Also Rules That Interest Rate May Be Unconscionable
Lending institutions increasingly are using mandatory arbitration clauses in an effort to control the costs of dispute resolution under agreements with their customers. Since 1925, federal law has by statute encouraged arbitration clauses so long as they do not create an unfair structure for the presentation and hearing of claims. Many states, including Delaware, followed suit, enacting laws that promote the use and enforceability of arbitration clauses.
Last month, however, the U.S. District Court for the District of Delaware held that a mandatory arbitration clause in a "pay day" loan agreement was unenforceable on the grounds that it frustrated the purposes of the Truth in Lending Act (TILA) and the Electronic Funds Transfer Act (EFTA). Johnson v. Tele-Cash, Inc., No. 99-104-GMS (D. Del. December 29, 1999) involved a pay day loan made by County Bank, an FDIC-insured, Delaware-chartered bank in Rehoboth Beach.
The Johnson decision is the first Delaware case invalidating an arbitration clause in the consumer finance context. This case is particularly significant for lenders because the court refused to dismiss the plaintiff's claim that a high-interest pay day loan was unconscionable despite Delaware's clear statutory authority permitting lenders and consumers to determine interest rates. County Bank's attorneys say they will appeal to the Third Circuit.
The Johnson decision joins a growing body of federal cases addressing the enforceability of arbitration clauses in consumer finance contracts. Nationwide litigation on this issue by class action plaintiffs and consumer finance companies has had mixed results. Compare Harris v. Green Tree Fin. Corp., Nos. 97-2029/98-1018 (3rd Cir. July 1, 1999) (upholding mandatory arbitration clause) and Randolph v. Green Tree Fin. Corp., No. 98-6055 (11th Cir. June 22, 1999) (invalidating mandatory arbitration clause). This issue will continue to be a subject of litigation until the Supreme Court or Congress resolves it.
In the Johnson opinion, Judge Sleet, a recent appointee to the federal bench, recognized the principles of the Federal Arbitration Act (FAA) and related policy that arbitration clauses are to be enforced in all appropriate situations. He expressed concern, however, that the mandatory arbitration clause contained in the plaintiff's contract precluded a class action against the defendants for their alleged TILA and EFTA violations.
As his reason for refusing to enforce the arbitration clause, Judge Sleet found that "Congress expressly intended to preclude the arbitration of claims arising under the TILA by explicitly allowing for the possibility of class relief under the statute." In making this finding, Judge Sleet relied not on the language of the TILA, but on an analysis of the legislative history, from which he discerned an "inherent conflict" between the TILA and the FAA. The TILA contains a provision limiting recovery in class actions to the lesser of $500,000 or 1 percent of the net worth of the creditor, but nothing in the language of TILA creates a right to proceed by class action or evinces any congressional intent to encourage class actions. Nevertheless, based on a portion of the legislative history, Judge Sleet concluded that the FAA was overridden by the TILA's express reference to the availability of class actions to enforce the statute. He reached the same result for arbitrability of EFTA claims based on an identical class action damages limitation in the EFTA. The Johnson decision is subject to criticism on the grounds that, while the FAA expressly promotes the use of arbitration clauses, nothing in the statutory language of the TILA or the EFTA suggests that Congress intended to preclude arbitration of claims under either statute.
Surprisingly, Johnson directly conflicts with an opinion delivered just four months earlier by Judge McKelvie of the same court (Sagal v. First USA Bank, 69 F.Supp.2d 627 (D. Del. 1999)). In Sagal, Judge McKelvie held that the TILA's limitation on damages for class actions did not override the enforcement under the FAA of an otherwise-valid mandatory arbitration clause because there is no direct conflict between the two statutes.
The Johnson decision's treatment of the plaintiff's claims of unconscionable interest terms is troubling for Delaware's large banking industry. By enacting the Financial Center Development Act in 1981, the Delaware legislature removed limitations on the interest rates that may be charged by a Delaware financial institution. Despite this clear statutory authority, and without precedent, Judge Sleet ruled that an interest rate that was "so one-sided as to be oppressive" could be unenforceable as a matter of law. While Judge Sleet did not affirmatively conclude that Mr. Johnson's pay day loan terms were usurious or unconscionable, refusing to dismiss his claims is an unprecedented interpretation of Delaware law on allowable interest and fees.
Pepper Hamilton's Consumer Financial Services Practice Group offers counseling and litigation services to consumer financial services companies on issues involving fair lending and fair credit reporting, the Truth in Lending Act and Regulation Z, the Real Estate Settlement Procedure Act and Regulation X, the Equal Credit Opportunity Act and Regulation B, the Electronic Funds Transfer Act, the Community Reinvestment Act, state insurance and consumer protection laws, and the myriad of other laws affecting the consumer financial services industry.
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