The Federal Arbitration Act (FAA) (9 USC 1-16) was initially passed in Its key provision is Section 2, which states in part:

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1 COMPULSORY ARBITRATION OF CONSUMER DISPUTES Published in the Fall 2001 edition of the Tulane Lawyer By Paul Barron, Professor of Law, Tulane Law School The Federal Arbitration Act (FAA) (9 USC 1-16) was initially passed in Its key provision is Section 2, which states in part: A written provision in a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract. Even though courts, including the Supreme Court, consistently reaffirmed the enforceability of arbitration clauses in contracts over the years, and articulated a federal policy favoring arbitration, consumer lenders rarely attempted to include arbitration clauses in their loan agreements. That changed in the late 1990s when lenders began routinely to insert an arbitration clause in their loan documents, requiring the parties to arbitrate any disputes that might arise from the transaction. One of the disputes that often arises in the context of consumer loans is an alleged violation of the Truth-in-Lending Act (TILA) (15 USC (b)). The TILA is essentially a federal statute that requires disclosure of various elements of the cost of credit to allow borrowers to make informed borrowing decisions. In addition to administrative enforcement, the TILA provides a private cause of action for actual damages and, in many cases, the right to recover a statutory penalty. Moreover, the TILA specifically authorizes class actions. Finally, the TILA provides for an award of attorney s fees to the prevailing plaintiff. The TILA litigation that has arisen over the last three years presents an interesting microcosm of the debate regarding the enforceability of arbitration clauses in the consumer context. Based on the arbitration clause in the loan documents, when borrowers file suit under the TILA, lenders, pursuant to Section 3 of the FAA, usually move to stay the proceedings and compel arbitration. Courts faced with such a motion generally confront three arguments raised by borrowers. The first is whether the arbitration clause itself is unconscionable. Unconscionability is a state law doctrine that allows a court to void a contract clause if it is outside the reasonable expectations of the parties (generally referred to as procedural unconscionability) and is overly harsh or one-sided (generally referred to as substantive unconscionability). Both procedural and substantive unconscionability must exist, to some extent, for the court to void the contract clause. Because the doctrine of unconscionability may be applied to any contract clause, not just an arbitration provision, unconscionability may be used under the language of Section 2 of the FAA to find the arbitration clause unenforceable. Obviously, the determination of whether a contract clause is unconscionable is factually intensive. A recent case, Gray v. Conseco, Inc., N0. SA CV DOC(EEX) (CD Cal. Sept. 29, 2000), 2000 WL , is a typical example of this factual

2 determination. In Gray, the courts reviewed the circumstances under which the loan contract was formed. Although the court determined that the loan document was a contract of adhesion, that is, it was a take-it or leave-it offer on the part of the lender, the court nonetheless found no unconscionability. Moreover, in Gray, the obligation to arbitrate was only binding on the borrower with the lender having the right to file suit in court for a borrower s breach. The second argument often raised by borrowers is whether arbitration is an adequate forum in which to vindicate TILA rights. The borrower s argument is essentially that, in the context of a consumer transaction, arbitration is unfair because the costs involved in arbitration, as opposed to low cost access to courts, make the forum inaccessible to the consumer. In many cases, arbitration clauses provide that the arbitration will be carried out under the auspices of an administering body (examples of these are the American Arbitration Association, the Center for Public Resources Inc., and the National Arbitration Forum), and that the rules of the administrating body will apply. Generally, the administrating body charges an administrative fee to handle the case, and under most arbitration rules, the parties split the cost of the arbitrator. The administrative fee is commonly calculated, based on the size of the claim. Commercial arbitrators fees are generally between $1,000 and $2,000 per day. Since these fees and costs can be substantial, the borrowers argue that cost of arbitration, as a practical matter, limits their ability to gain relief for TILA violations. Three federal circuit courts have addressed this issue. The first was Randolph v. Green Tree Financial Corp.-Alabama, 178 F. 3d 1149 (11th Cir. 1999). In Randolph, the Eleventh Circuit concluded that the arbitration clause in the loan contract was unenforceable as to a TILA claim because of the potential costs involved in the arbitration process. The court stated: [W]e conclude that the arbitration clause in this case is unenforceable, because it fails to provide the minimum guarantees to ensure that Randolph s ability to vindicate her statutory rights will not be undone by steep filing fees, steep arbitrators fees, or other high costs of arbitration. Id. at The Eighth Circuit, in Dobbins v. Hawk s Enterprises, 198 F. 3d 715 (8th Cir. 1999), came to a contrary conclusion. In Dobbins the district court had held that the arbitration clause was unenforceable because of the high administrative fee charged by the American Arbitration Association ($23,000) and the plaintiff s inability to pay. The circuit court reversed and remanded noting that these determinations needed to be made on a case-by-case basis. The court first pointed out that the administrative fee was high because the borrower s damage claim was grossly inflated (the plaintiff had sued for $50 million), and that the borrower had not fully explored the fee waiver possibility under the American Arbitration Association rules. The court further stated that if, after the borrower has lowered her demand to a reasonable amount and the waiver possibility is explored, the district court still found the fee beyond the plaintiff s means, it should accept the lender s offer, made at the oral argument, to pay the arbitration fee. The Sixth Circuit, in Stout v. Byrider, 228 F. 3d 709 (6th Cir. 2000), agreed with Dobbins. The court noted that the arbitration clause in Stout, different from the one in Randolph,

