CFPB bans mandatory arbitration clauses, allows class action against banks

Received 110,000 comments on proposed rule

The Consumer Financial Protection Bureau revealed its new rule to ban companies from using mandatory arbitration clauses, allowing consumers to participate in class action lawsuits.

The new rule mainly pertains to consumer financial products like credit cards and bank accounts that have arbitration clauses in their contracts that prevent consumers from joining together to sue their bank or financial company for wrongdoing.

However, the new rule is not applicable to mortgage finance. The CFPB noted in its release that Congress already prohibits arbitration agreements in the residential mortgage market.

And even beyond mortgages, in the Military Lending Act, Congress also has prohibited such agreements in many forms of credit extended to servicemembers and their families.

So for who the rule does apply to, according to the CFPB, it applies to the major markets for consumer financial products and services overseen by the bureau, including those that lend money, store money, and move or exchange money.

The CFPB explained that this new rule is meant to deter wrongdoing by restoring consumers’ right to join together to pursue justice and relief through group lawsuits.

"Arbitration clauses in contracts for products like bank accounts and credit cards make it nearly impossible for people to take companies to court when things go wrong," said CFPB Director Richard Cordray. "These clauses allow companies to avoid accountability by blocking group lawsuits and forcing people to go it alone or give up. Our new rule will stop companies from sidestepping the courts and ensure that people who are harmed together can take action together."

But arbitration clauses are not completely barred from company contracts. Under the rule, companies can still include arbitration clauses in their contracts, but companies subject to the rule may not use arbitration clauses to stop consumers from being part of a group action.

The rule includes specific language that companies will need to use if they include an arbitration clause in a new contract.

This new rule finalizes a proposed rule the CFPB released last May. At the time, the CFPB said it was seeking comments on a proposed regulation that would prohibit mandatory arbitration clauses that deny groups of consumers their day in court, putting into motion discussions that started toward the end of 2015. 

The bureau received more than 110,000 comments. This new rule is effective date 60 days after it is published in the Federal Register and applies to contracts entered into more than 180 days after that.

While organizations, such as The Leadership Conference, welcomed the new rule not everyone was as positive about it.

“The CFPB rule is simple. It says that consumers have the right to join together to enforce protections guaranteed by the Constitution, or federal, state, or local law. This is yet another example of how the CFPB is living up to its mandate – to put the concerns and welfare of the consumer above those of corporations that too often seek to take advantage of them,” said Vanita Gupta, president and CEO of The Leadership Conference on Civil and Human Rights.

On the other side, John Berlau, Competitive Enterprise Institute senior fellow said, “The CFPB has disregarded vast data showing that arbitration more often compensates consumers for damages faster and grants them larger awards than do class action lawsuits. This regulation could have particularly harmful effects on FinTech innovations, such as peer-to-peer lending.”

A previous study from the Mercatus Center at George Mason University, conducted by law professors Jason Johnston and Todd Zywicki, provided an overview and critique of the CFPB’s own report that they say shows such regulation would be counter-productive.

“The CFPB’s findings show that arbitration is relatively fair and successful at resolving a range of disputes between consumers and providers of consumer financial products, and that regulatory efforts to limit the use of arbitration will likely leave consumers worse off,” they conclude. “Moreover, owing to flaws in the report’s design and a lack of information, the report should not be used as the basis for any legislative or regulatory proposal to limit the use of consumer arbitration.”

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