Consumer protection attorneys are lauding a proposed federal rule that would effectively ban class action waivers in arbitration clauses included in new contracts for financial services.

At the same time they are bracing for a wave of legal challenges by business groups once the measure goes into effect, as anticipated.

The Consumer Financial Protection Bureau recently released a proposed rule that would prevent banks, credit card companies and other financial services providers from using pre-dispute arbitration clauses to bar their customers from bringing or joining class actions against them.

Although the measure is subject to revision following a 90-day public comment period ending Aug. 22, attorneys expressed little doubt that the CFPB would adopt a final rule along the lines of the proposed rule.

And adoption of the rule would be a “huge step” in favor of the consumer, said Lauren Guth Barnes, who practices in Cambridge, Massachusetts.

“It will allow consumers the opportunity to come back into the courthouse to pursue their rights,” said Barnes, who practices consumer protection law.

The rule is just the right antidote to a string of U.S. Supreme Court decisions upholding class action waivers in “small-dollar” disputes, according to Providence consumer protection lawyer John T. Longo.

“The Supreme Court squashed any chance of getting justice for consumers in these disputes, and finally the Consumer Financial Protection Bureau stepped in to try and level the playing field,” Longo said.

“Companies in the consumer financial industry have been able to manage litigation risk with class-action waivers and arbitration agreements. This rule would limit their ability to do so.”

— Donald R. Frederico, Boston

‘Gift’ for plaintiffs’ bar?

The central element of the CFPB’s proposed rule states that a provider of financial services or products “shall not seek to rely in any way on a pre-dispute arbitration agreement … with respect to any aspect of a class action … unless and until the presiding court has ruled that the case may not proceed as a class action.”

While companies would still be able to include arbitration clauses in their contracts, the rule requires the inclusion of explicit language telling the consumer that the arbitration clause cannot be used to stop them from being part of a class action.

“Many banks and financial companies avoid accountability by putting arbitration clauses in their contracts that block groups of their customers from suing them,” said CFPB Director Richard Cordray in a statement. “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.”

The U.S. Chamber of Commerce was quick to proclaim its opposition to the rule, with chamber leaders calling it “the biggest gift to plaintiffs’ lawyers in a half century.”

The rule would apply only to agreements entered after the rule’s effective date.

“So there’s still going to be some contracts that are subject to the prior language,” Barnes said. “But basically when there’s an update or a new contract that’s going to be entered into, that prohibition on collective action is going to be gone.”

The proposed rule also includes an element aimed at increasing the transparency of the arbitration process, requiring companies that use arbitration clauses to submit to the CFPB in a redacted form claims, awards and other materials related to arbitration cases. According to the bureau, such information would be used “to monitor consumer finance arbitrations to ensure that the arbitration process is fair for consumers.”

Longo said the reporting requirement is an important feature of the CFPB’s rule.

“Shedding some light on this ‘star chamber’ that is arbitration is going to be very helpful,” he said.

Bruce I. Kogan, however, said the reporting requirement is troubling.

“One of the primary benefits of any alternative dispute resolution mechanism is the opportunity the parties have to have the resolution be confidential.” said Kogan, a professor at Roger Williams University School of Law. “What is [the reporting requirement] going to mean in terms of the willingness of the parties to fully embrace the arbitration process?”

Necessary change?

Eliminating class action waivers is necessary in the financial services context because often the amounts in dispute do not justify a consumer going to a lawyer to pursue an individual claim, according to Boston attorney Josef C. Culik.

“Virtually every financial-services contract I see has an arbitration agreement,” Culik said. “The CFPB rule is important because banking and credit transactions — fundamental services that we must all engage in every day — are, for all practical purposes, not presently subject to judicial oversight.”

Culik offered another basic objection to class action waivers.

“The most insidious thing about arbitration clauses is that they prohibit consumers from using class-action lawsuits to stop widespread wrongdoing,” Culik said. “Most class actions demand that a corporation stop the prohibited practice. In contrast, in an individual case, or in arbitration, this is virtually impossible, and so the wrongdoing persists — usually in secret.”

