Mandatory arbitration clauses have
consumers signing away the right to sue
By Libby Wells • Bankrate.com

Every day, consumers are giving away one of their basic rights -- and most of them don't realize it. Buried in the microscopic legalese of many loan and purchase agreements is a provision that has a profound impact on a customer caught in a dispute with a bank or other company.

Mandatory arbitration clauses, which compel customers to give up their right to go to court, are becoming commonplace, especially in financial contracts, but consumers often are unaware of their existence or implications.

But this week, the Supreme Court began hearing a case that may have a major impact on the use of mandatory arbitration clauses.

"Most of the big banks have them. The numbers have approached or exceeded 50 percent in the lending arena," says Will Lund, director of Maine's Office of Consumer Credit Regulation. "It's probably more than that for credit cards."

Lund says arbitration clauses started showing up in 1985, but the trend boomed in the '90s beginning with Bank of America. In 1992, the lending giant announced that credit card and checking and savings account disputes would be resolved out of court. Soon after, another West Coast bank, Wells Fargo, mimicked that move -- at the same time it was fighting a class-action battle over late fees that later resulted in a multimillion dollar award to consumers.

"Lenders are very excited about arbitration clauses because they tend to spend a lot of money defending class-action suits. Arbitration eliminates class-actions," Lund says.

Other major creditors -- such as First Union Corp., First USA, American Express and MBNA -- have since done the same.

The arbitration alternative
In arbitration, a dispute is handled by a third party, called a "neutral," that hears both sides and makes a decision. Courts routinely use arbitrators to relieve the clogged legal system. In fact, some of them require arbitration of civil cases such as family and divorce disputes before a lawsuit can be filed. Just about any type of dispute, whether it's between a worker and an employer, a retailer and a customer, or an insurance company and a policyholder, can be arbitrated.

The majority of big business arbitration cases are handled by the American Arbitration Association, the National Arbitration Forum and Jams Endispute, all of which have long rosters of experts in the law and other fields.

Attorneys agree that arbitration has its advantages. For one, it's faster. The American Bar Association estimates it takes two years for the average court case to be resolved, compared with 8.6 months for arbitration. Expediency can save thousands in legal costs.

"If you bring a claim against a corporate defendant in a courtroom, they're just going to outlast you," says Ed Anderson, managing director of the National Arbitration Forum. "If there is no arbitration, the lawsuit system is a monopoly for the resolution of disputes, and lawyers can charge what they want. You don't see any lawyers getting rich on arbitration."

Arbitration is more flexible. Hearings are easier to schedule and can even be held over the phone. The rules are not as complex and the atmosphere is less intimidating than a courtroom for people who are not familiar with the legal system.

Arbitration also may be the only realistic way to handle disputes over online transactions. How would a person in the United States pursue a claim against a seller in England? Even if a person obtained a judgment against a foreign business, enforcement is difficult -- if not impossible.

Big business' out-of-court advantage
But some legal experts contend that arbitration between individuals and large companies is a lopsided playing field.

"It's wonderful when you have two parties of equal bargaining power who agree to do it," says Jeffrey Kodroff, a partner at the Philadelphia law firm Spector, Roseman & Kodroff. "But in a consumer vs. corporation setting, it's inherently unfair."

Consumer advocates have a long list of problems with arbitration in those cases:

• They say it strips an individual of his or her Constitutional right to due process. Arbitrators can make decisions based on what they think is equitable rather than what the law says; they have say-so over how much evidence can be submitted; the proceedings are confidential; and there is no written record that can be used as legal precedent.
• Most arbitration decisions are binding and cannot be appealed.
• Mandatory arbitration clauses force consumer consent before a dispute arises. "How do you know if you want arbitration before you know the nature of the dispute?" says Mark Budnitz, a law professor at Georgia State University. "How does a person know he may not want to go to court?"
• An individual who does not have a lawyer during arbitration is on unequal footing against a bank or corporation's legal experts. "Many times the customer has to go in by themselves," says Kodroff, "because it's not cost-effective for an attorney to take their case."
• Federal consumer protection laws, such as the Truth in Lending Act and the Fair Credit Reporting Act, "disappear" under arbitration clauses, says Lund, of Maine's Consumer Credit Regulation office. "The issue is: Do these consumer laws mean anything if you can't go to court? If a lender violates the law and the consumer wins, they get statutory damages and attorneys' fees. If you can't go to court, it's difficult to take advantage of those statutes."
• Some arbitration provisions maintain the company's right to go to court while prohibiting the customer from doing the same.
• Arbitration organizations vary in their rules of procedure and the rules can change frequently. "What are the rules? I don't know," says Budnitz. "It's a moving target."
• Fees vary and may be more expensive than filing a suit in small claims court, especially if the fee is based on a percentage of the claim. Costs go up when a consumer wants a full hearing as opposed to a telephone hearing or a decision based solely on a review of the documents.

Court-free consumers may fare better
But Anderson, of the National Arbitration Forum, says: "Pro-consumer attorneys would favor arbitration. Consumers do better in arbitration than they do in the court system. All the studies show that."

The American Bar Association says a consumer plaintiff wins 71 percent of the time in court and 80 percent in arbitration. Corporate plaintiffs win 63 percent of the time in arbitration and 87 percent in court.

Anderson says arbitration rules change to conform to legislation and court rulings.

"The rules of court change all the time," he says, citing the U.S. Supreme Court's May 15 decision to strike down the federal Violence Against Women Act of 1994, which gave victims of sexual violence the right to sue their attackers. "One day you could sue under that act and the next day you can't. When legal rules change we all scurry to change how we do things."

As for requiring customers to waive their right to sue before a dispute arises, Anderson says businesses that prefer to arbitrate are taking the same risk as individuals. "The business is making the same commitment to go to arbitration. It's the same commitment you make to pay the price or accept the warranty. If it were up to the lawyers, they would always choose court because they can stall the case."

Keeping it fair for individuals
Robert Meade, senior vice president of the American Arbitration Association, concedes that arbitration can be inequitable when it's a business vs. a consumer. AAA's focus is business-to-business disputes, but in 1998, with the input of consumer groups, it devised a separate protocol for proceedings involving individual consumers.

"We were concerned that there were some systems out there that were not fair," Meade says. "We've written a consumer protocol that covers some of those concerns. We've served as kind of a cheerleader, if you will."

AAA recommends that contracts allow disputes over small amounts of money to be heard in small claims court. "They don't have to arbitrate if they don't want to. That's a very important factor," says Meade.

The organization also encourages companies to make notifications of arbitration plain and conspicuous. Arbitration clauses are usually in fine print, stuffed in an envelope with the customer's credit card bill, buried at the bottom of a tedious insurance contract or bundled with packing materials when a consumer buys a new product such as a computer.

Lund says corporate lawyers are starting to take a second look at arbitration language and some agreements have become more consumer-friendly. For example, credit card behemoth MBNA is making it optional. "The consumer can write within two weeks and opt out of the change," he says.

MBNA also agrees to advance the customer the fee to initiate the claim, and the consumer has the right to attorneys' fees if he or she prevails. The fees, however, cannot exceed what it would have cost the individual to file the case in court. "This is different from any I've ever seen," says Lund. "They are making an effort to modify it."

Of course, this is all spelled out in the fine print under "change in terms," which means if the customers don't read the inserts, they waive their rights.

Lund says consumers have to inspect every piece of paper that accompanies loans, goods and services. "There seems to be no natural limit to the number of contracts that consumers can enter into that have these things," he says. "Going to court is a right we always thought we had, but you can rent a campsite for the night and might have to sign an arbitration agreement."

--Posted: Oct. 4, 2000