Non-negotiable mandatory arbitration clauses: From the perspective of the drafting party

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VOL. 24 NO. 10 NOVEMBER 2006164 ALTERNATIVES

A favorite technique of asking the par-ties folksy questions to gain confidence inthe mediator might be ill advised, too. Forinstance, in speaking to the king, saying,“How is the war going in Prussia?” mightnot be a good opening. Similarly a discus-sion with the captain inquiring as to how hiswill was coming might not be a good idea,and similarly with the shipbuilder on hiscapital punishment views.

The rapid-fire chalkboard approach out-lining issues and amounts, the hallmark ofmany mediators, would certainly fail ifhardly anyone could read what was put onthe chalkboard.

The only positive aspect of this type ofmediation was, of course, that the king hadthe power to settle any dispute on thespot—and terminally. There would be noappeal.

Fault could be discussed against theking’s admiral. But quite possibly, if theadmiral knew he was going to die anyway, hemight point the finger of fault at the king,creating such anger in the king that he mightorder everyone involved in the mediation tobe executed. The same would follow logicallyto the shipbuilder and the designer.

This was not a matter of dividing moneybetween parties, but rather of dividing headsfrom necks.

A prudent mediator in all the circum-

stances would have been most wise in orderto remain in good health to simply adjournthe whole matter indefinitely for furtherevidence or investigation or whatever couldconceivably be thought up, using bestmediation skills, perhaps even deferring thematter to a “Royal Commission.”

In fact, the investigator did exactly whata prudent mediator would have done:Nothing. Nothing was ever heard from himagain and the issue of fault was never identi-fied. Life went on with all parties intact.And in 1630 the king’s army and navyinvaded Germany without the Vasa. �

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Non-Negotiable Mandatory Arbitration Clauses: From the Perspective of the Drafting PartyBY PAUL BENNETT MARROW

Courts—for example, Hooters of AmericaInc. v. Philips, 173 F 3d 933 (4th Cir.1999)—and scholars—for example, JeanR. Sternlight, “Creeping Mandatory Arbi-tration: Is it Just?” 57 Stan. L. Rev. 1631(2005); Paul D. Carrington, “Uncon-scionable Lawyers,” 19 Ga. St. U. L. Rev.361 (2003)—love to condemn mandatoryarbitration clauses found in standard formcontracts on the grounds that they areunconscionable.

Usually drafted by a business operatorassumed to be opportunistic and predatory,these clauses are faulted for being one-sided—imposed without negotiation andfundamentally unfair because they cut theconsumer off from access to the courts.Inherent is the argument that arbitrators

will unfairly prefer the cause of the businessoperator to that of the consumer.

While undoubtedly there are oppor-tunistic and predatory business opera-tors—for example, Ting v. AT&T, 319F.3d 1126 (9th Cir 2003)—most are not.To the contrary, the vast majority of busi-

nesses seek to make a profit in a competi-tive environment that requires protectionnot only of their ability to make a profit,but also their reputation.

Most are repeat players who haveinvested heavily in their business and theirreputation, players who recognize thatthey need their borrowers, clients, cus-tomers and consumers to exist and thrive.In addition, sparked by their drive to min-imize lower operating costs, they crave sta-bility and recognize that their interests arebest served when they can build and main-tain a relationship with a “good” borrower,customer, client or consumer. Empirical

evidence substantiates these conclusions.See Jason Scott Johnson, “The Return ofBargain: An Economic Theory of HowStandard Form Contracts Enable Cooper-ative Negotiation Between Businesses andConsumers,” 104 Mich. L. Rev. 857, 897-898 (2006).

Unfortunately, little is written aboutwhy reputable parties insist on clauses thatare suspect as being unconscionable. Thereare many valid reasons. The law shouldaccommodate such concerns. This articlewill discuss mandatory arbitration clauseswithin the context of credit card issuers,and the realities of the credit card industry.