Longo cited two Supreme Court decisions in particular that illustrate the need for the rule change. In 2011 in AT&T Mobility v. Concepcion, and in 2013 in American Express Co. v. Italian Colors Restaurant, the court upheld class action waivers despite the plaintiffs’ argument that pursuing individual claims was impractical.

Barnes likewise took issue with the way courts have applied the Federal Arbitration Act in the context of consumers who lack the bargaining power to object to an arbitration clause in their credit card agreement.

“We’ve seen a shift over the last decade of the FAA being used as a club to prevent consumers from pursuing their grievances in court,” Barnes said. “When the FAA was enacted in 1925, it was really enacted to govern voluntary submission to arbitration between businesses.”

While companies would still be able to include arbitration clauses in their contracts, the rule requires the inclusion of explicit language telling the consumer that the arbitration clause cannot be used to stop them from being part of a class action.

Legal challenges

Longo expects the financial services industry to spend millions of dollars in legal challenges to overturn the anticipated final rule.

“I hope they won’t be successful, but for every dollar consumer advocates spend to support the rule, there’s going to be 20 dollars spent on the other side to fight it,” he said.

Donald R. Frederico, a class action defense attorney in Boston, said the proposed rule would have a significant impact on companies in the financial services industry.

“Up until now, and until this rule takes effect, companies in the consumer financial industry have been able to manage litigation risk with class-action waivers and arbitration agreements,” he said. “This rule would limit their ability to do so.”

Frederico sees two distinct legal theories for challenging the rule should it be adopted, both based on the underlying statutory authority for the CFPB’s action.

The bureau’s authority to restrict pre-dispute arbitration clauses is derived from the Dodd-Frank Wall Street Reform and Consumer Protection Act, which directed the CFPB to study the use of arbitration clauses in consumer financial markets.

Dodd-Frank also expressly authorized the bureau to promulgate regulations limiting the use of arbitration clauses “if the Bureau finds that such a prohibition or imposition of conditions or limitations is in the public interest and for the protection of consumers.”

Laying the groundwork for its rulemaking, in March 2015 the CFPB released a study of arbitration agreements that concluded that, while class actions provided a more effective means for consumers to challenge questionable practices by financial services providers, companies routinely used mandatory arbitration clauses to block them.

Some defense attorneys argue that Congress made an unconstitutional delegation of its authority by granting the CFPB the authority, in essence, to partially repeal the Federal Arbitration Act.

Frederico believes there is merit to that argument.

“You have the FAA, which places a priority on the ability of parties to privately agree on streamlined [ADR] procedures,” he said. “On the other hand, you have this rule, which is based on the premise that class actions and litigation are a good thing for consumers. The question is, was it proper for Congress to delegate that decision to an administrative agency when it would essentially undercut the principles underlying a congressional act, namely the FAA?”

Citing the language in Dodd-Frank authorizing the bureau’s rulemaking, Kogan said he doubted that the consumer finance industry would be successful arguing that the CFPB exceeded its authority.

“That’s always a crapshoot,” he said. “Agencies have a lot of authority when it comes to making regulations. That’s why we have agencies, and that [rulemaking authority] is what is usually delegated to them under the legislative enactment.”

Frederico also questioned the findings that the CFPB relied on to justify its rulemaking. According to Frederico, the bureau appeared to be just “counting numbers” in its study of pre-dispute arbitration clauses when it concluded that fewer class actions meant that consumers were not sufficiently protected.

“I question whether they’ve done enough qualitative analysis to give sufficient weight to that last point,” he said. “Class actions are sometime referred to as ‘legalized extortion.’ I think there’s a pretty good counter-argument that more class actions does not mean more consumer protection.”

But Barnes said industry complaints about the validity of the CFPB study were “unfounded.”

“This was one of the largest studies of these kinds of clauses that had ever been done,” she said. “It was not based on anecdotes. They were actually looking at the facts.”