A closer look at mandatory arbitration for consumers

In the John Warner National Defense Authorization Act of 2007, Congress made it unlawful for a lender extending consumer credit to an active duty member of the military or his or her dependent to require the borrower to submit to arbitration. A pending bill, S.2636, would permit a bankruptcy court to decide a core proceeding involving an individual debtor whose debts are "primarily consumer debts" notwithstanding an agreement to arbitrate. H.R. 3010, the Arbitration Fairness Act of 2007, introduced in both houses of Congress, is far broader: it would void pre-dispute provisions requiring arbitration of employment, consumer, or franchise disputes, among others. What is going on here?

It has become increasingly difficult for an individual to enter into any transaction without finding a mandatory arbitration clause lurking in the accompanying fine print. Buy a house, buy or rent a car or other consumer product, schedule surgery, apply for employment, or open a bank, credit card, or brokerage account, and an arbitration provision will likely be part of the bargain. Perhaps emboldened by the Supreme Court's twenty-year run of cases enforcing these provisions under the Federal Arbitration Act, many vendors now insert "class action waiver" provisions as well.

Those who regard agreement as the core of contract law have taken issue with the notion that these provisions ought to create enforceable obligations. There is, of course, no bargaining, and the take-it-or-leave-it nature of the arbitration demand makes it difficult if not impossible to function in the modern economy without "agreeing" to these provisions. Most customers do not see the provisions, and research suggests that, even when they do, they do not know how to assess the likelihood or significance of what seems a far-off, unlikely contingency. An increasing number of courts have agreed, on contract grounds, that mandatory arbitration provisions may be unenforceable because they are unconscionable, particularly if the effect of the provision is also to cancel a right to assert on behalf of a class claims that cannot realistically be asserted by individuals.

Arbitration is said to be good for consumers. It is touted as a simpler, faster, less expensive alternative to litigation, and that reduced cost, it is said, inures to the benefit of all who buy goods and services. Of course, if the process is free or of limited cost to a consumer, arbitration may be the only hope for the resolution of a dispute by a neutral third party. The cost of legal services puts traditional litigation of most consumer grievances out of reach even for the middle class. But arbitration service providers such as the National Arbitration Forum have conducted studies that they say prove that customers actually do better in arbitration than they do in litigation. Claims like these are difficult to evaluate, because these arbitration systems are private. Decisions are not publicly available, and providers guard this information from disclosure. Moreover, recent, publicly available, research demonstrates that many businesses eschew arbitration clauses in their contracts with other businesses, calling in question whether the justifications offered for arbitration in the consumer context are correct.

But what are the costs of mandatory consumer arbitration? We focus on those that ought to be of particular concern to AJS members. At the broadest level, mandatory arbitration is displacing our public systems of dispute resolution for claims between individuals and businesses. Those systems, developed by neutral policy makers, are being replaced by private systems, incorporated by reference in boilerplate contracts. From start to finish they usually lack features that our litigation systems have developed to protect basic liberty and property interests and to provide realistic opportunities to secure compensation for injury and enforce important substantive norms. Thus, for example, there will likely be no formal service of process and no advice to the customer on where to find a lawyer. In any event, consumer lawyers, who would have to become conversant with a host of different arbitration systems, may be reluctant to represent individuals in these situations. Almost assuredly, discovery-if permitted at all-will be severely limited, and joinder of third parties will be difficult or impossible (they didn't agree to this process).

This may be acceptable if the customer has a small claim that is not susceptible to class treatment. After all, small claims courts have very abbreviated processes to save expense. But what of a medical malpractice or products liability claim? It is unlikely that the injured plaintiff will have adequate access through arbitration procedure to the doctor's past mishaps or the manufacturer's prior accident record. When the consumer is on the receiving end of an arbitration claim-the emerging approach of choice for collecting credit card debt-she may toss the junk-mail complaint into the trash and suffer default. If she happens to open the complaint, she will be unlikely to take such a claim as seriously as a lawsuit and will be less likely to seek legal advice, if it is even available.

