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Why are mandatory arbitration clauses so prevalent in consumer credit card agreements?

posted on 2008-05-12 by Justinian Lane
Justinian Lane

Mandatory arbitration agreements have been getting a lot of attention lately, particularly because of the high rate of "wins" when a creditor is a plaintiff. This win rate has been placed as high as 95%. The "reform" movement is quick to suggest that the reason the win is artificially high because there are so many default judgments in credit card agreements. I agree with that hypothesis. The vast majority of debtors will simply not respond when sued or taken to arbitration. Generally, people who get 3-6 months behind in their bills do so because they don’t have enough money to pay their bills - let alone to hire an attorney to defend them for not paying their bills. But where I disagree with the "reform" crowd is why I believe mandatory arbitration clauses are so prevalent in credit card agreements.
The "reformers" suggest that credit card companies favor arbitration because it is (a) cheaper and easier than court proceedings, and (b) prevents "deadbeats" from driving up the cost of litigation. Note that the latter claim acknowledges that defendants can and do drive up the cost of litigation; reformers usually attribute such tactics to plaintiffs, when it’s actually plaintiffs who have the greatest incentive to move litigation along.

Credit card companies know that perhaps 90 out of 100 people aren’t going to respond to legal action. Knowing this, the credit card companies obviously have an incentive to use the cheapest legal method to collect the debt. That’s arbitration, right? Wrong.

The process of suing a debtor or taking a debtor to arbitration is so similar that there won’t be any difference in legal costs for the creditor. In either case, the creditor’s attorney will have to draft a 1-2 page complaint that alleges a few basic facts: That the debtor has an account with the creditor and that the debtor owes the creditor X amount of dollars. Any competent lawyer can draft such a complaint in 30 minutes. Any competent lawyer who does collection work routinely can draft such a complaint in 5 minutes - debt collection firms have automated software that can crank out complaints that quickly.

Once the complaint is drafted, the next step is to either file it with the court and serve it upon the debtor, or to initiate the case with the arbitration agency and serve it upon the debtor. The National Arbitration Forum is the largest arbitration company in the country, and is used by many, if not most major credit card companies.

Let’s compare the cost of taking a debtor to arbitration vs. taking a debtor to court in the two populous states of Texas and California. The table below indicates the cost of filing and serving a complaint requesting $4,999, $7,499, and $25,000 in an NAF arbitration proceeding, in a Texas court, and in a California court:



In California and Texas, it is much cheaper to commence an action in court as opposed to arbitration. I have been unable to find a comprehensive listing of court filing fees by state, but the handful of states I checked are in line with the pricing of these states. As the table shows, it can be over five times as expensive to take a debtor to arbitration than it does to take him or her to court. So just to initiate the legal action, the courts have a substantial cost advantage over the arbitration system.

Again, recall that evidence suggests over 90% of these actions result in a default judgment. It’s also not cheaper to obtain a default in arbitration than it is in court. In arbitration or in court, the procedure to get a default judgment is the same: File a motion requesting a default judgment. The motion in either forum will be a one or two page document that explains that the debtor failed to respond to the lawsuit/claim in the required amount of time. The motion will then ask the court or arbitrator to grant a default judgment. An arbitrator will generally grant a default judgment without the necessity of a hearing. Many judges will grant a default judgment without a hearing, but some won’t. If a judge does require a hearing, it will be very quick- 15 minutes or less. I’ve seen them done in as few as five. Even if it takes an attorney a full hour at $200 an hour to get through the hearing, getting a default judgment through arbitration is still more expensive than getting a default in court. Plus, it’s easier to enforce a default judgment from a court (levying bank accounts, etc.) than it is to enforce a default from an arbitrator. All of this evidence suggests that if you’re planning on winning a majority of your cases through default judgments, it’s smarter to go to court to do so. So why do creditors put in mandatory arbitration clauses that prevent them from taking debtors to court?

Because mandatory arbitration clauses prevent debtors from taking creditors to court. Credit card companies get sued routinely for violations of such acronyms as the Truth in Lending Act (TILA), Fair Credit Reporting Act (FCRA), Fair Debt Collection Practices Act (FDCPA), Deceptive Trade Practices Act (DTPA), and a variety of other state and federal laws. In addition, many of these lawsuits turn into class action lawsuits, which the "reformers" constantly argue are an affront to God. By placing mandatory arbitration clauses in their contracts, credit card companies get to eliminate those evil class action lawsuits before they’re even filed.

