As the cost of resolving disputes in court has escalated, businesses have increasingly included clauses in their contracts requiring that any disputes be resolved by binding arbitration instead. Congress has enacted the Federal Arbitration Act (“FAA”) to foster and bring order to this practice and courts have consistently recognized that the FAA evidences a strong federal policy in favor of enforcing arbitration agreements. However, a February 2016 decision by the United States Court of Appeals for the Fourth Circuit demonstrates that even strong federal policies have limits.
In Hayes v. Delbert Services Corporation, Mr. Hayes had obtained a “payday loan” from Western Sky Financial, LLC (“Western”). Western was owned by Martin Webb, who was a member of the Cheyenne River Sioux Tribe, and Western’s office was located on the Cheyenne River Indian Reservation in South Dakota. However, Western’s regular practice was to assign the loans that it made to lenders and loan servicers who were not connected with the tribe or the reservation. After several assignments, Western’s loan to Mr. Hayes ended up being held by Consumer Loan Trust and being serviced by Delbert Services Corporation (“Delbert”), neither of whom had any connection with the tribe or the reservation.
Western’s loan agreements provided that their interpretation and enforcement were “subject solely to the exclusive laws and jurisdiction of the Cheyenne River Sioux Tribe” and that “no other state or federal law or regulation shall apply.” Western’s loan agreements initially provided also that the parties agreed that all disputes arising under them “will be resolved by binding arbitration…conducted by the Cheyenne River Sioux Tribal Nation by an authorized representative in accordance with its consumer dispute rules and the terms of this Agreement.” However, after several courts had refused to require borrowers to submit to binding arbitration because the Cheyenne River Sioux Tribe had no arbitration procedures or consumer dispute rules, by the time Western made its loan to Mr. Hayes, it had added to its loan agreement form a provision giving the borrower “the right to select…the American Arbitration Association, Judicial Arbitration and Mediation Services, or another service to administer the arbitration.”
Mr. Hayes filed a class action against Delbert in the United States District Court for the Eastern District of Virginia (the “District Court”) alleging that its collection practices violated the federal Fair Debt Collection Practices and Telephone Consumer Protection Acts. Delbert filed a motion to dismiss the case on the grounds that the District Court lacked jurisdiction because Mr. Hayes and the other class members had consented to the exclusive jurisdiction of the Cheyenne River Sioux Tribe. In the alternative, Delbert asked the District Court to compel Mr. Hayes and the other class members to arbitrate their claims against it rather than pursue them in court. The District Court declined to dismiss the case, but ordered Mr. Hayes and the other class members to arbitrate their claims against Delbert. Mr. Hayes appealed the order requiring the plaintiffs to arbitrate.
The Fourth Circuit began its discussion of the issues by recognizing the “strong federal policy in favor of enforcing arbitration agreements” and acknowledging that, because of that policy, courts generally “must rigorously enforce arbitration agreements according to their terms.” It noted that arbitration agreements are enforced even though “the waiver of the right to a jury trial is a necessary and fairly obvious consequence…” It acknowledged that courts had enforced arbitration agreements requiring claims to be arbitrated individually rather than by class action, requiring that claims be arbitrated in foreign countries, and specifying that disputes are to be resolved by applying the law of a specified locality.
However, despite the strong policy in favor of enforcing arbitration agreements, the Fourth Circuit said that “a party may not underhandedly convert a choice of law clause into a choice of no law clause—it may not flatly and categorically renounce the authority of the federal statutes to which it is and must remain subject.” The Fourth Circuit said that “Because the arbitration agreement in this case takes this plainly forbidden step, we hold it invalid and unenforceable.”
The Fourth Circuit’s determination that the arbitration provision was invalid and unenforceable despite precedent enforcing provisions requiring arbitration in foreign countries and specifying the local law governed disputes suggests that the court may have been influenced by Western’s sharp practices. Even though Mr. Hayes was only challenging Delbert’s collection practices, not asserting that the loan terms were illegal, the Fourth Circuit noted that the interest rate on his loan was 139.12% per annum and the interest rate on a loan to another member of the plaintiff class was 233.84% per annum. Nevertheless,Hayes v. Delbert Services Corporation serves as a reminder to parties wishing to avoid defending themselves in court that imposing onerous terms on an obligation to arbitrate disputes may prevent an arbitration clause from serving the desired purpose.