Credit card disputes are uniquely suitedto the arbitration process because theyinvolve few potential fact issues. The cardissuer (1) either did or didn’t advancemoney at the user’s instruction, (2) the usereither does or doesn’t have a Fair CreditBilling Act (15 U.S.C. §1601 et seq.; seealso www.ftc.gov/bcp/conline/pubs/credit/fcb.htm) claim pending or (3) the usereither did or didn’t pay the money back.

That’s pretty much it save for theextremely rare claim that the issuerengaged in a fraud. This factual simplicitymakes the credit card dispute a perfectarbitration candidate.

Issuer drafted clauses are attacked asbeing procedurally unconscionable on the

ADR THEORY

The author is an attorney and an arbitrator inChappaqua, N.Y. He is a member of the com-mercial roster of the American ArbitrationAssociation; Chicago-based ADR Systems ofAmerica LLC; National Arbitration Forum, ofMinneapolis, and National Arbitration andMediation, based in Garden City, N.Y. He is apublic arbitrator for the rosters of NASD andthe New York Stock Exchange. He is a member(MCIArb) of the Chartered Institute ofArbitrators in London. The author thanksSteven A. Certilman, Esq., for his thoughtfulcomments and insights.

(continued from previous page)

grounds that the cards are made too widelyavailable to individuals who have less thansterling credit. It’s the “Devil made me doit!” argument. But agreeing to advancemoney on behalf of someone with ques-tionable credit doesn’t entitle the benefici-ary to a free ride. Being willing to assumesuch a risk doesn’t mean that the issuer is tobe precluded from using any and all lawfulmeans to collect.

What about substantive unconscionabil-ity? Given the plethora of federal and stateconsumer laws that govern credit cards it’shard to imagine a viable substantive claim.Nevertheless, attempts directed at manda-tory arbitration are made because this is onefeature that isn’t regulated. But theseattempts should fail because issuers havegood reason to want mandatory arbitration.

Mandatory arbitration isn’t about over-reaching to the detriment of the user. It’sabout being sure that the issuer gets backthe money that indisputably it hasadvanced on the user’s behalf. And that’s asgood as good reasons can get!

DRAFTING THE CLAUSE: FORGET ABOUT NEGOTIATION

As a practical matter, negotiation with eachnew user isn’t practical or even possible. Sothe issuer takes it upon itself to structurethe card use terms and offers it on a take itor leave it basis. That’s not as onerous as itmay initially sound. There are lots ofissuers, and there is nothing to stop the userfrom shopping for favorable terms.

Still, today most credit cards are issuedon the understanding that usage is anacceptance of all the credit card agreementterms and conditions, which are sent alongwith the card when first issued. Andembedded in most of these agreements is amandatory arbitration provision.

Not only is arbitration imposed on theuser without negotiation, the issuer gets tospecify all the arbitration terms. So theissuer gets to select the forum for any pro-ceedings, to exclude the right to a jury trial,to select applicable state and federal law,and to dictate the terms of the arbitrator’sauthority.

But there’s more! Some clauses shortenstatutes of limitation, seek discovery, pre-vent class actions and bar counterclaims forinjunctive relief, punitive damages and

attorneys fees. And if all the above isn’tenough, the arbitration process assumes afinal award, and usually denies the user theright to appeal the outcomes, except thatusers have limited statutory vacatur rights.

And there’s yet more! Some issuersreserve the right to unilaterally modify themandatory arbitration clause at anytime,even after the card is first issued and used.

The only choice the user has is to eithernot use the card at all, or use it subject to allthe terms the draftsman has deemed appro-priate. Admittedly, this is a harsh reality.But just because it’s harsh doesn’t mean it isunconscionable. Lets try to understand whythe need for the harshness.

WHAT’S ON THE CARD ISSUER’S MIND?

So why do credit card issuers insist onmandatory arbitration? To start, considerthe risks involved. The nature of the rela-tionship between an issuer and user is quitesimilar to that of lender and borrower: carduse obligates the issuer to advance cash—aloan on behalf of the user, who is the equiv-alent of a borrower. Until the advance isrepaid, the issuer bears the entire risk. Atthe same time, while the debt remainsunsatisfied, the user has complete controlover the existence of the risk.

