CFPB releases preliminary results of arbitration study

By Christopher Reese

On December 12, 2013, the Consumer Financial Protection Bureau (CFPB) released the preliminary results of its investigation into the use of arbitration agreements in connection with consumer financial products or services. Section 1028(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required the CFPB to conduct such an investigation and provide a report to Congress summarizing the results.  The CFPB noted that its analysis is preliminary and is subject to change as more results are received.

The preliminary report is likely just the first step toward the issuance of regulations by the CFPB prohibiting or regulating the use of arbitration clauses in agreements concerning consumer financial products and services.  Section 1028(b) of the Dodd-Frank Act permits the CFPB to impose such regulations, if it finds that they are in the public interest and for the protection of consumers based on the results of its study.

The CFPB focused its initial investigation on the use of arbitration agreements in connection with three consumer financial products and services: credit cards, checking accounts, and general purpose reloadable prepaid cards.  The CFPB noted that its investigation going forward may look at additional consumer financial products, such as student loans.  For this preliminary report, the CFPB looked only at what it called the “front-end” of disputes involving consumers – “who files these disputes, in what numbers, against whom, and about what.”  The report states that the CFPB intends to address the “back-end” in the future – “what happens, in how long, and at what cost.”  Additionally, the CFPB notes that it intends to look more deeply at consumer cases filed in federal and state courts other than small claims courts, along with additional investigation into consumer class actions.

The CFPB found that larger bank issuers of credit cards are more likely to include arbitration clauses in their credit card agreements than smaller bank issuers and credit unions.  This means that even though most issuers of credit cards do not include arbitration clauses in their credit card agreements, a majority of outstanding credit card loans are subject to arbitration agreements because issuers of large numbers of credits cards use such agreements.  The CFPB also found that larger banks tend to include arbitration clauses in their consumer checking contracts more often than do smaller banks and credit unions.  The result, again, is that even though most banks and credit unions do not include arbitration clauses in their checking account agreements, a significant percentage of insured deposits in checking accounts are subject to arbitration agreements.  As for prepaid cards, arbitration clauses are included in most agreements.

Ninety percent of the arbitration agreements reviewed by the CFPB include provisions prohibiting class arbitration, and the American Arbitration Association is the arbitration administrator most frequently selected.  Most of the arbitration agreements also contain small claims court carve-outs, which allow either party to file an action in small claims court, and thus avoid arbitration, where the disputed amount falls within the jurisdiction of the relevant small claims court.  Approximately one quarter of the arbitration agreements give consumers the option to opt out of them, and most require the consumer to opt out within either 30 or 60 days.  Very few of the arbitration agreements place time limits on the filing of claims in arbitration, while most provide disclosure to consumers of certain important differences between arbitration and litigation, such as the lack of a jury trial, limited discovery, and limited rights to appeal.

We will continue to closely monitor the CFPB’s activity in this area and will be prepared to provide analysis of any regulations the CFPB may issue based on its findings.

Pennsylvania’s Superior Court holds that lenders cannot attach real property held in tenancy by the entirety if it has separate judgments against each spouse

By Stephen J. Shapiro

In Pennsylvania, as in many other jurisdictions, real property owned jointly by a husband and wife – property held in a “tenancy by the entirety” – cannot be attached to satisfy the debt of only one spouse. Rather, a creditor only can attach entireties property if it has a judgment against both spouses. In a recent decision, the Pennsylvania Superior Court held that a creditor may not consolidate separate judgments against individual spouses into a single judgment that would enable the creditor to attach entireties property, even if the separate judgments relate to the same debt.

In ISN Bank v. Rajaratnam, a partnership that owned a property in Philadelphia borrowed almost $7 million from ISN Bank in 2005 to finance a conversion of the property into condominium units. Arasu Rajaratnam signed an agreement pursuant to which he personally guaranteed repayment of the loan. In 2007, in connection with the bank’s agreement to extend the maturity date of the loan, both Mr. Rajaratnam and his wife signed an agreement guaranteeing repayment of the modified loan.