3 clearly specif[ied] the established organization [the American Arbitration Association] whose rules will govern the arbitration. Id. at 715. It was in the context of these three circuit court decisions that the Supreme Court reviewed the Eleventh Circuit s decision in Randolph, in Green Tree Financial Corp.- Alabama v. Randolph, 531 U.S. 79 (2000). The majority, made up of Justices Rehnquist (writing the opinion), O Connor, Scalia, Kennedy and Thomas, started with the view that arbitration of statutory rights was favored. The only substantive issue the majority addressed was the circuit court s conclusion that the arbitration clause was per se unenforceable because it contained no allocation of arbitration costs or fees. The majority, reversing the Eleventh Circuit, held that it was not unenforceable. Importantly, the majority did not articulate a per se rule validating arbitration of TILA claims in every case. The Court stated: It may well be that the existence of large arbitration costs could preclude a litigant such as Randolph from effectively vindicating her federal statutory rights in the arbitral forum. Id. at 90. Yet the Court chose not to remand the case for further inquiry as to the likely amount of the arbitration fees and how much of those fees the borrower would be obligated to pay. Finding that the borrower had the burden of showing that the amount of the fees precluded her from vindicating her rights and that she failed to do so, the Court simply reversed the lower court s decision. As a result, the Court stated: How detailed the showing of prohibitive expense must be before the party seeking arbitration must come forward contrary evidence is a matter we need not discuss. Id. at 92. In a dissent filed by Justices Ginsberg (writing the opinion), Stevens, Souter and Breyer, the dissenting justices concluded that the issue should have been remanded for a determination of what fees the borrower would be obligated to pay. In the view of the dissenting justices, at that point a determination could be made as to whether the costs involved made the arbitral forum inaccessible. The dissent stated: As a repeat player in the arbitration required by its form contract, Green Tree has superior information about the cost to consumers of pursuing arbitration. In these circumstances, it is hardly clear that Randolph should bear the burden of demonstrating up front the arbitral forum s inaccessibility, or that she should be required to submit to arbitration without knowing how much it will cost her. Id. at 96. The third argument generally raised by borrowers is whether Congress had evinced an intention to preclude waiver of judicial remedies for TILA disputes. Although, as noted above, the TILA provides for state or federal court resolution of private actions by borrowers alleging violations of the Act, there is nothing that expressly precludes the use of arbitration to resolve the dispute. Here, the argument of borrowers focuses on the fact that the TILA permits class actions and that class actions are not available in arbitration unless expressly provided for in the contract. Two federal circuit courts have addressed this argument. The Third Circuit s opinion in Johnson v. West Suburban Bank, 225 F. 3d 366 (3d Cir. 2000), is detailed and comprehensive. In Johnson, the court noted that Congress intention to preclude the waiver of judicial remedies for the statutory rights found in the TILA must be found in