I was inspired to write this post because the "reform" movement has been making a false argument. They’ve been arguing that mandatory arbitration clauses are used because it’s so much cheaper to "go after deadbeats" in arbitration than it is to court. Therefore, mandatory arbitration clauses benefit consumers who do pay their bills because the cost savings is passed on to them. This is plainly false because it’s more expensive to "go after deadbeats" in arbitration than it is to use the court system.

* In Texas, the jurisdictional limit for the Justice of the Peace courts is $10,000. Thus, any suit for $10,000 or below can be brought in JP court, where filing fees are between $10 and $20, depending on the county. Sheriffs will personally serve a defendant for fees ranging from $50 to $70, depending upon the county. The figure of $72 assumes a filing fee of $17 and a service fee of $55. Depending upon the county, filing and service costs may differ by $10 or so. The filing fee in all County Courts of Law in Texas is $232, and the jurisdictional limit of those courts are $100,000. The $287 figure was derived by adding $55 for service of process to the $232 filing fee.

** In California the jurisdictional limit of small claims court is $7,500. Filing fees vary from county to county, but not by more than a few dollars. I used an average fee and estimates the service of process fee of $50.00, which seems to be the going rate in most major metropolitan areas of California. Sometimes this means using the Sheriff, other times it’s a third party process server. For more information on California court filing fees, visit http://www.courtinfo.ca.gov/selfhelp/lowcost/getready.htm#fees


Home Deport Ends ILC Bid: Victory for the Banking Industry?

posted on 2008-05-12 by Aaron Halegua
By Aaron Halegua | bio
The American Banker reported (log in required) that Home Depot announced that it would end its bid to purchase a Utah industrial loan company (ILC). This comes just less than one year after Wal-Mart withdrew its bid to buy an ILC. These bids by companies such as Wal-Mart and Home Depot have been vehemently opposed by an aggressive banking lobby, which does not welcome the competition from commercial firms. For now at least, it seems that this lobby has won.

Congress has been trying to clarify the rules governing who can own an ILC charter, but no agreement has been reached. In the meantime, the FDIC has imposed a moratorium (twice) on evaluating ILC bids from commercial firms. The moratorium is scheduled to end next Thursday. If the Home Depot application was still pending, there would be some pressure on the FDIC to make decisions on the issue of who can own an ILC. Although there are still some bids pending, such as one from the Blackstone Group, Home Depot’s withdrawal removes much of the pressure.

Nonetheless, the banking industry will still continue to press for federal legislation that restricts commercial firms from owning FDIC-insured institutions. Chris Dodd, Chairman of the Senate Banking Committee, has promised to talk with ILC supporters and get legislation on this issue moving in 2008.

While Home Depot reports that its own internal business strategy explains its recent decision to withdraw, it's hard to believe that the unwelcoming regulatory and policy environment that its bid encountered was not a factor. If policymakers were serious about helping to create economic opportunities for lower- and middle-class Americans, some feel that more should be done to support efforts like Home Depot’s – which was planning to use its ILC to offer credit to consumers and businesses, particularly those construction companies owned by or employing immigrants and foreign-born nationals.


Collection industry has duty to treat consumers equitably

posted on 2008-05-12 by Robert Markoff
Robert Markoff, president, National Association of Retail, Collection Attorneys (NARCA) - Washington

As a young man, the future President Abraham Lincoln suffered financial hardship. At least three judgments were entered against him for non-payment of debts. Lincoln paid the first judgment in installments. For the other debts, the sheriff sold a few of Lincoln's possessions, including his horse and saddle ("Colleges' debit-card deals draw scrutiny," Cover story, News, March 17).

Today's turbulent economy is leaving many people unable to pay their debts. Consumers are disturbed when they, like Honest Abe, fall behind. Knowing that one of this country's most highly regarded citizens faced and overcame serious financial problems can provide some perspective in hard times.

