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Justinian Lane

Why are mandatory arbitration clauses so prevalent in consumer credit card agreements?

Mandatory arbitration agreements have been getting a lot of attention lately, particularly because of the high rate of "wins" when a creditor is a plaintiff.  This win rate has been placed as high as 95%.  The "reform" movement is quick to suggest that the reason the win is artificially high because there are so many default judgments in credit card agreements.  I agree with that hypothesis.  The vast majority of debtors will simply not respond when sued or taken to arbitration.  Generally, people who get 3-6 months behind in their bills do so because they don't have enough money to pay their bills - let alone to hire an attorney to defend them for not paying their bills.  But where I disagree with the "reform" crowd is why I believe mandatory arbitration clauses are so prevalent in credit card agreements. 

The "reformers" suggest that credit card companies favor arbitration because it is (a) cheaper and easier than court proceedings, and (b) prevents "deadbeats" from driving up the cost of litigation.  Note that the latter claim acknowledges that defendants can and do drive up the cost of litigation; reformers usually attribute such tactics to plaintiffs, when it's actually plaintiffs who have the greatest incentive to move litigation along. 

Credit card companies know that perhaps 90 out of 100 people aren't going to respond to legal action.  Knowing this, the credit card companies obviously have an incentive to use the cheapest legal method to collect the debt.  That's arbitration, right?  Wrong.

The process of suing a debtor or taking a debtor to arbitration is so similar that there won't be any difference in legal costs for the creditor.  In either case, the creditor's attorney will have to draft a 1-2 page complaint that alleges a few basic facts: That the debtor has an account with the creditor and that the debtor owes the creditor X amount of dollars.  Any competent lawyer can draft such a complaint in 30 minutes.  Any competent lawyer who does collection work routinely can draft such a complaint in 5 minutes - debt collection firms have automated software that can crank out complaints that quickly

Once the complaint is drafted, the next step is to either file it with the court and serve it upon the debtor, or to initiate the case with the arbitration agency and serve it upon the debtor.  The National Arbitration Forum is the largest arbitration company in the country, and is used by many, if not most major credit card companies.

Let's compare the cost of taking a debtor to arbitration vs. taking a debtor to court in the two populous states of Texas and California.  The table below indicates the cost of filing and serving a complaint requesting $4,999, $7,499, and $25,000 in an NAF arbitration proceeding, in a Texas court, and in a California court: 

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In California and Texas, it is much cheaper to commence an action in court as opposed to arbitration.  I have been unable to find a comprehensive listing of court filing fees by state, but the handful of states I checked are in line with the pricing of these states.  As the table shows, it can be over five times as expensive to take a debtor to arbitration than it does to take him or her to court.  So just to initiate the legal action, the courts have a substantial cost advantage over the arbitration system. 

Again, recall that evidence suggests over 90% of these actions result in a default judgment.  It's also not cheaper to obtain a default in arbitration than it is in court.  In arbitration or in court, the procedure to get a default judgment is the same: File a motion requesting a default judgment.  The motion in either forum will be a one or two page document that explains that the debtor failed to respond to the lawsuit/claim in the required amount of time.  The motion will then ask the court or arbitrator to grant a default judgment.  An arbitrator will generally grant a default judgment without the necessity of a hearing.  Many judges will grant a default judgment without a hearing, but some won't.  If a judge does require a hearing, it will be very quick- 15 minutes or less.  I've seen them done in as few as five.  Even if it takes an attorney a full hour at $200 an hour to get through the hearing, getting a default judgment through arbitration is still more expensive than getting a default in court.  Plus, it's easier to enforce a default judgment from a court (levying bank accounts, etc.) than it is to enforce a default from an arbitrator.  All of this evidence suggests that if you're planning on winning a majority of your cases through default judgments, it's smarter to go to court to do so.  So why do creditors put in mandatory arbitration clauses that prevent them from taking debtors to court? 

Because mandatory arbitration clauses prevent debtors from taking creditors to court.  Credit card companies get sued routinely for violations of such acronyms as the Truth in Lending Act (TILA), Fair Credit Reporting Act (FCRA), Fair Debt Collection Practices Act (FDCPA), Deceptive Trade Practices Act (DTPA), and a variety of other state and federal laws.  In addition, many of these lawsuits turn into class action lawsuits, which the "reformers" constantly argue are an affront to God.  By placing mandatory arbitration clauses in their contracts, credit card companies get to eliminate those evil class action lawsuits before they're even filed. 

I was inspired to write this post because the "reform" movement has been making a false argument.  They've been arguing that mandatory arbitration clauses are used because it's so much cheaper to "go after deadbeats" in arbitration than it is to court.  Therefore, mandatory arbitration clauses benefit consumers who do pay their bills because the cost savings is passed on to them.  This is plainly false because it's more expensive to "go after deadbeats" in arbitration than it is to use the court system. 

* In Texas, the jurisdictional limit for the Justice of the Peace courts is $10,000.  Thus, any suit for $10,000 or below can be brought in JP court, where filing fees are between $10 and $20, depending on the county.  Sheriffs will personally serve a defendant for fees ranging from $50 to $70, depending upon the county.  The figure of $72 assumes a filing fee of $17 and a service fee of $55.  Depending upon the county, filing and service costs may differ by $10 or so.  The filing fee in all County Courts of Law in Texas is $232, and the jurisdictional limit of those courts are $100,000.  The $287 figure was derived by adding $55 for service of process to the $232 filing fee.

