3rd Circuit Invalidates Arbitration Provision on Consumer Loan Due to Illusory Arbitral Forum
The U.S. Court of Appeals for the Third Circuit recently found a consumer loan agreement’s arbitration provisions were unenforceable because: (i) the arbitral forum designated by such provisions’ forum selection clause was illusory; and (ii) the forum selection clause was non-severable.
The facts were straightforward. Plaintiff, a New Jersey resident, entered into a loan agreement with one of the defendants for a $5,000 loan. Plaintiff was charged a $75 origination fee and a 116.73% annual interest rate over the seven-year loan term, resulting in a $35,994.28 finance charge. The loan was sold to another defendant and serviced by two additional defendants. The loan agreement included, among other things: (i) provisions requiring that all disputes be resolved through arbitration conducted by the Cheyanne River Sioux Tribe under its laws and rules, without regard for federal and state law; and (ii) a clause delegating questions regarding the arbitration provisions’ enforceability to the arbitrator.
Plaintiff subsequently filed a lawsuit against Defendants in federal district court asserting that the loan was usurious and unconscionable, and that the arbitration provisions were void. Defendants moved to compel arbitration, which the district court denied. Defendants appealed, arguing that their request was denied in error because, among other things: (i) Plaintiff failed to specifically challenge the delegation clause’s enforceability; (ii) the arbitration agreement was erroneously construed as an impermissible prospective waiver of statutory rights; (iii) the loan agreement’s arbitration provisions permitted the use of arbitral forums other than the tribal forum; and (iv) the loan agreement’s severability clause should have been applied to sever any unenforceable provisions while allowing arbitration to proceed.
The Third Circuit, applying a plenary review standard, disagreed. The Court found that Plaintiff had sufficiently challenged the delegation clause by: (i) alleging in his Complaint that “‘[b]ecause the arbitration procedure described in the agreement is fabricated and illusory, any provision requiring that the enforceability of the arbitration procedure must be decided through arbitration is also illusory and unenforceable’”; and (ii) asserting in his opposition to Defendants’ motion to compel arbitration that “‘the delegation clause suffers from the same defect as the arbitration provision.’” The Court also found, citing Seventh and Eleventh Circuit opinions holding that the tribal forum in question did not exist, that it did not need to address the prospective waiver question because the tribal forum was illusory. The Court then found that construing the arbitration provisions to allow arbitration by an organization other than the tribe would be irreconcilable with the provisions’ forum selection clause and that, accordingly, the only arbitral forum permitted by the agreement was the tribal forum.
Finally, the Court found that because the tribal forum was illusory, New Jersey contract law governed the agreement. Applying New Jersey contract law, which prohibits severance of a contractual provision where severance would “defeat the central purpose of the contract,” the Court found that because the tribe or its rules were referenced in most of the arbitration provisions, the forum selection clause was central to the parties’ agreement to arbitrate and, therefore, was non-severable. Accordingly, the Court, affirmed the lower court’s decision, finding: (i) the tribal forum designated by the arbitration provisions’ forum selection clause was illusory; and (ii) the forum selection clause was non-severable, the loan agreement’s arbitration provisions, including the delegation clause, were unenforceable.
The opinion is available here: http://www2.ca3.uscourts.gov/opinarch/172161p.pdf.
