Borrowers shouldn’t be denied access to what many consumer advocates consider a powerful legal remedy — class action lawsuits — when they sign contracts that include mandatory arbitration clauses that are popular with lenders.
That’s the thrust of new regulations proposed by the Consumer Financial Protection Bureau, which also wants to monitor claims, awards, and related materials that are filed in arbitration cases to ensure the arbitration process is fair to consumers.
If enacted, the proposed regulations would still allow companies offering consumer financial products and services, including private student loans, to include arbitration clauses in their contracts. While lenders could still require that individual complaints be handled through arbitration, they could not bar consumers from bringing or joining group claims in the form of class action lawsuits.
A 2015 study published by the bureau to lay the groundwork for the proposed regulations concluded that class action lawsuits can motivate companies to address problematic practices. During the five-year period studied, class action lawsuits generated $2.7 billion in settlements on behalf of 160 million consumers.
“Many banks and financial companies avoid accountability by putting arbitration clauses in their contracts that block groups of their customers from suing them,” CFPB Director Richard Cordray said in announcing the proposed rule change. “Our proposal seeks comment on whether to ban this contract gotcha that effectively denies groups of consumers the right to seek justice and relief for wrongdoing.”
Groups representing lenders and other businesses have criticized the proposal, saying arbitration has worked well for consumers and that the rule will create additional expenses that will raise costs for consumers.
The Consumer Bankers Association — which represents lenders holding 65 percent of all bank, thrift and credit union assets — issued a statement claiming that the CFPB’s own study demonstrates arbitration is a quicker and lower-cost solution for consumers that produces higher recoveries for individuals ($5,389 versus the average recovery of $32.35 in a class action suit).
In an opinion piece published by JD Supra, attorneys with Atlanta-based Alston & Bird said they expect the CFPB to press forward with the new regulation, and that the industry will challenge it in court.
The CFPB will take public comments on the proposed regulations and is expected to take action after the 90-day comment period ends.
Regardless of the outcome of CFPB’s push impose new regulations on mandatory arbitration clauses, it’s a good opportunity for anybody who might be subject to one to learn more about how they work.
Arbitration is a process to resolve disputes using non-judicial, neutral third parties who make final and binding decisions. The common justification for arbitration is that it is believed to be speedier and less costly than court action. Business groups tend to back arbitration as a means of dispute resolution, whereas consumer groups argue that the third parties conducting the process are frequently not neutral, but rather have a bias toward business interests.
Pre-dispute arbitration clauses
Many standard contracts and credit agreements contain pre-dispute arbitration clauses, often buried in fine print, that require arbitration as the sole means of dispute resolution. These clauses appear routinely in agreements for credit cards, mortgages, automobile loans and private student loans, as well as for other financial products and services. When you sign an agreement containing arbitration clauses for, say, a private student loan, you are agreeing to forfeit your right to sue the lender in court, and to accept the judgement of an arbitration panel to resolve disputes.
The CFPB proposal
The CFPB proposal would not affect the ability of a financial product or service provider to include and enforce arbitration clauses in their contracts as a means to prevent private, individual lawsuits from disgruntled consumers. However, the CFPB’s proposal would allow consumers to band together and file class-action suits in court against providers despite the presence of arbitration clauses in contracts. The proposal would also force providers to insert new language in their contracts that acknowledges the right of consumers to pursue class-action lawsuits in order to seek relief.
CFPB arbitration study
Pursuant to a Congressional mandate contained in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, the CFPB in 2012 undertook a study of arbitration clauses found in a number of product markets, including the one for private student loans. The March, 2015 study included the following findings:
- A large number of consumers are affected by arbitration agreements, including half of all consumers with checking accounts or credit cards.
- About 75 percent of surveyed consumers were unaware of the arbitration clauses.
- In general, consumers are reluctant to pursue claims against companies by themselves, especially small claims.
- Each year, an average of about 32 million consumers are eligible for relief through financial class action settlements.
- The CFPB could not find evidence to confirm that arbitration clauses reduce prices for consumer goods and services.
The student loan market
The market for student loans is dominated by federal programs, including the Direct and Perkins Loan Programs. According to the Consumer Bankers Association, 91 percent of student and parent loans, comprising about $100 billion a year, are federally issued, whereas 9 percent are privately disbursed by banks and other lenders. About $91 billion of the $1.2 trillion in outstanding student loans are private. The CBA notes that private student lenders “can frequently offer a lower interest rate than the federal government, especially when the borrower has a strong credit profile or has a cosigner.”
Use of arbitration clauses in student loan agreements
The 2015 CFPB study sampled seven student loan contracts, one from each of the six largest private student loan providers plus a standard contract used by 250 credit unions. The Bureau did not gather information about contracts from smaller providers. The study found that six of the seven (85.7 percent) contracts contained an arbitration clause. By way of contrast, federal Direct Loans and Perkins Loans do not contain an arbitration clause.
The CFPB study found that 83.3 percent of private student loan arbitration clauses provide opt-out language, which allows a consumer to reject the arbitration clause within a specified time period (generally 30 or 60 days). Normally, you have to send a letter and sign a request form to exercise your right to opt-out.