** In California the jurisdictional limit of small claims court is $7,500.  Filing fees vary from county to county, but not by more than a few dollars.  I used an average fee and estimates the service of process fee of $50.00, which seems to be the going rate in most major metropolitan areas of California.  Sometimes this means using the Sheriff, other times it's a third party process server.  For more information on California court filing fees, visit http://www.courtinfo.ca.gov/selfhelp/lowcost/getready.htm#fees

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Posted at 11:47 AM, Jan 22, 2008 in Mandatory Arbitration
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Comments

The main problem with arbitration, as I see it, is that it nullifies contracts. For example, drivers are statutorily required to carry liability insurance but then unethical insurance companies use the arbitration statutes as a firewall against being sued for refusal to pay a just claim. The insured, for all practical purposes possesses a worthless insurance policy. As an example, my daughter was rear ended while stopped at an intersection to make a left turn. Ordinarily this would have been a no brainer but both drivers had the same insurance company. The company refused to pay medical and disability on either my personal injury coverage or through the other driver's liability coverage. When we filed a small claims suit the insurance company requested a jury trial which automatically moved the case into arbitration and required refiling a formal complaint in the Oregon Circuit Court. The insurance company had previously demanded an independent medical exam that was conducted by a physician whose license to practice medicine had been suspended in both Arizona and Oregon.The insurance company attorney had 9 ethics violations complaints filed against him with the Oregon Bar. He failed to answer the arbitration complaint within the 20 day time limit. The Oregon Circuit court refused to file the motion for a default judgment even though they filed the opposing attorney's answer to it. My daughter was disabled by the accident and under treatment for a period of six months. The arbitrator awarded her a total of $60 for disability. Since no attorney would touch the case just because of the fact that it would go to arbitration it would not have gone to arbitration at all except for the fact that I am a paralegal and competent to file the pleadings. While I filed the initial small claims suit, since it was my insurance policy, my attorney sued the other driver and we eventually prevailed and collected what was owed us. The case took six months to resolve and included more than 12 court filings and depositions just for the arbitration, plus an appeal against the trial court judge's final order. The arbitration cost 12 times times more than a small claims court hearing which could have settled the matter in 15 minutes. The only time an arbitration hearing is less time consuming to the Oregon court and less expensive to the parties is when the plaintiff consumer is denied their right of a fair hearing because an attorney refuses to take the case or they cannot afford the fees. After the arbitration I filed a complaint with the Oregon Department of Insurance against the insurance company. Their investigators found the company guilty of forcing an insured to take legal action in order to collect a just claim. This is a statutory violation in Oregon. No action was ever taken against the insurance company. Oregon's arbitration statues are blatantly biased in favor of the defendant corporations and impose a punitive liability on the plaintiffs which dissuades them from filing suit or going to arbitration. In Oregon any suit under $50,000 is subject to arbitration. Attorneys routinely inflate their damages in order to avoid arbitration. Hillary Clinton and other candidates are now proposing to make health insurance mandatory the same as auto insurance. This means the working person will have no guaranteed contractual coverage of their health care costs.

Posted by: Eliduc | January 28, 2008 12:05 PM

I have never been a fan of manditory binding arbitration (especially, this mail order arbitration garbage found in most credit card contracts), unless both partys willingly and knowingly agree. This is not the case in almost all credit card contracts where it's buried in tons of small print verbage (no doubt done intensionally) or pawned off as an ammendment later down the road.

The real crummy part, is attorney fees are the same (in some cases, more depending on the jurisdiction taken). Even though in the case of mail order arbitrations....the attorney didn't even have to leave their desk. At least in a court case, minus court call, the attorney has to show up in person, documents must be filed with the court, etc. Theirs at least some documents to show the attorney actually did something for the fees. In mail order arbitration, the attorney can use blanket terms, such as "research" (commonly used by most attorneys), only without providing or doing any work at all and charging hours of fees.

It appears the bottom line is that reformers, as referred to earlier, use binding manditory arbitration because it's easiest, not really cheaper, for them to obtain a real confirmed binding judgement through it.

Consider, that in many binding manditory arbitration contracts, you forfit your right to participate in a class action suit, most arbitrations cannot be challenged (they are binding & final), you cannot subpoena prospect witnesses, the arbitrator is usually chosen by the party whom requires the arbitration process (to no supprise), you have very little time to present material facts. Sounds like a bargain for the opposing party, but what do you get out of it?

Posted by: Jon | July 15, 2008 2:18 AM

I have never been a fan of manditory binding arbitration (especially, this mail order arbitration garbage found in most credit card contracts), unless both partys willingly and knowingly agree. This is not the case in almost all credit card contracts where it's buried in tons of small print verbage (no doubt done intensionally) or pawned off as an ammendment later down the road.

The real crummy part, is attorney fees are the same (in some cases, more depending on the jurisdiction taken). Even though in the case of mail order arbitrations....the attorney didn't even have to leave their desk. At least in a court case, minus court call, the attorney has to show up in person, documents must be filed with the court, etc. Theirs at least some documents to show the attorney actually did something for the fees. In mail order arbitration, the attorney can use blanket terms, such as "research" (commonly used by most attorneys), only without providing or doing any work at all and charging hours of fees.

It appears the bottom line is that reformers, as referred to earlier, use binding manditory arbitration because it's easiest, not really cheaper, for them to obtain a real confirmed binding judgement through it.

Consider, that in many binding manditory arbitration contracts, you forfit your right to participate in a class action suit, most arbitrations cannot be challenged (they are binding & final), you cannot subpoena prospect witnesses, the arbitrator is usually chosen by the party whom requires the arbitration process (to no supprise), you have very little time to present material facts. Sounds like a bargain for the opposing party, but what do you get out of it?

Posted by: Jon | July 15, 2008 2:21 AM