During the past decade, banks and other financial institutions have increasingly included arbitration clauses in many of their agreements, including loan agreements, mortgages, retail installment sales agreements and lease agreements. Certainly, there are a number of reasons for this, including the perception that the arbitration forum is a more efficient and less costly forum to resolve claims.
Another significant benefit that an institution may enjoy from the inclusion of an arbitration clause in their agreements is that it may act as an insurmountable defense to a disgruntled customer's attempt to obtain class certification of any claims that the customer may assert against the institution. Of course, banks and other financial institutions have a substantial incentive to avoid having class actions maintained against them. In New Jersey, courts have been liberal in granting class certification, particularly where the claims asserted are based upon standard form agreements. While the amount at issue on plaintiff's individual claims are frequently quite small, and vary from several dollars to several hundred dollars, when those claims are aggregated amongst a large group, the potential exposure to the financial institution can no doubt be tremendous. Further, the granting of class certification of a large class of claimants, perhaps residing in many states throughout the country, may have a chilling effect on future business operations of a financial institution. Thus, many financial institutions opt to settle class actions at an early stage and perhaps pay a relatively substantial amount of attorney's fees to class counsel rather than face potentially devastating judgment -- even when they think the claims have little merit. Also, by doing so, the institutions will save significant legal expenses since consumer class actions are extremely expensive to defend.
One defense in the arsenal of a financial institution is the inclusion of an arbitration clause in the form agreement at issue. The insertion of these arbitration clauses in form agreements has succeeded in preventing many cases from proceeding as class actions although we hasten to note that the use of arbitration clauses has also sparked substantial litigation throughout the country as plaintiffs and class action lawyers have sought to invalidate the arbitration clauses on a number of grounds. Admittedly, the results nationwide of these attempts have been mixed, but many courts have held that the arbitration clauses are enforceable and have dismissed proposed class actions from the court system.
A New Jersey Appellate Court has recently held that a properly drafted arbitration clause will serve as a bar to prosecuting a class actions in the court system. In Gras v. Associates First Capital Corp., 346 N.J. Super 41 (App. Div. 2001), the Court was faced with several loan agreements between plaintiffs and defendant, that each included an arbitration agreement.
The arbitration provision read:
[t]his agreement applies to all claims and disputes between [plaintiffs] and [Associates]. This includes, without limitation, all claims and disputes arising out of, in connection with, or relating to:
- Your loan with us today;
- Any previous loan from us and any previous retail installment sales contract or loan assigned to us;
- All the documents relating to this or any previous loan or retail installment sales contract;
- Any insurance purchased in connection with this or any previous loan or retail installment sales contract; . . . .
- Any claim or dispute based on a federal or state statute;
The arbitration agreements also specifically prohibited class action arbitration.
The existence of the arbitration provision notwithstanding, plaintiffs brought suit in connection with credit life insurance that they purchased. Through class counsel, plaintiffs alleged, among other things, that defendants were liable under New Jersey's Consumer Fraud Act. The defendants filed a demand for arbitration and, after plaintiffs sought to strike the arbitration demand, filed a motion to stay the trial court action pending arbitration.
Plaintiffs opposed the effort to move the claims into arbitration by arguing that the arbitration agreements were unenforceable because (1) they unconscionably deprived plaintiffs of their right to proceed as a class action, and (2) plaintiffs had not knowingly and voluntarily agreed to arbitrate their Consumer Fraud Act claims. The trial court rejected both arguments and stayed the matter pending arbitration. The Appellate Division affirmed and held that plaintiffs had no statutory right under the Consumer Fraud Act to seek class certification and that the public policy interests that supported the maintenance of class actions did not override the policy favoring the enforcement of arbitration clauses. In addition, the Appellate Division also held that plaintiffs' agreement to arbitrate had been knowing and voluntary. Thus, the current landscape in New Jersey would appear to be favorable to the enforceability of an arbitration provision in a consumer agreement.
However, despite this pro-arbitration ruling, there are a number of potential pitfalls that a lender must avoid when drafting an arbitration clause. Some of these pitfalls and ways to avoid them are set forth below.
New Jersey courts have not addressed in a published opinion the question of whether a class-wide arbitration may be held if the arbitration agreement does not specifically prohibit it. Courts from other states are split on the issue, some have ordered class-wide arbitration, other courts have refused to order class-wide arbitration. The United States Supreme Court is scheduled to decide the issue this term in Greentree v. Bazzle. That case is on appeal from the holding of the South Carolina Supreme Court that class-wide arbitration was required where the arbitration clause that the lender drafted did not explicitly state that there could be no class-wide arbitration. The theory behind the South Carolina Supreme Court's ruling was that the lender had the opportunity to specifically bar class actions and failed to do so. The Bazzle case is also expected to have important things to say about the argument made in many cases that the prohibition on class treatment is unconscionable. One clear lesson is that the arbitration provision should expressly prohibit the institutions and prosecution of a class action in the arbitration forum.
The New Jersey Appellate Division in Gras said that an arbitration clause that merely provides that all claims will be subject to arbitration does not constitute a knowing and voluntary waiver of the right to bring federal and state statutory claims before a court. Although an arbitration clause need not list all statutory claims that will be subject to arbitration, the clause should, at a minimum, state that all matters in dispute -- including federal and state statutory claims -- are arbitrable.
The New Jersey Supreme Court has not issued any published opinion about whether an arbitration clause that is first included in an "envelope stuffer" that is sent to the customer after the original agreement has been signed is binding on the customer. That issue is presently before the Appellate Division in Shea v. Discover Bank, which is on appeal from an unpublished holding of a trial court that the arbitration clause in the envelope stuffer was not enforceable. In general, our courts vigorously search the parties' transaction to make sure that a party's decision to forego access to the courts is knowing and voluntary. For example, the New Jersey Supreme Court recently held that an arbitration clause contained in an employment manual was not enforceable where the employee had not signed the manual or specifically agreed to the arbitration. Also, last December the Appellate Division in Paul v. Timco, 336 N.J. Super. 180 (App. Div. 2002) held that an arbitration agreement that was not in the customer's original automobile financing agreement, but was in an extended warranty service contract that was mailed to the customer after the financing transaction closed was not enforceable. These cases strongly suggest that New Jersey courts will not enforce arbitration agreements that are contained in envelope stuffers. Therefore, have the customer sign the document which included the arbitration provision.
Frequently, the arbitration agreements that are successfully challenged are those that try to do too much or that seek to reserve rights for the financial institution that are not afforded to the borrower. One particular concern of courts are arbitration clauses that would impose an undue share of the arbitration costs on the consumer. Another problem area is arbitration agreements that would require the arbitration to be held in a forum that is inconvenient to the customer. If your primary goal in drafting an arbitration agreement is to prevent class litigation, leave it at that. Minimize the "legalese" and write it in plain English.
The recently enacted New Jersey Home Ownership Security Act (the so-called "predatory lending" act) provides that a high cost mortgage loan agreement may not require a borrower to bring his claims in a more costly, less efficient forum than the courts. (An earlier version of the bill expressly prohibited arbitration although.) This statutory language would not seem to bar the use of arbitration clauses for high cost mortgage loans, but must include an "opt-out" option for the customer/borrower. Therefore, it is likely that courts will carefully scrutinize arbitration clauses in loans that meet the definition of a high-cost mortgage loan to determine if they comport with the statute.
We suggest that every financial institution analyze whether it wishes to try to adjudicate certain claims in an arbitration forum rather than a judicial one. If it does, then the agreements which will include an arbitration provision should be carefully drafted to meet statutory and case law criteria for enforceability.