If there were no consequences for non-payment of one's obligations, the temptation would be for no one to pay his bills. Debt collection is an important part of our economy. All consumers would be penalized if businesses were unable to recoup losses resulting from bad debt. In 2005, $39.3 billion was repaid, saving the average American household $351 in reduced prices and greater purchasing power.

Nonetheless, just as consumers must act responsibly, so too must collection professionals. Members of the collection industry should never miss the opportunity to do the right thing in helping consumers meet their responsibilities.

The industry need only look back at one of its predecessors when considering its professional conduct. Within a year of the sheriff's sale of Lincoln's possessions, Lincoln became a lawyer whose main court practice involved debts. Honest Abe was a collection attorney.


Do Not Be Fooled Arbitration is an Inexpensive Option

posted on 2008-05-12 by Mark Hutchins
By Mark Hutchins

Consumer lending contracts often contain arbitration agreements which provide that disputes arising under the contract can be taken to arbitration rather than court. Arbitration is a private process where claims are decided by arbitrators who are legal experts. One advantage of arbitration over court litigation is that parties receive the same legally binding outcome that they would have received in court, but they get to that outcome more quickly and less expensively than in court. Once the prevailing party obtains an arbitration award, the award can be “confirmed” into an enforceable judgment by trial courts in all states.

Arbitration has received increased media attention lately, as a national association of trial lawyers has named eliminating consumer arbitration as their top agenda item for 2008. As a part of this push, legislators have introduced federal and state bills that would curb or kill consumer arbitration. The most visible bill is the “Arbitration Fairness Act” (H.R. 3010, S. 1782) that was heard in Senate and House subcommittees in late 2007.

Unfortunately, much of the lobbying, public relations and advocacy that has driven these bills has contained fundamental inaccuracies about how consumer arbitration actually works. From my experience, arbitration is a much quicker and less expensive method of resolving collections disputes. Of course, these savings benefit not just lenders, collectors, and debt buyers, but they also benefit consumer borrowers in the form of better and less expensive consumer lending products.

Because of the trial lawyers’ push to ban consumer arbitration, it is especially important to recognize arbitration’s benefits and to educate others about it. I want to take the opportunity here to address a few of the most important points that have been subject to misinformation.

First, arbitration does not stack the deck against consumers. No one wants a system that is unfairly tilted in favor of one type of party over another, and courts reviewing arbitration awards would never allow it. The available data about arbitration outcomes clearly establishes that business and consumer parties win in arbitration at the same rate that they win in court. Even consumer advocacy groups seeking to ban arbitration have now conceded this point.

Second, arbitration is clearly less expensive than court, particularly in default cases. According to the National Arbitration Forum website, the arbitration filing fee for a $4,999 claim is only $70 where the opposing party does not file a response. For a $7,499 claim the arbitration filing fee is also only $70, and for a $25,000 claim the fees is only $120. All of these filing fees are lower than the corresponding fees to file a lawsuit in Texas and in California, for example (see chart below).

Debt N.A.F. Texas California
$4,999 $70 $72 $95
$7,499 $70 $72 $120
$25,000 $120 $287 $280

Third, arbitration procedures are more efficient than court procedures in several important areas that magnify arbitration’s cost savings. For example, instead of hiring local counsel in each jurisdiction where litigation must be filed, arbitration claims can be filed from a central location against respondents in any U.S. jurisdiction. Also, arbitration proceedings can be conducted as “document hearings” that do not require in-person appearances. Finally, arbitration’s procedural rules apply nationwide, eliminating the need to comply with varying state and local procedures in each jurisdiction where a claim is filed.

Lastly, there are many advantages to be found in integrating arbitration into an organization’s collections procedures. The filing of an arbitration claim opens up “work with” opportunities that could potentially lead to settlement before the arbitration proceeds to its conclusion.

From my experience, arbitration’s lower fees and procedural conveniences combine to make arbitration a much less expensive option than court to resolve collections disputes. It is important to understand these facts so that we are not swayed by the anti-arbitration pundits who are presenting inaccurate information. Keep your eyes open for any anti-arbitration bills in your state, and stand ready to educate decision makers and others about arbitration.