When the borrower defaulted on the loan, the bank confessed judgment in the amount of almost $5 million against Mr. Rajaratnam under the 2005 guaranty agreement. The bank also sued Mrs. Rajaratnam under the 2007 guaranty agreement, and obtained a $3.3 million deficiency judgment against her. The bank then moved to consolidate the two judgments, presumably so that it could attach entireties property held by the Rajaratnams.

On appeal from the trial court’s denial of the bank’s motion to consolidate, the Superior Court affirmed. The Court held that “separate actions by spouses resulting in separate judgments are not sufficient to encumber entireties property.” Rather, “[t]o establish a joint debt that may serve as the basis for a lien on entireties property, the two spouses must act together in the same transaction and in so doing incur a joint liability.” Because the judgments against Mr. and Mrs. Rajaratnam “were entered pursuant to separate documents, in separate transactions, and for separate considerations [and were] not even in the same amounts,” the Court held that the judgments could not be consolidated into a single judgment.

The ISN Bank case makes clear that lenders who are relying on entireties property as collateral for a loan must take care to not only have both spouses sign a single guaranty, but also must pursue and obtain a single judgment against both spouses simultaneously. The fact that both spouses have guaranteed the same obligation may not be sufficient in the absence of single judgment against both spouses.

Third Circuit advises parties to use plain language when drafting arbitration agreements

By Christopher Reese

The Third Circuit recently affirmed the United States Bankruptcy Court for the District of Delaware’s denial of a motion to compel arbitration in In re Nortel Networks, Inc.  In doing so, the Third Circuit advised parties wishing to arbitrate their disputes to make that intent clear by “reducing agreements to arbitrate to plain language that can be recognized and enforced by courts examining only the text of the agreement,” and to avoid “hid[ing] their intent to [arbitrate their disputes] in the shadows of the text.”

In 2009, the multinational telecommunications firm Nortel Networks declared bankruptcy.  Nortel entities around the world filed petitions in U.S., Canadian, English, and French courts to begin insolvency proceedings.  Nortel’s bankruptcy was quite complicated, since it had “numerous subsidiaries located in multiple jurisdictions,” and “multiple Nortel entities owned the business lines and intellectual property that comprised the global Nortel brand.”  Because the value of Nortel’s assets would diminish over time, a plan to sell Nortel’s assets had to be devised quickly to maximize the return on the sale.

Nortel debtors from around the world entered into an Interim Funding Agreement, which “created a framework for Nortel debtors to sell assets without first agreeing how to allocate the proceeds of any sale among the relevant debtors.”  The Agreement required the debtors that signed it to place the proceeds of any sales of assets into escrow and to negotiate in good faith in an attempt to reach agreement on how to allocate the proceeds.  The Agreement did not contain the words “arbitrators” or “arbitration” or identify any arbitral association.

After the Agreement was approved by the necessary courts, the Nortel debtors held nine auctions, which raised approximately $7.5 billion in proceeds.  The parties then negotiated as required by the Agreement but were unable to agree on a protocol to allocate the proceeds of the auctions.  The U.S. Nortel debtors moved the Bankruptcy Court to resolve disputes about asset allocation.  Nortel debtors from other countries cross-moved to compel arbitration. The Bankruptcy Court denied the cross-motion to compel arbitration and approved a judicial allocation protocol.  An appeal to the Third Circuit followed.

The Third Circuit had little trouble affirming the Bankruptcy Court, finding that the “dispute begins and ends with the text of the Interim Funding Agreement,” “which does not reveal an intent to arbitrate disputes about the allocation of the auction funds.”  Rather, the Third Circuit explained, the language of the Agreement provided only that the debtors “would negotiate the procedure by which to divide the funds.”  Applying New York law on contract arbitration (the Agreement contained a New York choice-of-law clause), the Third Circuit refused to consider any extrinsic evidence suggesting that the parties intended to arbitrate because the Agreement was not ambiguous.