Is it any wonder, therefore, that theissuer would want to create an environmentthat encourages the user to remove the risk?

Of course, the issuer is in the business,and is compensated for taking risk byextremely high-interest assessments. Butthat doesn’t mean that the issuer will nottake any and all risk reduction measures.Why? Because the magnitude of the riskcan accelerate without warning if the issueris exposed to the vagaries of bankruptcyproceedings initiated by the user.

When issuers look at the market, this issome of what they see:

1. The environment is competitive. Thereare many issuers. Users aren’t loyal andcan easily establish and terminate rela-tionships with multiple issuers.

2. While they see a large population ofpotential users, issuers can’t accuratelydetermine who is and who isn’t a goodpotential user. The information theyhave about a given potential user isimperfect.

3. Even if issuers obtain good informationabout any given user, the information isalways in the past tense. Things can anddo change.

4. Issuers know that many users either areopportunistic or have the potential tobecome opportunistic if necessity sorequires.

5. Issuers require a mechanism with whichthey can signal their intentions tocounter opportunism in a forceful,expeditious and prompt manner.

6. Issuers know that the judicial systemisn’t user friendly and subject to delaysbecause, in the courthouse summaryjudgment rarely is available.

7. Because of competition and the goal ofbuilding a continuing relationship, andthe need to preserve their reputation,issuers must appear to be reasonablewhen confronted by requests for awaiver of any “right” that is “granted”by the issuer and contained in the creditcard agreement.

Let’s now look in some detail at theseconcerns.

INCOMPLETE INFORMATION

All issuers know that there are good usersand opportunistic users. The challenge isscreening out the bad guys.

Even the most diligent issuer hasavailable only partial information aboutcredit worthiness. Services such asEquifax (www.Equifax.com), Experian(www.Experian.com) and Transunion(www.Transunion.com) are a start, butthey also are far from perfect. Informa-tion can lag about a card’s issuance orusage. Things often do change: The userloses a job or incurs an unexpected debtfor something like medical bills not cov-ered by insurance, etc. So over time, eventhe “good” user can degrade and becomeopportunistic—with the issuers havingno forewarning whatsoever.

Good users are valuable to the issuer. Itis in the issuer’s best interests to take reason-able steps to accommodate the good user,whenever possible, so long as its doing sodoesn’t undermine its ability to recover anyamounts advanced on the user’s behalf.

The standard-form credit card agree-


VOL. 24 NO. 10 NOVEMBER 2006 ALTERNATIVES 165

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VOL. 24 NO. 10 NOVEMBER 2006166 ALTERNATIVES


ment contains a number of rights favoringthe issuer precisely because of the shortfallsof information and the changing nature ofeach risk situation. These may include theright to charge late fees, to withhold bene-fits such as frequent flyer miles, and manda-tory arbitration. These rights are designedto signal the possibility of cooperation, aswell as to signal the issuer that opportunismwill not be tolerated and, when necessary,secure the issuer’s position.

The good user most likely is aware ofthe need to preserve good user status. Inother words, the good user knows thevalue of a good credit rating. The gooduser, like the issuer, is a repeat player whois concerned about his or her credit repu-tation. But good users can, and do,encounter circumstances that put theircredit worthiness in jeopardy. When thishappens, the good user may want theissuer’s assistance.

The good consumer need not be penal-ized just because of a change in circum-stances. More often than not the optionexists to call the 800 number shown on allcards and to ask for help. Employeesresponding to these calls are often given acertain amount of discretion to say yes orno. Discretion is a win-win, with the issuerwinning favor for being reasonable and theuser being able to get help when needed.The value of the benefits accorded by dis-cretion have even been quantified andreduced to a mathematical equation! SeeLucian A. Bebchuk and Richard A. Posner,“One-Sided Contracts in CompetitiveConsumer Contracts,” 104 Mich. L. Rev.827, 831-833 (2006).