Mark Hutchins is the Managing Owner for Catalina Consulting, a company he started to provide consulting services to the credit and collection industry upon leaving his position as Vice President of Business Development for Asset Acquisitions Group LLC. Prior to consulting, Mr. Hutchins worked for Asset Acceptance LLC from December 2001 through March 2007. He held several management positions in the Legal Department including Outsourcing, Arbitration, Collections, and Pre-Legal until he was promoted to Assistant Vice President – Legal in December 2003. In April, he was transferred to the Marketing Department as an Assistant Vice President – Marketing and Acquisitions. Prior to joining Asset Acceptance, Mr. Hutchins held varying positions of responsibility in the Credit and Collection area for Ford Motor Credit Company. Mr. Hutchins has a BA in Material Logistics and Marketing from Michigan State University, and a MBA in Management and Information Systems from Wayne State University. Mr. Hutchins has been in the collection industry since 1999.


Canceled debt can become a tax liability

posted on 2008-05-12 by CCN Admin
Bills are piling up to the point where you dread opening your mailbox. If only your creditors would forgive your debt. Sometimes, they will -- but even then your money troubles might not disappear. Canceled debt in many cases is considered taxable income. And if a creditor forgives thousands of dollars of debt, you can find yourself whacked by a big tax bill. And that is not the only consequence. Forgiven debt can raise your income to the point where you're ineligible for certain credits and tax deductions, or part of your Social Security benefits is taxed, said Bob Scharin, a senior tax analyst with Thomson Tax & Accounting. Of course, having a creditor absolve you of debt can be a financial lifesaver. Still, a tax bill isn't what many expect when debt is being erased. "People definitely are initially shocked," said Robin McKinney, executive director of the Maryland Cash Campaign, which helps lower-income taxpayers file returns. McKinney said she sees many such cases of shock now with car loans. The cars are repossessed and the loan balances wiped out, yet consumers receive a form saying they owe taxes on thousands of dollars of forgiven debt. "Some people have even said, 'If I had known this was a consequence, maybe I would have tried harder to refinance the loan,' " she said. Credit-card bills are one of the most frequent types of forgiven debt -- and it is taxable.Scharin notes an instance in which a consumer owed $21,270 on his credit card in 2004. The issuer, MBNA America Bank, agreed to accept about $4,600 to settle the debt. But the consumer balked at paying taxes on the $16,670. He argued that the settlement was a retroactive lowering of his interest rate and that he had repaid the principal. A tax court recently ruled against him.Home-mortgage debt is another area where many are trying to negotiate relief. Given the rise of foreclosures, Congress granted a temporary tax break for those whose housing debt is wiped out. Under the new law, you won't have to pay taxes on up to $2 million of forgiven debt on a primary residence. Any debt wiped out on a second home is still subject to tax. If the bank forgives the home-equity loan you used to make substantial improvements to the house, that won't be taxed, either, Scharin said. But if that home-equity loan was taken out for other reasons -- say, to buy a car -- then the forgiven debt will be taxed. Again, this tax break is temporary. It applies to mortgage debt forgiven last year and through 2009. Students, too, can catch a break. Many student-loan forgiveness programs are available if borrowers work in particular fields, such as nursing or teaching, after graduation. This debt relief is not taxed, Scharin said. Steve Hannan, executive director of the Maryland Consumers Rights Coalition, said negotiating for debt relief "is a good move," but you must realize the tax consequences. He advises consumers to obtain any settlement in writing and find out if the creditor will notify credit-reporting agencies that the debt is forgiven. "It doesn't do any good if the debt has been forgiven but nobody knows about it," he said. Keep all documentation to prove the debt was forgiven, in case a debt collector in the future tries to collect it again, he said. While credit-card debt generally is taxed, it won't be taxed along with any other debt that is canceled in cases of bankruptcy or insolvency. As for documents, if you have $600 or more of canceled debt, you will receive a Cancellation of Debt form, or 1099-C, for tax purposes. (Even if the amount is less than $600, you are expected to report it as "other income" on your tax Form 1040.) The IRS wants you to pay taxes on a pay-as-you-go-basis, McKinney said. If it looks as if you will owe a chunk of taxes on forgiven debt, you should pay estimated taxes on the amount or risk being hit with a penalty later, she said. If you don't have the money to pay the tax bill, you'll have to set up a payment plan with the IRS, she said.



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