Scope of arbitration clauses
The Bureau found that most arbitration clauses applied to all disputes between the lender and consumer. As long as either party invokes the clause, the dispute must go to arbitration rather than the courts. However, 83 percent of private student loan arbitration clauses granted a small-claims “carve-out” allowing certain small disputes to be pursued in small claims court. Although consumers don’t need the carve-out to file a claim in small claims court, the carve-out allows it even if the other party objects.
All the private student loan arbitration clauses specifically prohibited class-arbitration proceedings. Furthermore, a third of the clauses banned class-action lawsuits even in cases not subject to arbitration. Only one of the seven contracts placed a limitation on the amount of damage available through arbitration.
Types of disputes
According to Nolo.com, the kinds of disputes you might have with a private student loan provider, servicer or debt collector that would cause you to seek arbitration or action in small claims court typically involve unfair or incompetent servicing practices. Less frequently, you might want to institute a private or class-action lawsuit in cases involving fraud.
Federal student loans offer borrower benefits, including access to deferment, forbearance, and income-driven repayment programs, and the potential for loan forgiveness after 10, 20 or 25 years of payments that are typically not available from private student loan providers. In some cases, you may be at the mercy of the private providers should you lose your job, experience a medical problem or otherwise find yourself in financial distress.
According to the Consumer Bankers Association, “It is in the lender’s best interest to do everything in their power to help borrowers repay their loans, including extending grace periods and modifying loans.”
You should check your contract to find out whether your lender has some criteria for deferring or modifying loans, although there is no guarantee that your lender will agree to a new arrangement. You therefore might want to pursue arbitration if you find yourself unable to repay your loan and your provider is unwilling to consider or agree to a modification.
With government and private student loans alike, disputes can arise over the handling of payments, including:
- Losing your checks or other forms of payment, and then charging you a late fee
- Applying extra payments that you make to pay down your loan principal in a way that maximizes your interest charges, such as applying the payments to interest and principal, rather than to principal alone
- Processing partial payments in a way that maximizes late fees
- Providing incorrect information when you want to pay off your loan early
- Not being informed when your loan account is transferred to a new servicer, resulting in misdirected payments, frustration, and possible late fees or delinquency
By the way, the CFPB has a Student Loan Ombudsman specifically tasked to help borrowers with complaints. The ombudsman can’t guarantee results, but usually can get the lender to respond to your problem. You can submit a complaint about a private student loan or about the servicer that collects payments on your federal student loan here.
Why you might prefer court over arbitration
According to Public Citizen, a non-profit watchdog group, you might prefer to go to court to resolve a dispute with a private student loan provider (assuming you had that right) for a few reasons:
- You might feel the playing field is stacked against you. While judges are accountable to higher courts and to the public, arbitrators are accountable to the market. As they are usually business executives or corporate lawyers, they may have little empathy for the consumer.
- Contrary to the perceived wisdom, arbitration can be more expensive than going to court. Arbitration comes with high fees, whereas some lawyers are willing to pursue class action suits on a contingency basis, meaning that if you lose the case, you owe the lawyer nothing.
- If the arbitration goes against you, you may have no recourse to appeal.
- Arbitration clauses may impose limits on the amount you can collect, limits that don’t exist in class action lawsuits.
- Arbitrators often split the difference between the claims of the opposing parties, and thus tend to award smaller amounts than do judges and juries.
Rights federal student loan borrowers give up
Generally, when you take out a federal student loan and then refuse to make the payments, the government can take a number of actions without first getting a court order, including:
- Garnishing up to 15 percent of your disposable pay
- Offsetting up to 15 percent of your Social Security payments for retirement or disability
- Intercepting your federal or state income tax refunds
- Intercepting state lottery winnings
- Charging you up to 20 percent of each payment for collection fees
- Preventing the renewal of a professional license
- Banning you from receiving FHA and VA mortgages
- Banning you from further federal student aid
- Banning you from enlisting in the armed forces
- Revoking deferment and forbearance options
- Reporting your delinquency to the major credit bureaus, potentially cratering your credit rating
- These actions are generally not available to private lenders, who require a court order before they can garnish your earnings.
Pushback from business groups
Critics of the CFPB’s proposed regulations include the U.S. Chamber of Commerce, which called the proposal “the biggest gift to plaintiff lawyers in a half century.” The Chamber takes the position that the proposal will eliminate arbitration for most consumers, making no distinction between compulsory and voluntary arbitration.
The American Financial Services Association contends that the CFPB arbitration study shows that consumers are better served by arbitration agreements and that 60 percent of class action suits studied by the CFPB resulted in no money for the plaintiffs.
The American Bankers Association characterized arbitration an “efficient, fair and low-cost method of resolving disputes.”
The Consumer Bankers Association alleged that the CFPB’s “pre-baked” proposal is “political rather than substantive.”
Attorneys with Atlanta-based Alston & Bird said that because the “underlying data in the CFPB study is controversial and lends itself to other conclusions, it seems likely that there will be significant judicial challenges to the rule.”
While the lending industry was expecting the CFPB would seek such a rule change, the proposal it’s put forward “represents the conclusion of the preliminary rounds. Now the main event begins.”
Eric Bank writes about small business, personal finance and science. He holds a master’s of science in finance from DePaul University and an MBA from New York University.