March 2008
In This Issue
Lender Arbitration Clauses
LENDER ARBITRATION CLAUSES CALLED INTO
QUESTION
By John H. Culver III and Glenn E. Ketner III ("Bo")
Lending institutions should re-examine the
content and execution of their consumer
arbitration agreements following a recent
North Carolina Supreme Court decision.
Background
Recent Decision
Impact
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newsletter, please contact John
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LENDER ARBITRATION CLAUSES
The North Carolina Supreme Court's recent Tillman v. Commercial Credit Loans, Inc.
(665 S.E.2d 362, NC 2008) decision appears to have dramatically changed North
Carolina's longstanding approach to mandatory arbitration provisions in consumer
loan agreements. For the first time, the North Carolina Supreme Court has struck
down a contract provision as "unconscionable."
The Court refused to enforce the arbitration clause on the grounds that it was:
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z
z
unfairly one-sided
prohibited class action lawsuits
saddled low-income consumers with prohibitively high arbitration costs
BACKGROUND
In 2002, a class of so-called "sub-prime" borrowers sued their mortgage lender and
its corporate parents and affiliates, all part of Citigroup. The complaint primarily
asserts that the lender committed an unfair and deceptive trade practice (among
other claims) by selling the borrowers "single-premium credit insurance." The
mortgage documents contained a mandatory arbitration clause. In 2003, the lender
moved to compel arbitration. The trial court denied the motion because it found
that the arbitration clause was unconscionable. The N.C. Court of Appeals reversed
the trial court and, consistent with long-standing precedent, found that the
arbitration clause should be enforced.
RECENT DECISION
In a split decision, the North Carolina Supreme Court reversed the Court of Appeals
and held that the trial court was correct. Writing for a plurality, Justice TimmonsGoodson found that the arbitration clause was unconscionable and must be
declared void and unenforceable. While acknowledging a strong public policy
favoring arbitration agreements, the plurality opinion found problems with both the
way in which the arbitration clause was formed and with several specific terms of
the clause.
The plurality opinion relied on the trial court's conclusion that the plaintiffs had
shown that they were "rushed though the loan closings" without being told of the
arbitration clause. Justice Timmons-Goodson also found that, because the plaintiffs
were relatively unsophisticated consumers signing an agreement drafted by the
lender, the bargaining power between the parties was "unquestionably unequal."
Turning to the terms of the arbitration clause itself, the plurality opinion found
three specific problems, the collective effect of which was to render the agreement
unconscionable:
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z
The provisions concerning costs - in particular an arrangement by which the
lender would automatically pay for only the first eight hours of any
arbitration hearing with any additional time and any appeals paid for under a
"loser pays" provision - were oppressive given the plaintiffs' limited financial
means. The plurality concluded that this provision controlled the question of
costs even though the rules of the specified arbitration forum allocated costs
differently because the agreement provided that its terms trumped any
inconsistent rules of the arbitration forum. The plurality was also concerned
that the arbitration clause would chill the willingness of the plaintiffs' bar to
agree to represent Citigroup's borrowers for a fee contingent on the outcome
of the case.
The plurality found the agreement was too "one-sided" because it excepted
1) foreclosure proceedings and 2) legal actions in which the total damages,
costs and fees did not exceed $15,000. Although these exceptions applied to
both parties, the plaintiffs convinced the plurality that since the lender had
brought over 2,000 collection actions in N.C. courts and had not once
initiated an arbitration, the provision effectively gave the lender access to the
courts for its grievances while denying the consumers access to the courts.
The plurality disapproved of the agreement's prohibition on joinder and class
actions. Although Justice Timmons-Goodson acknowledged that a provision
that prohibits class actions "may be insufficient to render an arbitration
agreement unenforceable" on its own, its presence contributed to the
conclusion that the agreement was "egregiously one-sided." She was
apparently persuaded by the argument that the ban on class actions only
benefited the lender, because there was no practical likelihood of a lender
ever seeking a class action against its borrowers.
Arbitration has long been favored under federal law, and the dissent argued that
the plurality's approach was improper under the Federal Arbitration Act (the
"FAA"). Justice Newby in dissent maintained that federal law preempted the
approach used by the majority. He argued that the FAA prevents a state court
from finding a dispute resolution clause unconscionable based on features unique
to the arbitration context.
IMPACT
The effect of this decision on future cases is unclear. Three justices (Justices
Timmons-Goodson, Brady and Hudson) signed the plurality opinion authored by
Justice Timmons-Goodson, two justices (Justices Edmunds and Martin) concurred in
the result only and two justices (Justice Newby and Chief Justice Parker) dissented.
Since there were not four votes for the plurality opinion, it is possible that the
concurring opinion will control future cases.
Although some courts in other states have found arbitration agreements with similar
provisions unconscionable, the decision in Tillman puts North Carolina at the
forefront of a new judicial hostility to arbitration in the consumer lending context.
At a minimum, lenders whose loan agreements contain mandatory
arbitration provisions must now carefully consider whether the terms of
their agreements remain enforceable. There will be opportunity for courts
trying to apply the Tillman decision to reject previously enforceable mandatory
arbitration provisions in consumer agreements. What may have once seemed
ironclad agreements are now in doubt.
John H. Culver III chairs the litigation department at Kennedy Covington, focusing his practice on financial and
other business-related litigation. Glenn E. Ketner III ("Bo") is an associate in the litigation department at Kennedy
Covington, focusing his practice on employment law issues and commercial litigation.
Kennedy Covington is one of the largest law firms in the Carolinas with offices in Charlotte,
Raleigh, Research Triangle Park, Columbia and Rock Hill. Our attorneys use their diverse
experience and knowledge to counsel clients in varied industries such as banking and finance,
real estate, technology, health care, manufacturing and the services sector. At Kennedy
Covington, we give more than a legal opinion; we provide a business perspective.
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in finanical litigation issues. The information provided herein is general in nature and should not
be relied upon as legal advice as to specific factual situations. Our financial services
litigation practice group welcomes your comments or inquiries about this newsletter or about any
specific matters you may wish to discuss with us.
Financial Services Litigation and Financial Restructuring Attorneys
F. Daniel Bell III (Dan)
Todd W. Billmire
Lawrence E. Behning (Larry)
J. Michael Booe (Mike)
Jo Ann J. Brighton
John H. Culver III
Brian C. Fork
John R. Gardner
Sara W. Higgins (Sally)
A. Lee Hogewood, III
David N. Jonson
Glenn E. Ketner III (Bo)
Joseph B.C. Kluttz (Joe)
Margaret R. Westbrook
Amy Pritchard Williams
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