CFPB Proposal May Expose Financial Institutions To Class Action Litigation
In October 2015, the Consumer Financial Protection Bureau (“CFPB”) announced it was considering proposed regulations that would likely expose financial institutions to class action lawsuits and increased litigation. The regulations, if enacted, would have a wide ranging impact on a host of consumer financial products including checking account deposits, credit cards, money transfer services, private student loans and installment loans. The CFPB estimates that these arbitration provisions affect tens of millions of consumers.
At the heart of the proposed regulations is the elimination of arbitration clauses included in many, if not most, consumer finance contracts. These so-called “free pass” arbitration clauses: (i) require consumers to raise any disputes or claims arising under such contracts in a private arbitration proceeding; and (ii) prohibit consumers from litigating their claims before a judge or jury. Significantly, by restricting the forum for consumer complaints to arbitration, consumers are effectively precluded from joining their claims in a class action lawsuit. As discussed below, financial and economic considerations often dis-incentivize consumers from pursuing litigation of small dollar claims on an individual basis. However, the CFPB’s proposed regulations would eliminate those economic restraints and trigger increased litigation.
Specific CFPB Proposals
The genesis of the proposed regulations was the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank required the CFPB to study consumer financial markets and authorized the CFPB to issue regulations to protect consumers. Based on its findings, the CFPB concluded that consumers rarely bring actions against institutions and opined that the dearth of claims was not the product of universal customer satisfaction, but rather the prohibitive language in consumer contacts. The CFPB report stated further that consumers, and financial institutions that are compliant with the law, are best protected from unscrupulous practices when consumers are able to aggregate their claims. To remove the contractual impediment to class action lawsuits, the CFPB proposed to effectively prohibit pre-dispute arbitration agreements that precluded claimants from joining a class action unless and until a court refuses to certify the class action.
Potential Escalation of Class Action Litigation
The most significant threat to financial institutions is the potential escalation of class action litigation. To fully appreciate this risk, a brief overview of the economics that drive class action litigation is warranted.
Not surprisingly, commercial litigation is often driven by the proverbial pot of gold at the end of the rainbow. To succeed in litigation, a claimant must satisfy two fundamental thresholds, to wit, establishing that: (i) another party is responsible, or liable, for some form of economic injury suffered by the claimant; and (ii) sufficient damages will be available to make the claimant whole and to justify the burden and expense of litigation. If a potential claimant is reasonably confident that he can satisfy those threshold barriers, the claimant is incentivized to pursue the claim. However, where one of those elements is missing, the incentive to litigate is eliminated. If, for example, a consumer can clearly establish liability, but the potential economic recovery is miniscule, the consumer is not likely to pursue that claim. Indeed, a CFPB survey found that only 2 percent of consumers would pursue small dollar lawsuits. Additionally, if the economic rewards are limited, claimants will have a difficult time securing legal assistance to pursue the claim. Litigating low dollar claims is oftentimes not worth a claimant’s time or aggravation. Simply put, the juice is not worth the squeeze.
Take for example a situation where a bank customer believes that she was inappropriately charged an overdraft fee of $15. Even if the claimant can clearly establish that she was wronged, the economic realities would not justify litigating that claim. In other words, if thousands of bank customers who believed they were charged an inappropriate $15 overdraft fee are able to join together to pursue their claims, the economic restraints are eliminated. In that setting, the potential aggregated recovery would justify legal fees and incentivize lawyers to organize a class of similarly situated claimants. However, the analysis changes dramatically if arbitration provisions are eliminated and consumers are given an option to join a class action filed in court by a group of similarly-situated claimants. This is particularly true where punitive damages – or additional financial awards intended to punish the wrongdoer – are available. The class action framework also removes the burdens on the individual consumers insofar as most of the plaintiffs are simply “free riders” who are not expected to actively participate in the lawsuit yet retain the right to participate in any recoveries in the event that the litigation is successful.
In sum, if these regulations are enacted, the laws of economics dictate that it would lead to an escalation in class action litigation against financial institutions.
CFPB Request for Comment
The proposed regulations are not necessarily a fait accompli. The CFPB is seeking comment from affected institutions to evaluate the potential administrative costs, legal fees and the increase in the cost of credit. The CFPB’s proposal can be found at www.consumerfinance.gov.
If you have any questions regarding this Client Alert, please contact John C. Kilgannon at 215.751.1943 or the Stevens & Lee attorney with whom you normally consult.
This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.