Litigation procedure is expensive. But if we believe that (for example) discovery, with all its abuses, or real service of process on balance delivers better adjudications, then mandatory arbitration simply delivers second-class justice.

A second problem is the displacement of publicly-accountable, neutral decision makers in our justice system. Of course, ethics (if not law) requires that arbitrators be neutral in deciding any arbitration case. But there may be a tilt to the justice that eventually is dispensed.

Parties to consumer arbitration contracts generally choose their arbitrators. This seems like an even-handed provision until one realizes that the drafters of arbitration clauses in consumer contracts typically specify the arbitration service to be used in the event of a dispute. The drafters are repeat players who can keep track of arbitrators and their decisions and systematically refuse to select the ones that they don't like. Indeed, a profit-driven business would be foolish not to strike an arbitrator that it knew was consumer friendly, at least in cases that mattered most. Individual arbitrators-themselves small businesses out to make a profit-of course, understand this. It would be surprising if, over the long run, these incentives did not affect the character of the justice that mandatory arbitration systems deliver. The arbitration service providers-profit-making businesses as well-will cite their own studies to refute this. But (typically invoking customer privacy) they will not release their data.

The final problem that ought to be of concern to AJS members is the displacement of the common law itself in settings where individuals make claims against businesses or vice-versa. In consumer-business arbitration cases, arbitrators are not required to articulate (and are sometimes prohibited from articulating) their decisions in written opinions. In any event, like all else in the arbitration systems, those opinions, if written, remain private. Although the repeat players have access to decisions in which they are parties, the public cannot know how decisions are trending, whether new claims or defenses are being recognized, or how the law might be evolving. Indeed, legal evolution, a hallmark of our common law, is also retarded because arbitrators cannot look to each others' decisions in an attempt to reach consistency across cases. Consumer law, such as it is in the United States, as well as areas of tort and employment law, could well be frozen into whatever pattern existed in the decisions at the point where mandatory arbitration pushed the common law aside. Precedent is, of course, about justice-reaching like decisions in like cases-but it is also important in advising clients how to behave. This public good is lost with widespread arbitration.

In many settings, arbitration can be more flexible than litigation, can use a decision-maker who is an expert in the field, and can deliver results more satisfying to the parties than those that could be achieved in litigation. In international settings, the New York Convention, which facilitates the cross-border enforcement of both arbitration clauses and arbitral awards, may actually make arbitration superior to ordinary litigation. But these advantages are characteristic of cases where relative equals actually choose arbitration as a way to resolve their disputes.

Unlike traditional arbitration, the mandatory arbitration clauses in consumer-business contracts are not built on real agreement at all. This lack of real agreement, the unfairness of the repeat player effect, and the harm secret decisions are doing to our public justice system have given traditional (i.e., business-to-business) ADR a bad name. Many other countries (including members of the European Union) recognize that consumers are in a different position than are businesses disputing with other businesses and thus merit special protection in contractual dispute resolution provisions. The sooner Congress corrects the state of affairs in this country, the better.

The Federal Arbitration Act requires a complete overhaul. If there are serious federalism objections to the uniform approach in H.R. 3010, states must be given the power to protect consumers and others who are systematically disadvantaged in mandatory arbitration. Yet, freedom of choice means little if there are no feasible alternatives. States and the federal government must also rethink their approaches to state-sponsored dispute resolution, the compensation of injury, and the enforcement of important social norms. Consumer protection statutes that provide for recovery of attorneys fees and multiple damages can open the courthouse door. Court-connected ADR programs staffed by trained volunteer lawyers can cut into crushing backloads. Moreover, there has been some creative rethinking of how lawyers can provide limited engagement, affordable representation to litigants who would otherwise be completely self-represented.

Finally, if we are no longer content to rely as heavily as we have in the past on private litigation for these purposes, we must provide adequate alternatives. Administrative agencies are well-positioned to provide informal processes with basic attributes of fairness. State laws enacted to protect the public can be enforced by attorneys general or other public officials, either on their own initiative or in response to individual complaints. Any of these alternatives is preferable to mandatory consumer arbitration.