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Arbitration Agreements Can't Wholly Reject the Law, 4th Cir. Says

By Casey C. Sullivan, Esq. on February 09, 2016 | Last updated on March 21, 2019

Payday loans tend to be exploitative. Tribal payday loans tend to be really exploitative, since those quick cash advances can be made outside the restrictions placed on non-tribal lenders. That means payday loans with annual percentage rates of over 500 percent in some of the worst cases.

This case isn't about the legality of the usurious loans themselves, however. It's about the allegedly illegal practices used to collect on borrowers' debts. And those borrowers are finally getting some good news -- their ability to bring suit challenging debt collection practices is not limited by their loan agreements' arbitration clause, the Fourth Circuit ruled last Tuesday, holding that arbitration agreements cannot categorically reject the "requirements of state and federal law."

A Dime Today, a Hundred Dollars Tomorrow

James Hayes borrowed $2,525 from the online tribal payday lender Western Sky Financial in 2012. That loan came with 139.12 percent interest -- significantly less than the 355 percent interest rates that got the lender sued by the New York State Attorney General in 2013, but still pretty dang high. Hayes owed over $11,500 in finance charges over the life of the two-year loan.

When Hayes didn't pay, Delbert Services Corporation took over to collect his debts. Hayes filed a putative class action. Delbert sought to compel arbitration, citing Western Sky's loan agreement. That agreement subjects "any disputes" related to the loans to arbitration.

Cannot Use Arbitration to Evade the Law

The Fourth Circuit acknowledges early in its opinion the strong "support of Congress and the Supreme Court" have shown for arbitration. But, it explains, arbitration agreements cannot be enforceable when they purport to create "a system of alternative dispute resolution while simultaneously rendering that system all but impotent through a categorical rejection of state and federal law."

As the Fourth Circuit writes, "no one appears to seriously dispute that Western Sky's payday loans violated a host of state and federal lending laws." Indeed, Western Sky knew just that, the Court explains, which is likely why its agreement said it was "subject solely to the exclusive laws and jurisdiction of the Cheyenne River Sioux Tribe," while no state or federal laws shall be applicable.

If Czarist Russia, Why Not Cheyenne River Sioux?

The ruling stands in contrast to a Supreme Court opinion from this past December. In DirectTV v. Imburgia, the Court explained that there's wide latitude in choosing the governing law for a contract. Parties "might choose to have portions of their contract governed by the law of Tibet, the law of pre-revolutionary Russia, or ... the law of California."

But, the Fourth Circuit notes, the Federal Arbitration Act, while giving parties "the freedom to structure arbitration in the way they choose," that freedom "does not extend to a 'substantive waiver of federally protected civil rights,'" including the right to pursue statutory remedies. Western Sky's arbitration clause "almost surreptitiously waives a potential claimant's federal rights through the guise of a choice of law clause," the court explains.

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