Arbitration rules not always fair when borrowing money

On the Money
From the August 5, 2011 print edition

Many individuals and small businesses borrow money in times of crisis. The old saying, “If you don’t need it, I’ll lend it,” seems particularly true. When we have excess money, usually we’re not thinking of borrowing.

That situation opens the door for a subtle and dangerous form of lender protection called “mandatory binding arbitration” (MBA). Here’s a closer look at this treacherous lending practice.

Binding arbitration clauses are often found in credit card agreements, automobile financing contracts and many mortgage loans. The two largest arbitration companies are the National Arbitration Forum and the American Arbitration Association.

According to the National Consumer Law Center, the kind of passive notice that locks consumers into arbitration increasingly ties them to a system (privately funded with no connection to the courts) that thoroughly stacks the deck when serious disputes arise. Lenders alone select the arbitration service — often one dependent on them for repeat business.

Those same companies often write the arbitration rules. Not surprisingly, those rules often demand complete secrecy about the proceeding and its outcome while limiting what evidence consumers can present.

Consumers usually pay more for arbitration proceedings than they would for a public court proceeding. If they lose, there’s no appeal — that means even legal errors in an arbitrator’s decision are frequently beyond remedy. Moreover, if they refuse to participate in this rigged game, these clauses often dictate they’ll automatically lose the dispute with no further recourse.

Here are problems and dangers.

• Arbitration frequently costs more than taking a case to court. In many cases, a borrower may have to pay a large fee simply to initiate or respond to the arbitration process. This can deter a borrower from even bringing a complaint. On a small claim, total fees for arbitration can easily exceed the amount awarded.
• Mandatory binding arbitration clauses generally bind only the borrower — not the lender. The lender retains its rights to take any complaint to court while the borrower can only initiate arbitration.
• Borrowers often are unaware they’ve agreed to binding arbitration. The mandatory binding arbitration clause is often tucked away in a paragraph of fine print or provided as a separate form. Lenders often don’t mention it until the borrower is ready to sign the agreement.Credit card companies often issue a new card-member agreement, which by default must be accepted. These tactics deprive borrowers of their right to make an informed decision and create unconscionable contracts.
• Arbitration doesn’t follow clear, well-established, consistent rules and procedures such as those required for litigation in the court system.For example, arbitrators aren’t required to follow procedures that enable one side in a dispute to request information from the other (legal “discovery”). The result is that borrowers, who usually have limited resources, have difficulty getting information needed to support their claims.In addition, arbitrators aren’t required to consider legal precedent in making their decisions. Most decisions can’t be appealed, and there are generally no review bodies or other oversight to ensure that arbitrators follow fair procedure or the law.
• The lender generally picks the arbitration company.In theory, both parties agree to the selection of a neutral, independent arbitrator. In reality, the lender designates the arbitration company in the contract. This situation can definitely affect the impartiality of the arbitrator.

As the above demonstrates, in mandatory binding arbitration, a lender requires a borrower to agree to submit any dispute that may arise to binding arbitration prior to completing a transaction with the company. The borrower is required to waive their right to sue, to participate in a class-action lawsuit or to appeal.

The link between arbitration and legal enforceability is based on contract law. The arbitration decision is effectively a new contract between the parties.

Therein lies the hazard. The borrower has given up their full rights under the law. Furthermore, since the borrower was likely operating under the duress of a financial predicament, the bargaining positions of the lender and borrower weren’t equal. This is the Doctrine of Duress and Unconscionability.

The concept of unconscionability has two elements: procedural unconscionability and substantive unconscionability

A contract is procedurally unconscionable when a party can’t negotiate the terms of a contract because of unequal bargaining power or lack of meaningful choice. In addition, a contract may be procedurally unconscionable when terms are hidden within a contract.

A contract is substantively unconscionable when it imposes unduly harsh or oppressive, one-sided terms.

Courts have, and will refuse to enforce, a contract that is both procedurally and substantively unconscionable.

For more information regarding opposition to binding arbitration, visit www.stopbma.org,www.consumersunion.org or and www.consumerlaw.org.

© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.