This discretion is limited, however, toissues involving the user’s performance. Itis commonplace for a user to ask for awaiver of late fees where the paymentarrived one or two days late. The issuer’semployee has discretion to grant therequest based on the user’s track record. Incontrast, requests concerning terms aimedat the consequences of a “breakdown,” i.e.,a termination of the relationship are neverwaived. See Jason Scott Johnson, “TheReturn of Bargain: An Economic Theoryof How Standard-Form Contracts EnableCooperative Negotiation Between Busi-nesses and Consumers,” supra at 858-59;Lisa Bernstein, “Private Commercial Lawin the Cotton Industry: Creating Coopera-

tion Through Rules, Norms, and Institu-tions,” 99 Mich. L. Rev. 1724 (2001)). Thisis because to do so would jeopardize theissuer’s ability to recover the amounts thatit has advanced on the user’s behalf.Mandatory arbitration is a breakdowndefault term.

THE TOOL OF CHOICE

There are users who simply are oppor-tunists. No question about it. This realityis known to every issuer. Opportunisticusers have little regard for their reputa-tion. They are prepared to run up largeoutstanding balances with little intentionof paying them off. They are even dis-posed to frustrating collection in thehopes that the issuer will compromise aclaim. The problem is that the issuer maynot be able to identify this type of useruntil it is too late.

As noted at the outset, the user holds allthe cards until it’s time to pay the outstand-ing balance. From that day forward, theissuer must move quickly to ensure that thedamage is held to a minimum. How doesmandatory arbitration serve this need?

In the courthouse, the denial of anypleaded fact requires a trial, unless thedenial can be shown to be without anypossible merit whatsoever. This is oftenquite difficult. The need for a trial meansthat the issuer is subject to the unpre-dictability of the court system, as well asdelay and expense.

Summary judgment is almost neveravailable to the issuer, in particular becauseit has the burden of proving to thefactfinder that it advanced money on theuser’s behalf, and that it did so at the user’sspecific instruction.

This is an odd result given the relation-ship between the issuer and the user. Afterall, what fact issues can exist in a relation-ship that involves only three fact questions:Did the user call upon the issuer toadvance money? And if so, did the issuercomply? And is there an unresolved FairCredit Billing Act claim? Nevertheless, for-get about summary judgment.

The issuer’s position can be furtherundermined by protracted discovery, andan inability to secure scheduling prefer-ences. And there always is the possibilityof an appeal, and even a remand for anew trial.

Given these hurdles, it isn’t surprisingthat an opportunistic user wouldn’t find theprospect of a suit in the court system verythreatening.

So faced with the prospect of delay, theissuer sooner or later will consider the pos-sibilities for compromise. A bird-in-hand isworth far more than one in the bush, and isjust what the opportunistic user counts on.

While mandatory arbitration is nopanacea, at the very least it gives the issuergreater control over timeliness of resolu-tion and removal or reduction of risk. Therules of the CPR Institute—which co-publishes this newsletter—the AmericanArbitration Association, and Irvine,Calif.-based provider JAMS all providefor either fast track, expedited proceed-ings, or streamlined proceedings. Min-neapolis-based National ArbitrationForum permits a document hearing onclaims of less than $75,000.

Even if the regular rules apply, speedi-ness is encouraged by these serviceproviders as well as the arbitrator handlingthe case. Thus, discovery is toleratedalthough not available as of right, and thenonly under the arbitrator’s careful watch. Inthe end, soup to nuts, an arbitration canproduce an award in far less time than acomparable courthouse proceeding.

To be sure, mandatory arbitration pro-vides other benefits for the issuer, althoughnone is as important as the speediness of theprocess. Mark Fellows, “The Same Result asin Court, More Efficiently: ComparingArbitration and Court Litigation Out-comes,” Metropolitan Corporate Counsel 32(July 2006).

Most cited is the benefit of confidential-ity. Arbitration awards are normally notmade public whereas jury awards are. Thisbenefit is supposedly prized by an issuer notbecause of inclinations to conceal theamount of an award, but because of the veilof secrecy thrown over the reasoning offeredby the arbitrator as support for the award.

But is this a real benefit in cases involv-ing credit cards? Probably not. The factualissues in these cases are mostly simple andof little interest as precedent. Either the userreceived the advance and the goods or serv-ices associated with the transaction, or he orshe didn’t. So the chances that an arbitratorwill issue a reasoned opinion that deals withanything other than the specific case factsbefore him or her is remote.