4 the text, legislative history, or in an inherent conflict between arbitration and the statute s underlying purposes. Id. at 371. This test comes from the Supreme Court s decision in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 26 (1991), in which the Court held that an employee was bound to arbitrate his statutory claim under the Age Discrimination in Employment Act (ADEA). The court, in Johnson, looked first at the statutory language and found nothing that expressly precluded arbitration. The court noted that, although the statute clearly contemplated class actions, it did not provide a right to such actions. That right, according to the court, arises from Rule 23 of the Federal Rules of Civil Procedure, not the TILA. It then looked to see if the legislative history evinced a congressional intention to preclude a waiver of the judicial forum. The court found that although there was some legislative history that suggested Congress viewed class actions as a useful enforcement tool under the TILA, there was no clear intent shown to preclude arbitration to insure the ability to bring a class action. Finally, the court turned to the issue of inherent conflict between arbitration and the public policy goals of the TILA. In brief, the court noted that the borrower s argument was that the TILA s purpose was not remedial, but was to deter unfair credit practices. As a result, the borrower argued, class actions are crucial to provide effective deterrence. The Third Circuit, while stating that this argument carried force, ultimately found it to be unpersuasive. First, according to the court, the existence of the statutory penalty and the provision for attorney s fees to a successful claimant means borrowers will bring the necessary private actions to insure the deterrence goal of the statute would be met. Second, the court noted that the TILA also provides for administrative enforcement that can be used to further deter unfair credit practices. Finally, the court concluded that Supreme Court s decision in Gilmer made clear that there was no unwaivable right to bring a class action. The court noted that the statute involved in Gilmer, the ADEA actually provides for collective litigation by employees, and yet the Supreme Court held that an arbitration provision was enforceable. The Eleventh Circuit also came to the conclusion that requiring a borrower to resolve a TILA dispute through arbitration is not incompatible with the existence of the right to bring a class action under the TILA. In Bowen v. First Family Financial Services Inc., 233 F. 3d 1331 (11th Cir. 2000), the court did not reach the issue of whether an agreement to arbitrate is unenforceable with respect to TILA claims on the ground that there is an inherent conflict between arbitration and the underlying purposes of the TILA. This was because that broad issue was not properly raised below. The court, however, agreed with the Third Circuit in Johnson that Congress did not create a non-waivable right to pursue TILA claims in a judicial forum, either individually or through a class action. Id. at In addition, although the Supreme Court did not address the class action argument in Green Tree because that issue had not been decided below, when Green Tree was remanded back to the Eleventh Circuit, that court stated:

5 Giving full weight to the congressional policy embodied in the FAA, we hold that a contractual provision to arbitrate TILA claims is enforceable even if it precludes a plaintiff from utilizing class action procedures in vindicating statutory rights under TILA. Randolph v. Green Tree Financial Corp. Alabama, 244 F. 3d 814, 819 (11th Cir. 2001). Based on these cases, there seems little doubt that if the arbitration clause is properly drafted and is made conspicuous to the consumer, it will be enforced in TILA cases. Certainly, a properly drafted arbitration clause will make clear the costs that the consumer must incur to use the arbitration process. The teaching of Green Tree strongly suggests that those costs borne by the consumer, if any, must be modest. Further, while courts certainly have approved arbitration clauses that require only the consumer to arbitrate disputes under the loan agreement, the greater the mutuality, the less likely the clause will be challenged. Finally, the arbitration clause must be clear that the arbitrator has the power to grant the same remedies, including awarding attorney s fees, as would a court. These cases also strongly suggest that the courts will enforce properly drawn arbitration clauses in actions for violations, in loan transactions, of similar consumer protection statutes like the Real Estate Settlement Procedures Act and The Equal Credit Opportunity Act even though they, too, have a provision expressly permitting class actions. Each act provides for administrative enforcement, attorney s fees to a prevailing consumer and either a statutory penalty or the potential for punitive damages. Hence, the reasoning of the Third Circuit in Johnson that there is no inherent conflict between arbitration and the deterrent nature of these statutes should be persuasive.