On March 1, 2016, the Fourth Circuit refused to re-hear a February 2, 2016, decision in Hayes v. Delbert Services Corporation (Docket No. 15-1170). In that decision, the Fourth Circuit reversed an Eastern District of Virginia’s decision upholding an arbitration clause on the ground that the clause was, in actuality, a way for the defendant loan servicer to avoid liability under federal and state law. See Hayes at 22-23.
Hayes is a putative class action filed against payday lender Delbert Services Corporation (Delbert)—which was the loan servicer for a loan originated by Western Sky Financial, LLC (Western)—challenging Delbert’s debt collection practices, as well as the arbitration and choice of law clauses in the original loan agreement. Id. at 6. Western was owned by a member of the Cheyenne River Sioux Tribe (Sioux). Its offices were located in Sioux territory, but it originated loans throughout the United States. Id. at 4-5. Each loan contract had clauses selecting Sioux tribal law as the governing law of the agreement, explicitly stating that state and federal law does not apply to the contract, and mandating arbitration before a Sioux tribal arbitration panel. Id. at 6-7. Later versions of the contract—such as the contract at issue—also permitted the parties to select arbitrators from reputable arbitration associations (such as AAA or JAMS) to arbitrate the dispute. Id. at 8. The Eastern District of Virginia struck down the forum selection clause, but upheld the arbitration clause, finding that it permitted the parties to choose reputable arbitration organizations to arbitrate any dispute.” Id. at 9.
The Fourth Circuit reversed, holding that the arbitration clause “fails for the fundamental reason that it purports to renounce wholesale the application of federal law to the plaintiffs’ federal claims.” Id. at 16. The court held that Delbert—which was not Sioux-affiliated, and could not argue that it was not subject to federal law on that basis—could not evade federal law by selecting an arbitrator and then arguing that federal and state law did not apply due to the waivers in the loan contract. Id. at 16. The court recognized that although the Supreme Court typically upholds arbitration waivers and clauses giving arbitrators authority to arbitrate federal statutory rights, it also cautioned that this freedom does not extend to a “substantive waiver of federally protected rights.” Id. at 18 (quoting 14 Penn Plaza LLC v. Pyett, 556 U.S. 247, 273 (2009)). The court found that the arbitration agreement in this case fell precisely within that category, holding that, although parties are free to waive certain rights—such as a trial by jury—they cannot use this freedom to enact a “choice of no law clause [by] flatly and categorically renounc[ing] the authority of the federal statutes to which it is and must remain subject.” Id. at 20-21. The court also found that the provision waiving federal law was not severable from the rest of the arbitration agreement, because avoiding liability under federal law was one of the central purposes of the agreement. See id. at 21.
We have previously reported that arbitration clauses have been coming under increasing scrutiny by courts and regulators. This case is another example of that scrutiny, and shows another potential pitfall in drafting arbitration agreements. Although courts typically allow parties wide latitude in negotiating arbitration agreements, lenders should tread carefully and be cautious of provisions that may be interpreted as exempting the parties from federal or state law.