Mandatory Arbitration

Mandatory arbitration, also called forced arbitration or a pre-dispute arbitration agreement, is a term in a contract that requires the parties to resolve any future dispute through binding arbitration rather than in court. The defining feature is timing: the clause is agreed before any disagreement has arisen, for example as part of the account agreement a customer accepts to open a card, a bank account or a brokerage account. Arbitration the two sides choose after a dispute exists is a different thing, and federal law treats it differently.

Why the clauses are enforceable. The Federal Arbitration Act provides that a written provision in a contract to settle future controversies by arbitration "shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract" (9 U.S.C. 2). So the starting point is that a customer who accepted the agreement is bound by its arbitration clause, and the exceptions have to come from another statute.

What signing one gives up. FINRA requires a brokerage firm to print a disclosure immediately before any pre-dispute arbitration clause (Rule 2268(a)), and its first items are the plainest summary available: "All parties to this agreement are giving up the right to sue each other in court, including the right to a trial by jury, except as provided by the rules of the arbitration forum in which a claim is filed"; "Arbitration awards are generally final and binding; a party's ability to have a court reverse or modify an arbitration award is very limited"; and "the ability of the parties to obtain documents, witness statements and other discovery is generally more limited in arbitration than in court proceedings."

Class actions are where the products differ. In a brokerage account, FINRA rules require every agreement to state that no one may bring a class action to arbitration, and a firm may not enforce an arbitration agreement against a member of a certified or putative class until the class is denied, decertified or the customer is excluded or leaves it (Rules 2268(f) and 12204). Consumer banking contracts can go the other way. The CFPB's 2015 study of arbitration clauses in consumer financial contracts found that "nearly all the arbitration clauses studied include provisions stating that arbitration may not proceed on a class basis," which in practice closes off class proceedings in court as well. The same study found most clauses carved out small claims court for the consumer or for both sides, and that some, a minority in the card and checking samples, allowed the customer to opt out within a stated window, generally 30 or 60 days.

Where federal law says no. No residential mortgage loan, and no home-equity line of credit secured by the borrower's principal dwelling, may include terms that "require arbitration or any other nonjudicial procedure" (15 U.S.C. 1639c(e)). The Military Lending Act forbids a creditor to require a covered servicemember or dependent to submit to arbitration, and makes any arbitration agreement unenforceable against them notwithstanding the Federal Arbitration Act (10 U.S.C. 987(e)(3), (f)(4)). Federal student loans have their own rules for schools, covered on the borrower-defense page.

The rule that did not survive. The Dodd-Frank Act told the CFPB to study these clauses and allowed it to restrict them (12 U.S.C. 5518), while preserving a consumer's freedom to agree to arbitration "after a dispute has arisen." In 2017 the Bureau issued a rule barring covered providers from using arbitration clauses to block class actions. Congress disapproved it the same year (Pub. L. 115-74), the Bureau removed it from its regulations, and under the Congressional Review Act it is treated as though it never took effect. The same law bars a substantially similar rule unless a later statute authorizes it (5 U.S.C. 801(b)(2)).

The clause names the forum or administrator that will hear disputes, the rules that apply, and often who pays the fees. When a dispute arises, the customer files a claim with that forum instead of a court; if the customer sues anyway, the company can ask the court to dismiss or pause the case and order arbitration. An arbitrator or panel hears the evidence and issues an award, which courts will overturn only on very narrow grounds.

Take an example. Nadia's checking account agreement contains an arbitration clause with a class-action waiver and a small-claims carve-out. She believes the bank wrongly charged her four overdraft fees of $35 each, $35 × 4 = $140. She cannot join a class action other customers bring over the same fees, because her clause bars class proceedings. She can file her own claim in arbitration, or, because the clause carves out small claims court, sue there for the $140. If the same account had come with a 30-day opt-out window and she had mailed the opt-out within it, the clause would not bind her at all. By contrast, a dispute with the lender on her home mortgage could go to court regardless of what she signed, because federal law bars mandatory arbitration in residential mortgage loans.

Pros

• Arbitration can be faster and less formal than a lawsuit, and the CFPB study found most clauses capped consumers' upfront costs.
• A small-claims carve-out, where the clause has one, leaves a court route open for modest disputes.
• In brokerage disputes, FINRA's rules require plain disclosures before the clause and keep class actions out of arbitration.

Cons

• The customer gives up a judge and jury, and awards are very hard to appeal.
• A class-action ban leaves a customer with a small claim to pursue it alone, and the CFPB found nearly all the clauses it studied had one.
• The CFPB's 2015 survey found consumers were generally unaware whether their card agreements contained arbitration clauses or opt-out rights.