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North Carolina Supreme Court strikes unconscionable arbitration clause in consumer loan contract.

February 4th, 2008 by Erich Vieth

In the January 25, 2008 decision of Tillman v. Commercial Credit Loans Inc., (2008 WL 201750;  Cause No. 360A06), the North Carolina Supreme Court analyzed the arbitration clause inserted into a consumer loan contract by a large loan company and concluded that it was unconscionable and therefore unenforceable:

The inequality of bargaining power between the parties and the oppressive and one-sided nature of the clause itself lead us to this conclusion.  Through the arbitration clause at issue in this case, defendants have not only unilaterally chosen the form in which they want to resolve disputes, but they have also severely limited plaintiff’s access to the form of their choice. . . . this particular arbitration clause simply does not allow for meaningful redress of grievances and therefore, under [Green Tree financial Corp. v.  Randolph, 531 US 79 (2000)], must be held unenforceable.

The trial court completely denied the defendant’s motion to compel arbitration.  The Supreme Court agreed, and refused to “rewrite the entire clause,” because the provisions of the arbitration clause “taken together, render it substantively unconscionable.”

Each of the two plaintiffs obtained loans from the defendant.  The first plaintiff obtained a $18,000 loan from defendant, and was charged $2000 for credit life and disability insurance.  The second plaintiff had obtained a loan of $21,000, and was charged premiums for life insurance ($1800), disability insurance ($1,100), and involuntary unemployment insurance ($1,200).  The first plaintiff had take-home pay of $258 per week to go with her Social Security and pension benefits.  The second plaintiff worked two jobs making about $12 per hour.  In this class-action suit, the plaintiffs both claimed that they did not want this insurance coverage and that defendants failed to provide them with disclosures regarding these additional fees, which they considered “deceptive, unfair, duplicative, imposed without adequate commercial justification or disclosure, and in excess of the fees permitted by North Carolina law.”

The arbitration clause allowed individual arbitration only, and it completely barred class actions.  The defendant’s contract offered two exceptions: actions to effect foreclosure and actions were the aggregate amount is $15,000 or less in damages.  With regard to costs, the party demanding arbitration would pay $125 fee.  The defendant would pay for a maximum arbitrator fee amounting to one day (eight hours) of hearings.  All other costs of arbitration would be paid by the non-prevailing party. Each party would pay his or her own attorney fees, expert fees and other expenses.

The trial court found that the pay compensation rates for an arbitrator in North Carolina ranged from $500-$2,380 per day. The court found that the plaintiffs’ only possibility of having legal representation was to enter a contingency fee contract (which is what they did).  To hire an attorney on an hourly rate in North Carolina would cost between 150-200 $50 per hour.

The court found that the damages suffered by each of the plaintiffs was “modest” ($2,000 for one plaintiff and $4,200 for the other).  The trial court found that

the relatively modest damages claimed by plaintiffs make it unlikely that any attorneys would be willing to accept the risks attendant to pursuing claims against one of the nation’s largest lenders, even with the prospect of a treble damages award and statutory attorneys fees.  It would not be feasible to prosecute the claims of the named plaintiffs and other putative class members on an individual basis.”

The trial court also held that the class-action mechanism denied by the defendant would have allowed “persons with relatively small claims to pool their resources and have those litigation expenses and costs shared among all class members.  The class-action device provides a means by which consumers with modest damages claims can obtain representation by competent counsel with sufficient resources to afford protracted litigation in complex cases.” 

A North Carolina Court of Appeals reversed the trial court’s decision, remanding the case to the trial court so that it could be sent to arbitration.  The North Carolina Supreme Court reversed the decision of the Court of Appeals, however, holding that the trial court had acted properly.  The Court of Appeals found that the arbitration contract was both procedurally and substantively unconscionable.  It was procedurally unconscionable because the plaintiffs were rushed through the loan closings, there was an allegation that the defendant did not mention the credit insurance or the arbitration clause, because of the disparate bargaining power between the defendant and plaintiffs, and because the defendant drafted the boilerplate-laden arbitration clause.  The Supreme Court found that the contract was substantively unconscionable because (in violation of Green Tree Financial) the plaintiffs were “precluded from effectively vindicating their rights in the arbitral forum.”  The Court relied upon language in Green Tree that “the existence of large arbitration costs could serve as a basis for holding an arbitration clause to be unenforceable.”

In this case, the Supreme Court noted that the plaintiffs had limited financial means, and that they lived from paycheck to paycheck.  The Court noted the high cost of hiring an arbitrator compared to the cost of going to court.  In fact, “most of the cost involved in an arbitration will be the arbitrator’s fees; in court, by contrast, neither party has to pay for the judge.”  The Supreme Court also reiterated the finding of the trial court with regard to the modest amount of damages at stake:

Because plaintiffs’ damage amounts were so low (under $4500 each), the trial court found that it was unlikely that any attorneys would be willing to accept the risks attendant to pursuing these claims.  The likelihood that an attorney would take a case controlled by the arbitration clause at issue here is even less because the arbitration clause prohibits the joinder of claims and class actions.  Therefore, neither attorneys nor plaintiffs are able to share the risks attendant to pursuing this litigation.

The defendant suggested that it would be willing to arbitrate the case under less onerous financial terms than those specified in the arbitration contract, but the North Carolina Supreme Court struck this offer down as inappropriate, indicating that it would not allow the defendant to offer to “rewrite any illegal or unconscionable contract.”  It cited prior North Carolina law, indicating that “reviewing courts should not consider after-the-fact offers by [defendants] to pay the plaintiffs share of the arbitration costs where the agreement itself provides that the plaintiff is liable . . .” ).

The North Carolina Supreme Court was especially disturbed by the exceptions to arbitration, which allowed the defendant to pursue thousands of foreclosure and collections actions against its customers in court, while not allowing plaintiffs to pursue their claims against the defendant in court. The trial court had noted that, for the entire time that the agreement had been in effect, no North Carolina borrower had ever requested arbitration of any dispute with the defendant, nor had the defendant demanded arbitration of any dispute involving any North Carolina borrower.  The court found, however, that the defendant never had the courthouse doors slammed shut on it, thanks to its clever exceptions in its arbitration provisions: “Every time defendants have taken legal action against a borrower, they’ve managed to avoid application of the arbitration clause . . . practically speaking … the exceptions appear to be designed for more for the benefit of defendants than for plaintiffs.  The one-sided as of the clause therefore contributes to our overall conclusion that it is unconscionable.”

The class-action prohibition of the arbitration clause

contributes to the financial inaccessibility of the arbitral forum as established by this arbitration clause because it deters potential plaintiffs from bringing and attorneys from taking cases with low damage amounts in the face of large costs that cannot be shared with other plaintiffs.  Second, the prohibition contributes to the one sidedness of the clause because the right to join claims and pursue class actions would benefit only borrowers.

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