonplace in many
consumer financial product agreements. So they can plan accordingly, banks
need to understand the roots of their prohibition and their potential implications
for arbitration clauses in nonmortgage-related products.
