IF YOU’RE TRYING to decide what credit card to apply for, you might compare annual fees, interest rates, and rewards. You probably wouldn’t give much consideration to whether that new piece of plastic comes with an arbitration clause attached. That’s because — according to a study I conducted with colleagues Elayne Greenberg, Paul Kirgis, and Yuxiang Liu — few people understand such clauses, which are typically buried in the fine print of a credit card contract or other consumer contract.
An arbitration clause is a complicated thing, but essentially, it’s contractual language stipulating that if a company does something wrong, consumers can’t sue, and can only settle the dispute through arbitration. For example, if your bank charged you and many others unwarranted fees, an arbitration clause could prevent a class-action lawsuit from being filed on your behalf. Instead, you would have to go to an arbitrator appointed by the company named in the contract. The arbitrator would consider arguments from both sides and then decide the case. Even if the arbitrator made a mistake about the law and wrongly ruled against you, there would be no chance to appeal.
Businesses say it doesn’t matter that consumers don’t understand arbitration clauses, because they insist consumers fare better in arbitration than in court.
Recently, however, the federal Consumer Financial Protection Bureau — a creation of Massachusetts Senator Elizabeth Warren — released a massive report that shows arbitration benefits businesses at the expense of consumers.
It found that removing the threat of a class-action suit is a huge plus for companies. If businesses don’t have to worry about consumers suing them, a key deterrent against corporate misconduct is removed. The prospect of paying significant sums in a class action goes a long way in deterring bad practices.
Historically, class action has been a popular consumer-protection strategy because it allows thousands of customers to band together to bring a shared complaint against a single organization. Going it alone through arbitration is less appealing and more cumbersome. Indeed, the Bureau’s report found few consumers took disputes to arbitration that were valued under $1,000.
That means that even if a handful of consumers really do prevail more quickly at lower expense through the arbitration process — as companies claim — those victories come at a high price for the rest of us.
You might be thinking that lawyers must strongly prefer class-action suits over arbitration because they get the lion’s share of any money awarded, but the Consumer Financial Protection Bureau study said that most class-action members are involved in settlements in which legal fees account for less than 20 percent of the payout.
Then there’s the argument that arbitration clauses save businesses money, which they then pass on to consumers in the form of lower prices. That doesn’t happen, the Bureau’s report said. It also found credit card issuers that eliminated arbitration clauses did not subsequently increase their fees and prices because of increased legal risks.
Arbitration clauses have long caused confusion, but the Bureau’s report has provided some clarity — it’s time for them to be banned from consumer contracts.
Jeff Sovern is a professor of law at St. John’s University School of Law and co-coordinator of the Consumer Law and Policy blog.