The most interesting part of the Third Circuit’s decision is its admonition that parties wishing to arbitrate disputes take care to “not hide their intent to do so in the shadows of the text.”  The Third Circuit noted that parties may agree to arbitration without using the word “arbitration” in their agreement, but also stated that “the absence of common signal words” makes it more difficult to determine that the parties intended to resolve their disputes in arbitration.  Parties wishing to arbitrate their disputes should heed the advice of the Third Circuit and ensure that their arbitration agreements indicate as clearly as possible their intent to resolve any disputes in arbitration.  Doing so will pull such intent out of the “shadows of the text” and significantly increase the likelihood that a motion to compel arbitration will be granted.

Plaintiffs fail to establish equitable tolling in another putative RESPA kickback case

By Monica C. Platt

In Riddle v. Bank of America, a judge in the Eastern District of Pennsylvania just granted summary judgment against the plaintiffs in a case alleging that banks and mortgage insurers participated in a “scheme” to pay purported kickbacks in violation of the Real Estate Settlement Procedures Act (RESPA). We have discussed other similar cases in prior posts on this blog.

RESPA prohibits giving or receiving “any fee, kickback, or thing of value” in exchange for a referral of settlement-service business. 12 U.S.C. § 2607(a). In Riddle, the plaintiffs alleged that their mortgage lender purchased mortgage insurance coverage on their loans in exchange for mortgage insurers’ agreement to reinsure that coverage with a reinsurance company affiliated with the bank.  The plaintiffs said that this agreement was a “thing of value” for the lender because the reinsurer supposedly was insulated from paying any real losses.

Plaintiffs brought their claims years after the statute of limitations had already run, but argued that the doctrine of equitable tolling saved their claims.

The Riddle court allowed the plaintiffs a limited period of discovery to try to establish a basis for equitable tolling, but the discovery was fruitless.  The plaintiffs could not show that they investigated their claims between the time their loans closed and the time their lawyers contacted them.  The court found that it was clear that plaintiffs were not diligent, and only elected to pursue litigation after they were solicited by their lawyers.  As the court put it, the plaintiffs did not proffer any evidence that they “did anything other than appear at their [loan] closings.”

The plaintiffs tried to argue that documents they received at their closings misled them about the reinsurance relationship between the mortgage insurers and the lender’s reinsurance company, but the court rejected that argument.  The court found that the plaintiffs’ real contention what that these documents “failed to disclose that [the Defendants supposedly] were violating RESPA.”  Thus, the plaintiffs, at bottom, were “trying to turn Defendants’ failure to inform them that they [allegedly] were running a scheme in violation of RESPA into an affirmative act of concealment.”  The court found that this argument was “circular and would eviscerate the statute of limitations.”

Pennsylvania’s Superior Court creates a conflict with the Third Circuit by holding that UTPCPL claims are not subject to the economic loss doctrine

By Stephen J. Shapiro

The Pennsylvania Superior Court’s recent decision in Knight v. Springfield Hyundai is notable for two reasons.  First, addressing an issue of first impression, the Court held that disputes arising in connection with automobile installment sale contracts are not subject to arbitration unless the installment sale agreement itself contains an arbitration clause.  Second, and contrary to a decision by the Third Circuit, the Court held that the economic loss doctrine does not apply to claims under Pennsylvania’s Unfair Trade Practices and Consumer Protection Law (UTPCPL).

In connection with her purchase of a used car, plaintiff Beverly Knight signed two documents – a Buyer’s Order, which included the terms of the purchase, and a Retail Installment Sales Contract (RISC), which detailed her financing agreement.  The Buyer’s Order contained an arbitration clause, but the RISC did not.

Alleging that the car dealer had misrepresented the condition of the vehicle she purchased, Knight sued the dealer and financing company in Pennsylvania state court.  Among other claims, Knight alleged that defendants violated the UTPCPL, which prohibits sellers from engaging in unfair or deceptive acts or practices, by misrepresenting characteristics of the vehicle.  The defendants filed the state law equivalent of a motion to dismiss, arguing, among other things, that the arbitration clause in the Buyer’s Order required Knight to bring her claims in arbitration and that Knight’s UTPCPL claim was barred by the economic loss doctrine.

The trial court dismissed several of Knight’s claims, including her UTPCPL claim, and held that she was required to arbitrate her surviving claims. Knight then proceeded to arbitration, at the conclusion of which the arbitrator awarded her $971.41, plus costs and fees.  Knight filed a motion in the trial court to vacate the arbitration award, which the trial court denied.