Arguably there might be some sensitiv-

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ity to the possibility of statistical studiesinvolving arbitrator awards, especially ifthese studies show that issuers will tend toprevail. But in reality, those studies alreadyexist in the general literature. See, e.g.,Michael T. Burr, “The Truth About ADR:Do Arbitration and Mediation ReallyWork?” Corporate Legal Times (February2004). The studies are not only widelyavailable through the Internet, but they alsoare posted on the Web pages of some of theservice providers. For example, NAFmakes available on its Web page a study byErnst & Young LLP titled “Outcomes ofArbitration—An Empirical Study of Con-sumer Lending Cases” (2004) (available atwww.adrforum.com).

Other benefits, some of which arefavorable for the user as well, are reducedcosts, and hearings that don’t necessarilyrequire an attorney because of institutionalinformalities and finality. And some feelthat arbitration is useful if the terms pro-hibit user-initiated class actions.

Rarely discussed is the benefit of deter-rence. Deterrence comes in more than oneform. Many see arbitration as a fait accom-pli. And given the limited factual issuesthat are likely to arise, there probably issomething to that argument. This realityserves to discourage many who might oth-erwise be tempted to frustrate collection.See Paul Bennett Marrow, “EliminatingUnconscionability in Assessing MandatoryClauses by Deploying the ‘Vantage Pointof Public Policy,’” 24 Alternatives 51(2006). Mandatory arbitration under cir-cumstances that appear to favor one or theother parties does deter.

DOES UNCONSCIONABILITY EXIST?

All this is not to say that mandatory arbi-tration clauses can never be uncon-scionable. The draftsman has to be mind-ful of that reality.

As a simple rule of thumb, if theclause serves no purpose other than toput the user at a disadvantage, it’s a goodbet that a court will throw it out. So don’tattempt to impose excessive costs byrequiring that the situs for the proceed-ings be at someplace far off or attempt toimpose an arbitrator who may be biased,or appears to be biased.

Some also argue that there is a so-called“repeat provider problem.” See, Carrie

Menkel-Meadow, “Do the ‘Haves’ ComeOut Ahead in Alternative Judicial Systems?:Repeat Players in ADR,” 15 Ohio St. J. onDisp. Resol. 19, 35-37 (1999).

This is an argument that should be ofgreat interest to Alternatives readers becauseit involves the credibility of all arbitrationservice providers.

Prof. Sternlight notes that providersof arbitration services such as AAA, NAF,JAMS and CPR must compete forclients, and therefore must be sure thatthe customer is satisfied with the out-comes. In addition, the providers arethought to have a financial interest inkeeping clients happy. “If the disputantcompany is displeased with the resultssecured through a particular provider, itmay well switch providers. Needless tosay, providers and arbitrators vehementlydeny the charge that they are biased.Providers urge that they have no directinfluence over their arbitrators.” Stern-light, supra at 1650.

The bottom line is that care must betaken when drafting any mandatory arbi-tration clause. It must never be assumedthat such a clause is beyond attack merelybecause the drafter can provide a reason forits terms. And to assuage critics such asProf. Sternlight, issuers are probably welladvised to insist that providers and arbitra-tors disclose the track record of any arbitra-tor who serves on more than one caseinvolving a given issuer.

What counts is that the preferences ofthe drafting party appear reasonable fromthe perspective of courts that are oftenbiased against boilerplate.

* * *

The drafting party must keep in mind thatmandatory arbitration clauses always willbe vulnerable because there is no regula-tory oversight. The default is to the courtsto determine the reasonableness of a clauseon a case-by-case basis. The drafting partyultimately must establish the reasonable-ness of mandatory arbitration. In doing sothe drafter must be able to prove the moti-vation is for a constructive purpose, andnot an attempt to overreach or frustratethe process, or to cut the nondraftingparty off from access to the courts to gainan upper hand. �

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Non-negotiable mandatory arbitration clauses: From the perspective of the drafting party