When handling consumer disputes, credit card companies have a critical tool for keeping down legal costs: The option to avoid court and go to arbitration.
Unbeknownst to many consumers, card agreements typically include an arbitration clause that waives a card holder's right to sue. This gives banks the ability to use the clause defensively to protect against lawsuits, or offensively to go after debt collections.
On Wednesday, a Congressional committee held a hearing on the Obama administration's proposal to ban arbitration clauses from credit card agreements as part of a wider push for consumer protections. The administration has already passed sweeping new regulations that prohibit widely criticized credit card practices such as arbitrary interest rate hikes and unfair penalty fees.
The banking industry, which is still scrambling to comply with that new law by February, now finds itself defending another practice.
"Arbitration is a valuable way for consumers and businesses to resolve disputes in a very low cost and fair manner. Take it away and consumers will suffer," said Kenneth Clayton of the American Bankers Association.
Some watchdog groups disagree. A study by Public Citizen found that credit card companies track arbitrators' rulings and do not enlist the arbitrators who rule against them.
The report, issued in 2007, found arbitrators earn about $400 or more an hour, with some earning up to $10,000 a day. Banks typically pay arbitration costs, or spell out cost sharing schedules in credit card agreements, said Alan Kaplinsky, a partner at Ballard, Spahr, Andrews & Ingersoll LLP and chair of its consumer financial services group.
The latest ammunition against arbitration came Sunday, when Minnesota Attorney General Lori Swanson announced a settlement with National Arbitration Forum, which administers arbitration's. Swanson had sued the St. Louis-based company for what she said was its unfair handling of debt disputes.
The lawsuit accused the firm of violating state consumer fraud, deceptive trade practices and false advertising laws by hiding financial ties to collection agencies and credit card companies.
The St. Louis-based company denied the accusations but cited mounting legal costs in agreeing to get out of the business of arbitrating credit card debts nationwide.
Among cases with an arbitrator appointed by the National Arbitration Forum, 94 percent resulted in decisions in favor of the business, according to the Public Citizen report.
Although banks more commonly use arbitration to go after unpaid debts, it also provides an important shield against costly class-action cases. Citing arbitration clauses, banks can request that lead plaintiffs in potential suits go to arbitration individually.
Opening the door for class-action and other lawsuits would push up the costs of banks' legal costs — which in turn would be passed on to consumers, said Kaplinsky, whose firm represents credit card companies and other financial institutions in consumer disputes.
So long as credit card companies follow the law, however, there shouldn't be a spike in lawsuits, said John Ulzheimer, president of consumer education for Credit.com.
"And if they do something wrong, they should be held accountable for that," he said.
Ulzheimer said a ban on arbitration clauses could be a way to ensure banks are careful to follow the new credit card regulations by taking away their shield against costly lawsuits: "I don't think the two things happening so close together is a coincidence."