On appeal, the Superior Court first held that the trial court erred in compelling arbitration.  Under Pennsylvania’s Motor Vehicle Sales Finance Act (MVSFA), an installment sale contract for the purchase of an automobile “shall contain all of the agreements between the buyer and seller relating to the installment sale of the motor vehicle sold.”  The Court held that this language clearly and unambiguously provides that “when a buyer makes a purchase of a vehicle by installment sale, the RISC subsumes all other agreements relating to the sale.”  Therefore, the Court held that the Buyer’s Order was subsumed by the RISC, and since the RISC did not contain an arbitration clause, no enforceable agreement to arbitrate existed.

The Superior Court also held that the economic loss doctrine, which prohibits plaintiffs from recovering in tort for purely economic damages, does not prohibit Knight from pursuing her UTPCPL claim on remand.  This holding contradicts the 2002 case Werwinski v. Ford Motor Company, in which the Third Circuit predicted that the Pennsylvania Supreme Court would hold that the economic loss doctrine bars claims under the UTPCPL.  The Superior Court did not discuss Werwinski, instead relying on Excavation Technologies, Inc. v. Columbia Gas Co., a 2009 decision in which the Pennsylvania Supreme Court stated that the economic loss doctrine bars claims “for negligence that result solely in economic damages unaccompanied by physical injury or property damage.”  From this statement, the Superior Court concluded that the economic loss doctrine only bars negligence-based claims and, because UTPCPL claims are statutory claims that do not sound in negligence, they are not barred by the doctrine.

The Superior Court’s reliance on Excavation Technologies for the proposition that the economic loss doctrine only applies to claims sounding in negligence is questionable.  The sole claim at issue in Excavation Technologies was one for negligent misrepresentation, so the Supreme Court was not faced with the question and did not hold that the economic loss doctrine is inapplicable to claims that do not sound in negligence.

Unless and until the Pennsylvania Supreme Court resolves the discrepancy, the economic loss doctrine will not be a viable defense to a UTPCPL claim in the Pennsylvania state trial courts, which are bound by Knight, but may still be a viable defense to a UTPCPL claim in the federal trial courts in the Third Circuit, which are bound by Werwinski.

Is the U.S. Supreme Court Poised to Eviscerate the Fraud-on-the Market Theory?

By Eric A. Boden

On November 15, 2013, the U.S. Supreme Court granted a cert petition in Halliburton Co. v. Erica P. John Fund, Inc., f/k/a Archdiocese of Milwaukee Supporting Fund, Inc. The petitioner, Halliburton, wants the Court to reverse a Fifth Circuit decision that refused to allow Halliburton to introduce price impact evidence at the class certification stage to rebut the presumption of reliance under the fraud-on-the-market theory.

If the Court rules for Halliburton, it would overrule or substantially modify Basic Inc. v. Levinson, which adopted the fraud-on-the-market theory and its associated presumption of classwide reliance in securities fraud class actions.

Halliburton challenges Basic’s fundamental premise: that an economic theory of inherent market efficiency should be dispositive, at the class certification stage, on the issue of reliance. First, Halliburton contends that the efficient market hypothesis has been roundly rejected by empirical evidence. Second, Halliburton cites to the difficulty federal courts have encountered applying the fraud-on-the-market theory and to the fact that no state courts have recognized it. Finally, Halliburton emphasizes that the Court’s more recent class-certification decisions in Wal-Mart Stores, Inc. v. Dukes and Comcast Corp. v. Behrend make clear that the elements of class certification cannot be satisfied by a presumption (like the presumption of reliance under the fraud-on-the-market theory) but instead must be “proven in fact.”

It is possible the Supreme Court will overrule Basic in its entirety, rejecting the fraud-on-the-market theory, which would draw into question the future of securities class actions. However, the Court may follow a more moderate course, and simply allow a defendant in a putative securities class action to rebut the presumption of reliance with evidence that alleged misrepresentations did not distort the market price of its stock.

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